Savings have soared during the pandemic, particular among older Europeans. Barclays Plc estimates that seniors amassed excess savings of 600 billion euros ($722 billion). This would surely provide a boost to Europe’s economy if unleashed upon the high streets. Yet most observers believe much of the cash will remain unspent.
What’s behind this hoarding? The region’s negative interest rates are supposed to deter saving and encourage spending and investment. For older savers, however, things look a bit different. Understanding how they respond when rates are so low is essential to encouraging them to put their cash to work.
Very low interest rates mean that you need a bigger savings or retirement pot to achieve any given level of income. The Bank of England’s base rate is just 0.1%. This means producing annual interest income of 10,000 pounds ($13,951) requires savings of 10 million pounds. Back when the rate was 5%, as it was prior to the 2008 Global Financial Crisis, you’d get that sum from savings of 200,000 pounds and with very little risk. The math does not even compute when interest rates are negative, as they are in the euro zone, where your capital is actually being eroded over time.
Low interest rates feed the fear among retirees (and those with half an eye on giving up their day jobs) that their savings won’t grow and they’ll eventually run out of money. So the thought of eating into this capital unnecessarily is uncomfortable and can lead to excessive caution.
This problematic impact of low interest rates predates Covid. A 2017 study showed that many U.S. retirees continued to accumulate savings even after they retired. People entering their 80s were richer than they were in their 60s and 70s, even allowing for inflation, largely because they were not spending as much as their wealth might have permitted. Indeed, the richest were spending 53% less than they could have.
Behavioral economics also suggests that people are less willing to spend a capital gain than they are interest or dividend income. The rationale is that they prefer the certainty of a “Bird in the Hand” to an unrealized, and less predictable, capital gain.
Another cause of this reluctance to spend savings is that individuals are steadily being made to assume all the risk in providing for their retirement.
In the past, the most fortunate retirees had index-linked final salary pensions, which provided a regular, guaranteed income. For most of the rest, guaranteed annuity products could replicate an index-linked income, at a price. Either way, you always knew how much you could spend each month and there was no risk that your savings could literally “run out.”
Today, it is more common for people to bear all the risk, such as inflation and market volatility, not to mention the inconvenience that they might simply outlive their money. Final salary pensions are far less common and the incomes paid by annuities are a lot lower than they once were because interest rates are so low. As such, the caution is understandable.
The problem is that excessive caution can hurt savers and the economy. Retirees end up living more abstemiously than necessary for fear of running out of cash. At the same time, the economy fails to benefit as those with the most cash are the least inclined to spend.