Introduction to Finance

dissaving 
involves spending 
of accumulated savings when 
consumption spending exceeds 
after-tax income

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7.4 Factors Aff ecting Savings
179
Economic Cycles
Cyclical movements in the economy are the primary cause of changes in levels of income, and 
they aff ect not only the amounts but also the types of savings. Economic cycles may be viewed 
in terms of the two- to four-year traditional business cycle or in terms of much longer cycles 
that correspond with generations of people.
Let’s begin with a discussion that concentrates on the traditional business cycle. In gen-
eral, interest rates on securities with short maturities are lower than interest rates on long-term 
maturities.
2
However, when economic activity is peaking, short-term interest rates are higher 
than long-term interest rates. Generally, interest rates are high because infl ation rates are high, 
and the Fed then raises short-term interest rates even further to slow economic activity and 
reduce infl ation. As a recession deepens, short-term interest rates fall faster than long-term 
interest rates. Finally, when interest rates get low enough, businesses will fi nd it attractive 
to borrow and grow. The savings rate usually goes down in a recessionary period and savers 
emphasize liquidity and safety when they do save. When the economy is growing, individuals 
usually save more and may hold their savings in riskier short-term securities.
Harry Dent Jr. discusses much longer cycles based on 
generation waves
, with the largest 
generation wave in the history of the United States being the baby boom wave.
3
In his view, 
a generation wave consists of birth wave, innovation wave, spending wave, and organization 
wave components, or stages. These components correspond with birth, coming of age, adult-
hood, and maturity. For the baby boom generation, the birth wave peaked in the early 1950s. 
The innovation wave peaked in the 1980s, a period of rapid introduction of new technologies, 
when the country began the movement from a production economy to an information eco-
nomy. According to Dent, the spending wave, in turn, which will peak early in this century, 
has driven the economic successes of the 1990s. The last stage will peak when the last baby 
boomers reach age 65 in roughly 2025. While a lot of economists are skeptical about broad-
based generalizations made by Harry Dent and others, all will agree that the economic clout 
of a large number of individuals moving through their life cycles at about the same time can 
infl uence the economy and the securities markets.
Life Stages of the Individual Saver
The pattern of savings over an individual’s life span follows a somewhat predictable pattern 
when viewed over the total population. A successful individual life cycle would have the fol-
lowing stages:
• Formative/education developing
• Career starting/family creating 
• Wealth building
• Retirement enjoying
Individuals save very little during their formative and education-developing stage simply 
because little income is produced. They, typically, consume a portion of their parents’ earnings 
and savings, which is substantial if they attend college. As they enter their career and family 
creating stage, they possess little savings but have large “earning power” potential. Their income 
increases. However, expenses also increase during these early family forming years. Saving and 
investing typically focus on purchasing a home and accruing life and disability insurance. 
By the time an individual reaches his or her wealth building stage, two new factors result 
in increased savings. First, income is typically much higher than at any previous time. Second, 
the expense of raising and educating children has been reduced or eliminated. Thus, it is this 
group that typically saves the most. At the retirement-enjoying stage, the individual’s income 
is sharply reduced. He or she may now begin the process of 
dissaving
. Pension fund payments 
along with accumulated savings are drawn upon for current living expenses.
2
We discuss the term, or maturity structure, of interest rates in detail in Chapter 8.
3
Harry Dent, Jr., 
The Great Boom Ahead
, (New York: Hyperion, 1993). Also see Harry Dent, Jr., 
The Roaring 2000s
, 
(New York: Simon & Schuster, 1998).

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180
C H A PT E R 7 Savings and Investment Process
The level of savings of individuals is therefore a function of the age composition of the 
population as a whole. A population shift to a large proportion of individuals in the productive 
middle-age years would result in a greater savings potential. These views of the life stages 
of the individual saver are consistent with the generation-wave approach described by Harry 
Dent Jr. That is, if a large number of individuals are moving through their individual life 
cycles at approximately the same time, their combined eff orts will have a major impact on the 
overall economy. On a collective basis, they spend at about the same time and are also likely to 
save at about the same time. Spending has kept the U.S. economy in almost continual growth 
since the early 1980s, and saving/investing in retirement plans and directly in mutual funds 
(which, in turn, buy bonds and stocks) helped the stock market reach historical highs during 
the 1990s. A substantial decline in stock prices preceded a downturn in economic activity at 
the beginning of the twenty-fi rst century, which was then followed by economic expansion and 
increasing stock prices until the onset of the 2007–08 fi nancial crisis and the 2008–09 Great 
Recession. Since then, economic recovery and increasing stock prices have prevailed.
Life Stages of the Corporation and Other Business Firms
As the fi nancial savings of individuals are governed partly by age, so the fi nancial savings 
generated by a business fi rm are a function of its life stage. The following are the life cycle 
stages of a successful business fi rm:
• Start-up stage
• Survival stage
• Rapid growth stage
• Maturity stage
Not all business fi rms proceed through all fi xed life cycle stages. To the extent, however, 
that a fi rm experiences the typical pattern of starting up, surviving, vigorous growth, and ulti-
mate maturity, its fl ow of fi nancial savings may experience a predictable pattern.
While developing the business idea and in the starting the business stage, the fi rm is 
spending cash rather than building cash. The business fi rm, typically, continues to burn 
cash as it tries to fi nd a successful operating niche. During the early part of the expansion 
years (rapid growth stage) of a successful business, the volume of physical assets, typically, 
increases rapidly. So rapid is this growth that the fi rm is unable to establish a strong position