How Spending and Saving Are Changing

America's prosperity may depend on consumers whose spending power is running out.

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Spend or save? It was once a fairly straightforward question: You spent what you needed and saved the rest. But as mass consumption has become a dominant force in the U.S. economy, the tension between spending and saving has become far more acute.

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After a grudging, three-year experiment with thrift, Americans now seem to be rediscovering retail therapy. Spending is up about 5 percent this year, a healthy rise considering that unemployment is high and the housing market remains depressed. But incomes have risen by less than spending, which suggests that people are saving less and turning once again to credit cards to fund purchases when they don't have the cash. For some shoppers, renewed spending power may even be coming from defaulting on past loans, which eases the crush of debt and frees cash.

A sustained boost in spending is just what the economy needs to get out of the doldrums. But if it brings with it a return to bad financial habits, then the economy could end up worse off overall. Many consumers still have too much debt, and millions of homeowners have lower net worth than they did a few years ago, due to punishing declines in home values. Plus, a lot of baby boomers are unprepared for retirement, which means they'll need to build up their nest eggs in a hurry. Spending too much now could leave a big hole later, cutting into spending indefinitely.

In the aftermath of a grueling recession, spending habits are changing in ways that economists and marketers are eager to understand. With money more scarce than it used to be, some changes are fairly predictable, such as the substitution of store brands for costlier designer brands. Other changes may be more subtle. And on some things, Americans may be trying out new ways of handling their money, only to settle back into familiar patterns.

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To gauge long-term changes in consumer behavior, I analyzed a variety of data going back to the early 1960s—an era many people think of as the heyday of the American Dream. In some measurable ways, life was in fact easier back then. But it's also true that Americans have set the bar for success a lot higher over time, which means we may feel less satisfied, even though living standards have tangibly improved. Here are 10 trends that have changed the way consumers manage their money over the last 50 years:

Stagnant income. Your income determines your spending (at least it should), and the median income today, after adjusting for inflation, is about 22 percent higher that it was in 1967, the earliest year for which there's comparable data. So the typical American has more money to spend than before. But it's well-known that inflation-adjusted income has drifted down over the last 15 years or so, with today's median income about the same as in 1997. That's a worrisome sign of stagnation that means many Americans are, in fact, falling behind. It's inevitable that spending habits will reflect that.

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More debt. Many Americans have compensated for declining income by borrowing more. The typical household today has nearly $21,000 in outstanding debt, including car loans, student loans, credit card balances, and other types of consumer borrowing (but excluding mortgages). In 1960, the typical household carried just $1,132 in consumer debt. Adjusted for inflation, the average debt load today is about 140 percent higher than it was in 1960.

This explosion in debt is one of the biggest factors affecting consumer finances. The advent of mass-market credit cards in the 1960s allowed consumers to buy stuff even if they couldn't muster all the money right away. But credit standards got too loose, and shoppers got too accustomed to easy purchases. Since the amount of household debt peaked in 2008, consumers have been digging out and banks have been tightening up on lending standards. But after three years of declines, overall debt levels have started going back up again. Shopping on credit seems to be one habit no mere recession is likely to break.

Sporadic saving. For much of the last 60 years, Americans saved between 7 and 10 percent of their disposable income. In 1960, for example, the savings rate was 7.2 percent. But saving fell out of fashion beginning in the 1990s, and by 2005 the savings rate had plunged to a modern low of 1.5 percent. Consumers started to save more once the recession hit in 2008, and some economists thought consumers would aggressively fix their finances by saving 10 percent of their income or more, for several years. But that hasn't happened. The savings rate got as high as 6.2 percent in 2009, but it has since fallen to less than 4 percent. Convincing consumers to save remains a hard sell.

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Cheaper staples. Some people always think prices are too high, but many basic products have gotten considerably cheaper. The typical family today spends just 7.5 percent of its income on food, for example, compared with about 21.5 percent in 1960. Clothing accounts for just 3.4 percent of the family budget, down from 8.8 percent in 1960. These costs have fallen consistently over the last 50 years, a trend that seems likely to continue, on account of more efficient manufacturing and cheaper products from overseas.

Yo-yo housing costs. Some homeowners may be surprised to hear it, but Americans today spend about the same proportion of their income on housing—roughly 19 percent--as they did 50 years ago. The figure drifted up during the recent housing boom, but not by nearly as much as home prices did, because many people rent their rather than own. And now, the sharp drop in home prices over the last five years, combined with low interest rates, has made homes highly affordable for buyers who have money saved for a down payment and are able to get a loan.

An affordable home is often considered the cornerstone of the American Dream—which is far from dead, if housing affordability is any indication. There are other problems that prevent people from buying a home these days, such as high unemployment and tough lending standards. But it's also true that the typical home has gotten bigger and more comfortable than it was during earlier times that now seem like the Golden Years. As the economy gradually improves and expectations moderate, the American Dream might start to seem within closer reach than many people think today.

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Continuously affordable transportation. Gas prices cause frequent anxiety, especially since they've risen sharply over the last 10 years and are highly unpredictable. Yet motor fuel accounts for just 3.2 percent of income, which is slightly less than levels of 50 years ago (and far lower than levels in the 1970s, when gas prices spiked). The total cost of a car accounts for 9.4 percent of income, down from 12.3 percent in 1960. Since mobility is another lifestyle trait that Americans strongly value, this too suggests that the American Dream might be in neutral, but isn't in the ditch.

Ample amusements. Americans spend 9 percent of their income on entertainment and recreation, up from about 6 percent in 1960. The extra spending mainly goes toward fancy audio and video equipment, something most people could cut back on if they had to. While we've become a society addicted to gadgets, revolutionary changes in electronics and digital technology have made these devices far more pwerful and useful than ever, something that's likely to continue.

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Education uber alles. The percentage of income spent on education has crept up by just 1.4 percentage points since 1960, to 2.4 percent of income. But that low percentage masks the high education costs borne by families with kids in college, and it may also understate the burden of student loans taken out to pay for school, which count as debt, not income. There's no doubt that education pays, since there's a strong correlation between educational attainment and lifelong earnings. But with many recent college grads unable to find jobs, a lot of people are rethinking the relative value of education. At a minimum, we may see a shift toward more affordable colleges, accelerated degrees, and a stronger focus on fields most likely to lead to paying work.

More spending on investments. The amount of money spent on financial services and insurance has risen from 4.1 percent of income in 1960 to 7.6 percent today. That's a sign of growing prosperity over that time and the democratization of investing, with millions of ordinary families now participating in the financial markets. The pool of individual investors has obviously shrunk over the last few years, as the housing bust combined with a sharp recession has reduced the money available for investing. But this is one expense that usually represents good news as it gets bigger.

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Runaway healthcare costs. As most families know, healthcare can be the biggest budget-buster they'll ever face. As a percentage of income, healthcare has risen from 6.1 percent in 1960 to 20 percent today. That's partly because of numerous advances that have allowed people to live longer and more healthfully, but also because of complexity and extraordinarily expensive late-in-life care that drives up costs for everybody. The huge spike in healthcare costs often devours money that's been saved elsewhere in the family budget. And for people without insurance, a medical problem can easily generate exorbitant costs far in excess of earnings or ability to pay.

The skyrocketing cost of healthcare is such a serious problem that it threatens to bankrupt the federal government, since Medicare and Medicaid spending is rising at an unsustainable rate. That makes it an economic problem as much as anything else. The American Dream is still attainable, but there may be one fresh caveat: Only if you stay healthy.

Twitter: @rickjnewman

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