Investor Behavior: Patterns of Savings and Capital Flow Analysis
Investment Theory: Patterns of Saving
Patterns of Savings
During the last half of the 20th century, there have been several significant changes in investment patterns of U.S. households.
Towards the end of the century, Baby-Boomers began to see weakness in the social security system and the low-level of social security benefits compared to current lifestyles.
Short-term tax advantages, together with long-term tax deferral and awareness of the need to build retirement assets, provided incentives for a major shift in asset allocation.
Emphasis on Pensions
The most striking change in US investor behavior over these fifty years has been increased emphasis on pension reserves in the household balance sheet.
Pension reserves became a much greater part of household wealth.
- In the 1950’s, Americans had seven times more invested in homes and consumer durables than in pension fund reserves.
- By the 1990’s, pension fund assets exceeded home equity.
This change accelerated in the 1970’s with ERISA and, in the 1980’s, with tax-deferred 401(k) investment accounts.
The percentage of wealth represented by equity in homes and consumer durables remained fairly stable over the period, although declining at the close of the century due to the boom in stock prices.
Inflationary Fears
At mid-century, memories of the Great Depression were strong.
The inflationary implications of central banking and abandonment of the gold standard had not yet caused widespread inflationary fears.
However, as government grew in scope, especially after Lyndon Johnson’s 'Great Society', a belief in permanent inflation became generalized and the popularity of life insurance declined compared to the first half of the century.
The following table shows the distribution of household wealth by decade:
| 1950s | 1960s | 1970s | 1980s | 1990s | |
|---|---|---|---|---|---|
Equity in Home & Durables |
27.5% |
22.7% |
26.1% |
27.7% |
20.4% |
Deposits & Credit Securities |
21.2% |
22.1% |
22.9% |
23.4% |
20.2% |
Stock & Mutual Funds |
17.3% |
23.6% |
12.7% |
9.9% |
19.5% |
Life Insurance Reserves |
5.0% |
4.3% |
3.3% |
2.0% |
2.0% |
Pension Reserves |
3.8% |
6.4% |
9.0% |
14.1% |
21.4% |
Non Corporate Equity |
25.1% |
20.3% |
22.5% |
20.0% |
13.6% |
Bank Personal Trusts |
0.0% |
0.6% |
3.6% |
2.8% |
2.9% |
Inflation and tax-deductible interest encouraged borrowing for home purchase.
Stocks and mutual funds were also perceived as offering protection against inflation, based on historical performance.
However, it was not until the US Treasury issued bonds indexed to the cost of living in 1997 that low-risk, partial inflation protection became available.
Decline of Non-Corporate Business
The table also shows a relative decline in ownership of non-corporate business.
In the 1950’s, doctors, lawyers, stockbrokers and other professionals were prohibited from doing business as corporations.
Over time, these restrictions were lifted, causing a shift towards incorporated business.
The ease and low-cost of incorporation and the general understanding of the advantage of limited liability led millions of self-employed to incorporate.
By the end of the century, equity in non-corporate business had fallen from second to fifth place in the distribution of household wealth.
Savings Habits Tabulated
The table below, derived from the Federal Reserve flow of funds accounts, shows changes in the saving and investment habits over the last half of the 20th century.
(Click to Enlarge)
Structural Changes in the Capital Market
By the 1960s, U.S. investors had begun to move away from direct holdings of equities in favor of mutual funds.
By the late 1990s, almost 40% of the money used to acquire financial assets came from the sale of corporate equities.
By 1990, almost 40% of household money used to acquire financial assets came from the sale of equities.
If there was any 'irrational exuberance' driving the stock market, it came from the general public that placed blind faith in the Common Stock Legend and saved regularly in long-term 401(k) plans and mutual funds.
A substantial portion of the corporate equities that were sold in increasing amounts since the 1980s were redeemed and taken out of circulation by corporate executives as a result of the popular buybacks and options programs.
Another thing to note is the rise in popularity of securitized debt.
Whereas time and saving deposits were the favorite fixed-income investment of the 1950s, by the end of the century the public preferred money market mutual funds and direct investment in bonds.
Are Americans Really Spendthrifts?
We often hear complaints that Americans borrow too much and save too little.
The implication is that someday there will be a Great Reckoning when excessive credit card debt comes due.
Although many Americans are clearly over their heads in debt, the situation is probably not as bad as suggested.
The meaning of savings to an economist is different from that of the ordinary person.
The first thing we should note is that there is a big difference between the economists' definition of 'saving' and the commonsense meaning of the term.
- To an economist, 'saving' is the difference between income and consumption.
- To the ordinary person, 'saving' is the increase in accumulated personal wealth from year to year.
The economists' definition of saving does not take into consideration:
- Social Security: The amount deducted from payrolls for social security taxes, because the government uses this money for current expenditures.
- Home Appreciation: The increase in value of one's home, due to inflation and population growth.
- When homes are financed by non-indexed mortgages, inflation produces real increases in the personal wealth of homeowners. In 2004, the average American had 55% equity in the family home.
- Public Wealth Accumulation: Government expenditures on parks, roads, and the infrastruture of civilization that represents substantial public assets for the benefit of all Americans.
- Unrealized Capital Gains: Market appreciation of assets in stocks, bonds, mutual funds, and pensions.
- Homestead and Debtor's Rights: The protection of certain assets against claims of creditors.
- In some states, an American's home, IRA plan, pension plan, and social security checks are protected against the claims of creditors, to a greater or lesser degree.
Savings is a Relative Concept
A billionaire has little need to put aside part of current income for a rainy day. Americans are among the richest people on earth and have less reason to save than citizens of less fortunate countries.
Even so, the financial assets of the average American household surpass the financial assets of the average Japanese, a nation widely acclaimed for habits of thrift.
Before proceeding, check your progress:
Self-Test
In the year 2000, an important change in American patterns of savings, compared to 1950, was that in 2000:
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By the late 1990s, half of the money U.S. households used to acquire financial assets came from current income. The other half came from:
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Economists do not include the following in their definition of household savings:
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