Saturday, November 13, 2010

Savings – What does that mean?

For more then about three decades, Americans had deleted word 'savings' from their dictionary. Average American family believed in so called 'enjoying life.' Unfortunately, they were getting enjoyment from materialism. Their government encouraged citizens to spend so that economy keeps moving ahead. Government was doing this to protect vested interest of the big corporates. For about 30 years, citizens were made to believe that only if they spend, economy would grow. If economy grows, they will have jobs and salary. Therefore, buzzword was spend, spend and spend.

However, common sense tells us that every borrowed fund has to be paid back sometime. When time to pay back arrived, Americans felt the heat. Towards the end of 2006/07 situation was so pathetic that average American family had negative savings rate. This means that every year they were spending more then what they earned. As per their official statistics, for every US$ 100 earned, families were spending US$ 110. Most families were spending 10% more then their income every year for several decades. In 2007-08 when USA and rest of the world went into crisis, families that had debt were hit severely. There were pay cuts and job losses but their loans and EMI continued. Since there were no savings, there wasn't anything to fall back upon. Do you know one of the biggest causes of divorces in USA? It is financial debt. In addition, divorce does not only affect couples, it also affects children. Children of divorced couples are very insecure.

However, USA has learnt its lesson. Last week while I was addressing a conference in Denver USA, local financial planners told me that people have started saving. From negative 10% savings, now average American family saves about 6% of income annually. Their government is now spending money to tell its citizens importance of savings. When I told them that in India savings to GDP ratio is more then 25%, they were amazed. They were shocked that even though we were saving so much, how our economy was booming. They also wanted to understand the secret of India that saved us during world financial crisis. The answer is our saving habits.

Borrowing is nothing but spending our future unearned, uncertain income today. When we borrow and spend we are spending our future income today – our spending happens today but repayment happens from future income. Future income is not earned yet and future is always uncertain. However once we borrow, our loan repayment becomes certain. Therefore, we are trapped into an uncertain income but certain loan repayment. During loan repayment tenure if there is any kind of income loss then savings can help bridge the gap. However if there is no savings then families get into difficulties. This is what happened to USA and several other western economies.

"The amount of money you have has got nothing to do with what you earn... people earning a million dollars a year can have no money and.. People earning $35,000 a year can be quite well off. It's not what you earn, it's what you spend." - Paul Clitheroe

- Gaurav Mashruwala

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