The More You Save, The Poorer Everyone Else Feels
(Bloomberg Opinion) -- Savings have soared during the pandemic, particular among older Europeans. Barclays Plc estimates that seniors amassed excess savings of 600 billion euros ($722 billion). This would surely provide a boost to Europe’s economy if unleashed upon the high streets. Yet most observers believe much of the cash will remain unspent.
What’s behind this hoarding? The region’s negative interest rates are supposed to deter saving and encourage spending and investment. For older savers, however, things look a bit different. Understanding how they respond when rates are so low is essential to encouraging them to put their cash to work.
Very low interest rates mean that you need a bigger savings or retirement pot to achieve any given level of income. The Bank of England’s base rate is just 0.1%. This means producing annual interest income of 10,000 pounds ($13,951) requires savings of 10 million pounds. Back when the rate was 5%, as it was prior to the 2008 Global Financial Crisis, you’d get that sum from savings of 200,000 pounds and with very little risk. The math does not even compute when interest rates are negative, as they are in the euro zone, where your capital is actually being eroded over time.
Low interest rates feed the fear among retirees (and those with half an eye on giving up their day jobs) that their savings won’t grow and they’ll eventually run out of money. So the thought of eating into this capital unnecessarily is uncomfortable and can lead to excessive caution.
This problematic impact of low interest rates predates Covid. A 2017 study showed that many U.S. retirees continued to accumulate savings even after they retired. People entering their 80s were richer than they were in their 60s and 70s, even allowing for inflation, largely because they were not spending as much as their wealth might have permitted. Indeed, the richest were spending 53% less than they could have.
Behavioural economics also suggests that people are less willing to spend a capital gain than they are interest or dividend income. The rationale is that they prefer the certainty of a “Bird in the Hand” to an unrealized, and less predictable, capital gain.
Another cause of this reluctance to spend savings is that individuals are steadily being made to assume all the risk in providing for their retirement.
In the past, the most fortunate retirees had index-linked final salary pensions which provided a regular, guaranteed income. For most of the rest, guaranteed annuity products could replicate an index-linked income, at a price. Either way, you always knew how much you could spend each month and there was no risk that your savings could literally “run out.”
Today, it is more common for people to bear all the risk, such as inflation and market volatility, not to mention the inconvenience that they might simply outlive their money. Final salary pensions are far less common and the incomes paid by annuities are a lot lower than they once were because interest rates are so low. As such, the caution is understandable.
The problem is that excessive caution can hurt savers and the economy. Retirees end up living more abstemiously than necessary for fear of running out of cash. At the same time, the economy fails to benefit as those with the most cash are the least inclined to spend.
Having a plan can help with the first issue. Whether it is something you’ve constructed yourself on a spreadsheet, or the product of an expensive visit to a financial advisor, you want to get a sound projection of what you can afford to spend to feel more comfortable tapping those savings.
Before the current mania for exceptionally low interest rates, a rough rule of thumb was that drawing down 4% of your capital per year in retirement was sustainable. Today the advice is more nuanced. Some advisors suggest that the sustainable rate is 3% or less. Artemis Investment believes that 4% is still possible, but only if 60% of your fund remains invested in equities. This is quite a big ask for many more cautious investors. Alternatively, if you are prepared to hold 40% in equities, a 3.5% withdrawal rate should be sustainable.
If you have sufficient financial flexibility to avoid drawing down on your investments in the aftermath of a market tumble, as happened last year, that can also make an enormous difference to your finances.
And you can channel savings into other assets that pay an income. This is one of the reasons why property remains a popular investment, notwithstanding the risk and the logistical challenges. Having at least some guaranteed income can help people feel more confident about treating their capital as money that can be spent.
Another form of income that’s often overlooked in the U.K. is the state pension. As many as a quarter of retirees, particularly women, fail to ensure that they receive the full benefit. The state pension increases in line with a complex formula that often sees it outpace inflation, more than maintaining its purchasing value. The full pension entitlement currently pays 9,339.20 pounds per annum.
Of course, one of the reasons that people hoard cash in their old age is because nobody knows how much elder care is likely to cost them. Ideally, you slump over your putter at a grand old age having just sunk a huge birdie putt on the 18th. Most people, though, err on the side of caution for fear of seeing out their final days in penury.
So if the government could make good on its promise to provide some certainty on care costs, the measures would very likely pay for themselves by freeing up excess savings.
And if all that fails to convince you to spend your hoarded cash, do it for the good of everyone else. Imagine the difference you can make by sharing your good fortune in these difficult times.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Stuart Trow is a credit strategist at the European Bank for Reconstruction & Development. He is also a pensions blogger, radio show host and member of numerous retirement, finance and audit committees.
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