Despite the improved economic performance since the Great Recession, many families still find themselves in a financially vulnerable state due to a lack of emergency savings.
Many financial experts suggest that an individual or family should have enough money to cover three- to six-months of expenses saved in an emergency fund in order to be prepared for unexpected financial needs. However, most Americans do not have adequate savings to cover “rainy days.”
A recent study by the Pew Charitable Trusts found that more than half of American families (55 percent) do not have adequate liquid savings to cover even one month of income in case of an emergency. Among lower-income families, the typical family has less than two weeks of income in bank accounts and cash. Even taking into account hard-to-access resources such as investments and retirement savings, the typical middle-income family would only have enough to cover approximately four months of expenses, which would not be adequate to cover a major economic shock.
Similarly, according to the Federal Reserve’s 2014 Report on the Economic Well-Being of U.S. Households, 55 percent of survey respondents indicated that they do not have emergency savings large enough to cover three months of expenses, though an additional 21 percent indicated that they could cover three months of expenses by borrowing money or selling assets. Another recent survey by Bankrate.com found that, although 82 percent of families have a household budget, 62 percent of Americans do not have savings for emergencies such as a hospital visit or car repairs.
While it is commonly believed that financial emergencies are rare, the data shows otherwise. The Precarious State of Family Balance Sheets study by the Pew Charitable Trusts, after analyzing data from 1979 to 2011, found that income volatility is extremely common, as almost half of all households experienced an income gain or drop of more than 25 percent over any given two-year period. The study by the Federal Reserve found that a quarter of their respondents had experienced some type of financial crisis over the past year, the most common being either a health emergency or the loss of a job. Emergency savings are a vital part of providing financial stability and helping to eliminate financial stress in households, as many families are one emergency away from going into debt, which further drains away financial resources. The lack of emergency savings can also affect homeownership and retirement savings.
Ironically, one reason that families do not save for emergencies is the fact that they are already in debt. Approximately three-quarters of families have some type of consumer debt, including a mortgage. As of September 2015, total household debt in the US was $12.07 trillion; the largest component of this debt is for housing, with mortgage balances at $8.75 trillion. The largest components of the remaining $3.31 trillion of non-housing debt are student loans (36 percent), auto loans (31 percent), and credit card debt (21 percent). Consumers are also likely to have more than one type of credit product; for example, 81 percent of consumers that have a student loan also have a mortgage. These multiple debt obligations can build on one another to reach dangerous levels. For instance, the Pew study found that around eight percent of households report that their debt obligations are more than 40 percent of their gross monthly income.
According to the Pew study, almost half of American households consider themselves to be income-constrained, meaning they spend an amount equal to or greater than their household income. When budgets are strained, it does not seem like there is enough for families to be able to put aside some of their income into savings. Well over half of these income-constrained households, just under a third of total respondents, also reported not having any emergency savings. It is common for indebted families to enter a vicious cycle of perpetual debt, with a lack of emergency savings due to paying off debt leading to additional debt in the future when financial emergencies occur.
The lack of emergency savings is a small oversight that can have huge consequences. Further education surrounding the need for emergency savings, and even programs encouraging families to save each month, can get at the root problem and help families avoid precarious financial situations. Even for those currently trying to pay off debt, an emergency savings fund can enhance financial stability. Because financial stability is a major factor in future economic mobility for both parents and children, the presence of emergency savings can benefit generations to come and the economy as a whole.