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Not So Negative Savings

The formula used by the government to calculate the savings rate is inaccurate.

This week's "the sky is falling" news was the fact that the personal savings rate dipped into negative territory in 2005 -- down 0.5% -- for the first time since the Great Depression.

While the nation grappled with financial collapse and massive unemployment, personal savings fell by 0.9% in 1932 and by a record 1.5% in 1933, according to Commerce Department statistics. Little surprise, the pundits pounced on this latest downturn.

One camp held that Americans are maxing out their credit cards in quiet desperation, spending all their after-tax income and dipping into savings just to keep up with rising fuel and food costs. This group points to the fact that consumer spending for December rose by 0.9%, more than double the 0.4% rise in income for the month. But minus food and energy costs spending rose by only 0.1%.

The second chorus repeated the oft-told story that people are still extracting equity from their overvalued homes and using the money to live beyond their means. This scenario could end in disaster if home values stop skyrocketing but spending continues to grow.

But technicalities may be driving the savings rate down, not spendthrift consumers who can't keep their wallets shut.

"As the baby boom generation retires, it automatically means we'll see a dramatic increase in the proportion of the population that, by definition, spends more than they earn" says Dallas Salisbury, president and chief executive of the Employee Benefit Research Institute.

When the Commerce Department calculates the savings rate, it adds up income, subtracts expenditures and checks out how much is left in the bank. When more is spent than is earned, that equals a negative savings rate.

Based on this comparison, the retired population is currently "dis-saving" at a negative rate of 12%, says Salisbury, citing findings from a study conducted by the Center for Retirement Research.

In layman's terms, this means that retirees are generating no income and spending to live. So their expenditures naturally far exceed their nonexistent earnings.

Salisbury adds that the proportion of the population over the age of 65 is currently at 13%. By the time the boomers are all retired, they will comprise 22% of the overall population.

"At that point, you can expect to see a negative savings rate every year," he says.

The same Retirement Research study shows that the amount spent last year by retirees, was enough to offset the amount saved by the working population, meaning people between the ages of 21 and 64, Salisbury says. The Retirement Research Center found that the latter group saved at a rate of roughly 8%.

And while it's true that economists are scratching their heads over the health of the real estate market, Scott Brewster, a certified financial planner and head of Brewster Financial Planning in New York, believes the odds are good that homes will continue to gain in value by the time retirement comes, even if appreciation is no longer skyrocketing.

Moreover, the formula used by the government to calculate the savings rate is an inaccurate reflection of how people save, says Madeline Schnapp, director of macroeconomic research at TrimTabs.

She points out the fact that government economists simply tabulate income, subtract outlays and looks at what's leftover in people's bank accounts. Meanwhile, higher-return savings vehicles including 401(k) plans, stocks, bonds and real estate are not counted as savings.

"No one's just putting their money into a savings account anymore," says Brewster.

"The government numbers are out of date... If you go back 20 years, people couldn't invest in stocks as easily because commissions were so high. Even mutual funds are a relatively new invention," says Brewster.

Instead, he finds that people are putting the bulk of their savings into tax-deferred vehicles like 401(K) plans or into real estate.

The Employee Benefit Research Institute estimates that $12 trillion in retirement accounts have been excluded from the savings rate.

"We see savings as quite robust because we look at savings flow," says Schnapp. "When you look at the amount of money flowing into bonds, mutual funds, money market accounts and stocks, it looks like growth has been very healthy."

If growth is rapidly accelerating but is being obscured by government data, then it's time to start worrying about the 1970s, not the 1930s.

Unchecked growth could mean inflation and the eventual devaluation of the dollar; and if the real purchasing power of Americans is eroded, the size of their savings accounts will be a moot point.