There are plenty of generic suggestions about how much money you should have in a “rainy-day” fund to deal with unexpected expenses or an income loss. Typically it is around three to six months income saved in an accessible liquid form such as savings/checking accounts or money market accounts. Ignoring the question of whether most of us actually do that (Hint: The answer is no), does that generic standard really apply to all income classes?
The JPMorgan Chase Institute looked at this issue differently in a recent report. They analyzed a significant sample of their account database to categorize volatility (monthly swings in income and consumption) and the correlation between income and consumption. After breaking the data up into quintiles of income levels, the Chase group calculated a one-month buffer for each quintile of income level and compared actual account balances to the recommended buffer level.
Volatility was found to be quite high. When volatility was arranged in order from the lowest (greatest negative change) up to the highest, the 25th percentile showed swings in consumption nearly steady at -25 percent for all income levels, and increasing slightly from 26 percent to 29 percent as income levels increased. The trends were similar yet smaller in income, with -9 percent to -15 percent representing the 25th percentile in incomes and 11 percent to 16 percent representing the 75th percentile.
In plain English, that means consumption is more volatile than income, and the amount of volatility is relatively constant across all income groups. Surprisingly, there was very slight positive correlation between changes in income and changes in spending.
The Chase report then used these volatility factors to create an overall worst-case volatility range that an average person in each income quintile should have to be considered a true one-month buffer. In other words, if in one month you get a negative change in your income equal to the 5th percentile of income change in your group and a positive consumption change that puts you in the 95th percentile of consumption in the same month (spending more with less income), do you have the account funds on hand to handle it? The report says no, but that the upper quintile is close enough that they may be able to squeeze by.
Here are the results by quintile for the amount needed, the average amount of assets in liquid form, and the shortfall for a one-month cushion. Remember that the “needed” value represents a change in both directions; so assume half that value represents both the drop in income and the rise in spending for that month.
Quintile 1 ($0-$23,300): $1,600 needed, $600 available, shortfall of $1,000.
Quintile 2 ($23,301-$40,500): $2,800 needed, $1,400 available, shortfall of $1,400.
Quintile 3 ($40,501–$63,100): $4,800 needed, $3,000 available, shortfall of $1,800.
Quintile 4 ($63,101-$104,500): $8,200 needed, $6,800 available, shortfall of $1,400.
Quintile 5 ($104,501-$153,600): $13,800 needed, $13,500 available, shortfall of $300.
The shortfalls in the first three cases are particularly troublesome since they make up a large percentage of income. Many in this position will have no choice but to fill the gap with credit, making the situation worse in future months.
Remember, this analysis covers only one bad month. What happens if you have two in a row, or more? Turn that unpleasant thought into a positive by reviewing your habits to build up your nest egg as much as you reasonably can. Unless you are in the highest income levels, this study suggests you could benefit from a good review.
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