Standard financial planning advice presumes that financial emergencies – the loss of a job, an illness or accident, or an unexpected car or household repair – are relatively infrequent for most households. But new research shows that many American households live in a constant state of financial uncertainty, experiencing major monthly swings in their income and expenses.
A recent report from the JPMorgan Chase Institute, which analyzed a sample taken from 2.5 million accounts, finds that volatility is the norm, even at higher incomes. According to the study, as many as 89 percent of Americans see their incomes fluctuate by more than 5 percent from month to month, while 60 percent see changes in spending greater than 30 percent from month to month. Moreover, these figures are roughly the same across all income levels.
Chase estimates that the average American household needs about $4,800 in savings to cope with these monthly shifts without falling into debt or cashing out assets – but it also finds that the vast majority of households fall short of this goal. The Chase analysis found that the typical middle-income household has about $3,000 in liquid assets, which means a shortfall of $1,800.
The report also found that the number one driver of income volatility for most households is labor income, which is perhaps not as stable as many might like to think. While some of the volatility is due to “five Friday months” and December bonuses, these factors still accounted for just 10 percent of monthly income volatility. The rest was due to changes in hours worked, overtime and “other factors not discernible in [the] data.”
The report’s findings reinforce a growing body of research on household income volatility, an important new framework for understanding the current state of Americans’ financial security – or lack thereof. This new research clearly points to the need for new ideas to help households manage the ups and downs of financial volatility without suffering too much hardship.
Volatility, for example, helps explain the persistent demand for payday loans and other expensive short-term loan products intended to cover temporary shortfalls in cash. According to the Pew Charitable Trusts, 12 million Americans spend $7 billion on payday loans every year. The payday loan industry’s own trade association points out that the majority of payday loan borrowers earn between $25,000 and $50,000 a year – a figure that’s consistent with the high prevalence of income volatility even within the middle class.
The true state of financial insecurity among American families may moreover be much worse than the Chase report seems to indicate. This analysis looked only at Chase’s own accountholders – Americans who are part of the financial mainstream and who are, as a whole, more affluent than the general population. The analysis does not include the 9.6 million households in America who have no bank accounts at all and who are disproportionately lower-income or minorities. Among Hispanic households, for example, nearly 18 percent are “unbanked,” according to the FDIC.
At the same time, the income volatility discovered in the Chase analysis could also explain why so many American households remain shut out of the financial mainstream. In a 2013 survey by the FDIC, more than a third of households who became “unbanked” gave up their accounts after a job loss or a major loss of income. The same survey also found that volatility might be preventing many households from amassing the savings they need to open or maintain a bank account in the first place. As many as 57 percent of unbanked households said they didn’t have enough money to open a bank account or to keep up the minimum balance, while one-third cited high or unpredictable fees.
As the Chase report notes, “the volatility that individuals experience carries not only a financial cost, but also psychological and cognitive costs.” Uncertainty makes it tough to plan ahead, let alone to save, and the stress of living from crisis to crisis no doubt pushes some to make financial choices they later regret.
For policymakers, the findings uncovered in this analysis pose a new challenge: how to encourage households to bolster their emergency savings and how to provide consumers affordable short-term credit when they need it.
Perhaps the boldest shift policymakers can make is to break down the now fairly rigid silos between different “buckets” of savings, such as for retirement and education. Flexibility to manage one’s finances might be the one thing Americans need most to survive in a volatile new world.