To Save or Not To Save

Any good financial planner worth his salt will tell you that you should have between three and six months of living expenses saved for unexpected emergencies. My guess is that most of us are not anywhere near that number. Why is it that we need so much set aside in a very liquid, convenient place? Let's take a look.

If you have watched the news over the past five years or so, you will have noticed an alarming trend in the number of layoffs around the country. Millions of people have lost their jobs since 2001. Just today GM announced several hundred more layoffs. The recent Delphi situation is causing concern for those employees. Maybe you have been a part of a recent downsizing.

A safety fund allows you to continue to live your life while looking for another job. Whether you need three months or six months of savings depends on the type of work you do. If you are a professional secretary, you will have a much easier time finding suitable work so a smaller emergency fund would be ok. If your work is more technical in nature, then a larger fund is needed, as it is more difficult to find comparable work.

This weekend, I read an article in our small local paper written by a local financial planner that discussed this very issue. In addition to the three to six months of living expenses he recommends a couple of weeks worth of funds in cash kept in a safe place at home. When I mentioned this to my wife, she wondered what that was about. I told her that in the event of a bank holiday or mandatory closing of the banks, you would need some cash to get you by until the banks reopened.

If we look back at the Great Depression of the 1930's, we find that people lost all of their savings when the banks ran out of cash and closed. Those that had some funds set aside at home were able to continue on for a while. I'm sure you have heard of several stories of older folks who passed away and left thousands of dollars hidden away in their houses. This was a direct result of the depression. Many people never trusted banks again. My own grandfather never went into debt after living through the depression. He paid cash for verything. He was not rich, just frugal.

Now, to be fair, there were some differences between then and now. For instance I can hear some of you saying that there was no FDIC to protect your deposits back then. That is true, however, banks in the 1920's kept a larger percent of their deposits on hand then we do now. The current reserve requirement for banks is less than 2%. The FDIC may tell you that your deposits are protected up to $100,000 but the truth is if a bank run occurred in this country, and because of the speed of the news it will happen much faster than it did back in the 1930's, the FDIC does not have the funds to pay everyone back. It would pay some, but it would be pennies on the dollar.

Think about the recent bankruptcy of United Airlines and the transfer of their pension plan to the Pension Benefit Guaranty Corporation (PBGC). This is an organization similar to the FDIC. Once the transfer took place, United retirees saw a 50 to 60% decline in their monthly benefit payments. Why because there is no way that the PBGC could cover that large of a pension plan. The same thing will happen when GM declares bankruptcy and petitions the court to turn over their pension plan to PBGC.

Neither organization has enough resources to cover all of the accounts that exist. Whether we are talking pensions or deposits.

Another major difference between the 1930's and today is the national savings rate. Back in the 1920's, before the depression hit, things were very different. There were no credit cards. There were no bank loans for average folks like you and I. As a result, most people saved for a rainy day.

Today, our national savings rate is negative. That means we are spending more than we make every year. Most of us rely on credit cards or home equity lines of credit for emergencies. Let me tell you, if a bank holiday occurs and that is the government's first line of defense against bank runs, most retailers will accept only cash. Cash will be king.

In the 1930's 80 per cent of the population lived on farms. Today, less than 20% live on farms, so we are more reliant on our food distribution system to put food on the table. For people with no savings and no job, that will create a huge problem.

Austrian economists tell us that whenever a government attempts to manipulate the currency in an effort to smooth out the natural ups and downs of the economy, malinvestments are made in areas of the economy where a false demand is created. All of those malinvestments must be cleaned up before the economy can return to normal. The purging of those malinvestments is usually a painful experience. This time will be no different.

To save or not to save, I think the answer is clear.