Pertinent Perils

Today, the JP Morgan Chase Institute released a study titled Weathering Volatility: Big Data on the Ups and Downs of U.S. Individuals from which the key finding can be summarized as (from page 5 of the study):

The typical household did not have a sufficient financial buffer to weather the degree of income and consumption volatility observed in our data. The typical household did not maintain enough liquid savings that could be accessed immediately in the event of a large, unexpected expense sustained at the same time as a loss in income. While many in the field of consumer finance have long advised that consumers maintain an emergency fund, our research into income and consumption volatility shows that a financial buffer is a more important consideration for individuals across the entire income spectrum than is generally understood. We find that not only was volatility high for income and consumption, but also changes in income and consumption did not move in tandem. This creates the risk that people might experience a negative swing in income at the same time that they incur a large, potentially unexpected, expense.

The study found that income and expenses for individual bank consumers fluctuated among all groups across the income spectrum: the relatively affluent and the less comfortable alike. While this finding is not unexpected, what is unusual is the size and scope of the data collection efforts of the JP Morgan Chase team to conduct their analysis and reach their conclusions. They considered a sample of 2.5 million out of a total of 27 million account holders of JP Morgan Chase Bank on which they analyzed 135 million financial transactions, over a 27 month period across all of the Bank’s consumer products (checking accounts, savings accounts, credit card accounts,  home equity accounts, mortgage and automobile loans) and obtained corresponding account information from the credit bureaux.

I was particularly interested in the study’s statement concerning the risk that people may experience a drop in income at the same time they incur a large, unexpected expense. Of course, this is exactly what happens to small business owners when disaster strikes: they experience large expenses (uninsured losses, insurance deductibles, etc.) even as their income fluctuates until the business can recover its earnings capacity and/or customers return to the disaster zone and normal economic activity resumes. Clearly small business owners need larger reserves of savings to cushion these shocks. But often we are seeing the opposite result: dwindling savings as small businesses are covering expenses from their own reserves as capital access is constrained. Indeed, I had reported in an earlier blog post that the small business development centers in New Orleans had shared with me that the local businesses they serve lacked sufficient funds to cover the costs they would incur should an evacuation be ordered – a particularly alarming finding in hurricane season.

The study concludes with a recommendation for greater innovation to make tools and financial products available to cushion the financial shocks resulting from fluctuations in income and expenses. I don’t agree entirely with that finding. The fact is we have such products available, but the large segment of the U.S. population that lacks basic bank accounts shows there is a problem with access. Similarly, many small business owners lack adequate insurance to cover their losses. Perhaps the focus should be not on financial innovation but on expanding financial literacy to inform people of financial solutions currently available to them.