Mellody Hobson Tells You How to Start Saving

Nov. 19, 2005 — -- Americans are saving less today than they have in decades. The current personal savings rate is at its lowest point since the Great Depression of the 1930s.

"The great generation that emerged in the 1950s and '60s still strongly adhered to those values of thrift and industry and long-term planning and savings," said Bob Manning, professor of finance at Rochester Institute of Technology in Rochester, N.Y.

"What we've seen today is that in the society of abundance, where materialism really is a reflection of one's social status, people have shifted away from what they see as old school values," he added.

Take Mike and Jaime Erickson of Chicago. They have less than $1,500 in the bank, but they belong to a country club, send their three children to private school and take an annual trip to Disney World.

"I look at the positives instead of worrying about what we should be doing economically," said Mike Erickson. "I say, 'Look, we've got a good life. Let's take it a day at a time and keep going forward and enjoy it.'"

"The temptation is that we need more to live well," said Ellen McGirt, a senior writer at Money magazine. "And we need more to compete and we need to make sure that we have all right things that make us look good in the workplace, to make us look good in the social marketplace."

"We do live beyond our means, and Jaime would never admit this, but we're trying to keep up with the Joneses," Mike Erickson said. "Other people have nice things, we have to have nice things."

The Ericksons are ahead of many Americans in that they own their home and already contribute money to retirement and college funds. Still, they say there is nothing to fall back on in an emergency.

So many families like the Ericksons are relying heavily on home equity and credit cards to get them through a crisis -- a major home repair, a car accident or unexpected illness. But once you build up that debt, it's hard to get back down.

And many experts say the best emergency plan is the thing that seems unpopular with young Americans -- a regular, old-fashioned savings account. Assuming an annual rate of return of 8 percent, if someone saves $50 a month, they will have $9,100 in 10 years. And if they save $75 a month, they will have $13,721 in 10 years.

For the fourth month in a row, the U.S. personal savings rate is negative -- below zero. That means, on average, Americans are saving none of their disposable income and, even worse, they're spending more than they have. So what do you do when the furnace breaks or the kitchen sink explodes and you don't have a rainy-day fund?

Mellody Hobson, president of Ariel Capital Management, an investment firm in Chicago, and "Good Morning America" financial contributor, answered questions about how and why you should start saving.

"GMA": There is a new trend of not saving. Do you think we, as Americans, need a major change in philosophy?

Hobson: Everyone knows they need to save money. It is the most obvious financial necessity, yet the one most people look past. In fact, the average credit card debt per household in the U.S. is up to $9,312. To make matters worse, personal savings is now negative. Creating financial security takes time, careful planning and, more importantly, commitment. All of your planning is worthless if you do not make a philosophical change in the way you approach spending and saving.

"GMA": Where do you start?

Hobson: Once you have made a commitment to change your habits, you need to determine where your income is going each month. By doing this, you can figure out how much you can regularly save, as well as the amount of money you need for emergency savings. In terms of emergency savings, the rule of thumb is that you should have three to six months' worth of living expenses available.

Once you calculate how much you can save each month, add this amount to your monthly "expense list" -- essentially, you want to think of it as you would any other bill. To ensure you remain committed to paying this "bill" each month, you may want to consider having the money automatically deducted from your checking account and deposited into a savings vehicle, such as a money market account.

It is important to note that you need to have savings outside of your 401(k) or other retirement account because you do not want to tap into your 401(k) or reduce your contributions if a financial emergency arises.

"GMA": You know, a lot of Americans live paycheck to paycheck. They don't have any money to save! How do you save money when you don't have any extra money?

Hobson: Consider taking a harder look at your food, transportation and household expenses. For example, are you eating out more often than you should? Can you take public transportation instead of your car? Could you lower your thermostat dial in the colder months and raise it in the warmer months? By questioning your regular routine, you will uncover easy ways to cut back that can result in significant savings over time. And start with the small stuff, like your spare change. According to Coinstar, $10.5 billion in change (including pennies) is sitting idle in American homes -- that's approximately $99 per household.

"GMA": OK, so I've found an extra $50 a month. Where do I put it?

Hobson: Money for your everyday living expenses should be kept in your checking account, but your savings should be kept in a separate account (or accounts) so that you are not tempted to dip into it. In terms of emergency savings, you want to put your money in a safe, liquid and easily accessible investment vehicle. Three good options include:

"GMA": Once I have my emergency fund -- three to six months' worth of my salary saved -- where do I start saving next?

Hobson: Once you have created an emergency savings fund, you may want to consider investing additional savings in stock mutual funds. Although mutual funds carry more risk than a money market or savings account, the rate of return will likely be higher. An index fund is a good place to start in that your fees will be low. Large investment firms such as Vanguard and Fidelity offer an array of index funds to choose from, but as with any investment, it is important to do your research. Be sure to look into the performance record, management history, expense ratios and minimum investment requirements. While many mutual fund families require an initial investment of $1,000 to $3,000 before you can enroll in an automatic investment program, some fund families waive the minimum if you commit to investing at least $50 to $100 a month.

"GMA": What if you have trouble making ends meet, are there any programs that can help you save to reach your goals?

Hobson: Individual Development Account programs assist qualified low-income families and individuals by matching their savings and providing financial literacy training. To qualify for an IDA, you must earn less than two times the national poverty level, which is approximately $19,000 for individuals (poverty level is $9,570 in 2005) and $38,700 for a family of four (poverty level is $19,350). In addition, you must be saving for a specific goal -- such as buying a home, paying for education or starting a business -- and attend financial literacy classes.

Generally, IDA programs are run by nonprofit organizations who partner with financial institutions -- funding for the programs comes from private foundations and the federal government. Nonprofits sponsor and manage the programs, while the partnering financial institution provides the savings vehicle. The specifics regarding IDAs will vary program to program, but many offer a matching rate of 2:1, so every $1 saved is matched by $2. The length of IDA programs can range from one to five years from start to finish, while the allowable savings goals can include large goals such as saving for a home to small goals such as home repairs.