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Personal savings rate could soar

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Apparently, all that Americans needed to spur them to save money was a meltdown in the financial industry. Earlier this year, the personal savings rate giddyapped this year above 4 percent for the first time this decade, according to the Bureau of Economic Analysis. After a few years where our savings barely nudged above the 1 percent mark, we’re now setting aside a more respectable amount of our disposable personal income.

Some economists say the rate will continue to climb over the next three to five years as consumers who have been affected to varying degrees by the financial crisis alter their spending and savings patterns.

A bitter lesson

Former Federal Reserve Board governor Lyle Gramley, now senior economic adviser with Soleil Securities Corp., says he wouldn’t be surprised to see the savings rate reach 8 percent.

“Consumers have learned a bitter lesson that their past behavior takes them way out on a limb that might get sawed off. They can’t count on the increase in the value of their home or their 401(k) to do all the saving they need to fund their retirement years or to educate their children or for medical contingencies. They’re going to have to do some of the savings themselves, so I think that will motivate a gradual rise in the savings rate,” says Gramley.

Keith Hazelton, senior vice president and director of economic research at the Oklahoma Bankers Association, goes considerably beyond that and says the fear factor among baby boomers could push the savings rate to 12 percent within the next five years.

“I think baby boomers will pay down debt with a vengeance. They have stepped to the brink of an abyss and seen a more grim future in the absence of paying down debt and increasing savings. If anything, this last year and a half, this recession, as severe as it’s been, has been instructive for this group that has dominated the country’s economy for 50 years.”

Unfortunately, a lot of people continue digging deeper holes for their finances. They fear an underfunded retirement but have expenses that need to be dealt with today, and without a properly funded emergency fund they’re making moves they may regret in the years ahead.

“All of a sudden they need extra money because their well doesn’t work and they’re pulling money out of IRA accounts,” says Mark Carruthers, a Certified Financial Planner in Garnerville, N.Y. “They’re taking a hit and paying the penalty. It shocks me. Most people live paycheck to paycheck. They were getting by during good times but now overtime isn’t readily available and their investments have decreased. As Warren Buffet says: You can’t tell who’s swimming naked until the tide goes out.”

Low-yielding safety

The fear factor could lead people to much safer investments as they repair their portfolios. Hazelton says he expects baby boomers to start allocating more savings resources to those types of instruments that can’t be easily affected by market or economic fluctuations — in other words: CDs, money market accounts and money market funds.

It’s understandable that consumers would seek safety for a greater portion of their portfolios after getting a collective whack upside the head in the stock market. But with inflation possibly remaining low for the next couple years, and even beyond that, being too heavily invested in low-yielding investments could do more harm than good to a portfolio.

High-yield one-year CDs are ranging from 1.1 percent to 2.08 percent. High-yielding money market accounts are running as high as 1.79 percent.

The average yield for money funds in the Crane’s 100 Money Fund Index is 0.12 percent. Peter Crane, co-founder of Crane Data LLC, which publishes Money Fund Intelligence, says he thinks the drop in money fund yields is just about done.

“We may inch down a little bit more but this is pretty much the bottom. The Fed cut has been fully digested. Money fund moves follow the Fed, so if the Fed doesn’t move, neither do these yields.”

A mixed-bag portfolio

Keep what’s necessary in fixed income and let the rest go to work elsewhere in the markets. Of course, what’s necessary varies from person to person. If you’re employed in an in-demand field and are in no danger of losing your job, then three months of living expenses may be enough. Others who don’t have that job security will want a considerably bigger cushion. But letting fear dictate a cash reserve that’s outsized is detrimental to your future financial health.

Brent Brodeski, managing partner at Savant Capital Management in Rockford, Ill., says his firm researched all of the bear market recessions going back to the Depression era. They looked at three strategies to determine which would provide the best outcome five years after the recession. The three strategies were having an entire portfolio of stocks, dollar-cost averaging monthly into stocks from cash or simply leaving it all in cash. They considered each strategy under different scenarios and in all cases, he says, the portfolio performed better under the two stock strategies. Cash was the worst outcome in every instance.

Brodeski isn’t a big fan of cash even when someone is nearing retirement.

“The key is to have the three-legged stool,” Brodeski says. “Have some short-term bonds, maybe one- to three-year maturities — all high-quality. Have some intermediates, maybe in the three- to 10-year range, and then some inflation bonds. The combination of those three legs to your stool assures that not only will you have the income or interest that’s produced by those bonds but also the dividends produced by your stocks. Have enough in bonds and cash so you don’t have to sell your stocks at a loss.”

When it comes to buying bonds, you can buy them individually through a broker or by using an online service such as Zions Direct. You can buy individual corporate bonds inexpensively through the Corporate Notes program at many brokers.

There are hundreds of mutual funds that package corporate bonds or Treasury bonds, or you buy them in exchange-traded funds such as iShares.

If you’re interested in Treasury bonds or agency bonds, visit Treasury Direct.