ByJeanne C. Marra
In a word association game, the term “income volatility” would likely spur thoughts of two experts—Jonathan Morduch and Rachel Schneider. Morduch, a professor of public policy and economics at New York University, and Schneider, a senior vice president with the Center for Financial Services Innovation (CFSI), are authors of The Financial Diaries: How American Families Cope in a World of Uncertainty. Through data around cash flows and personal stories of study participants, the book shares insights from the lives of 235 low- and middle-income families as they navigate through a year of financial transactions, and challenges popular assumptions about how Americans earn, spend, borrow and save.
The authors brought the issue of income volatility and its framework from the U.S. Financial Diaries (USFD) research study to a recent event in St. Louis, co-sponsored by the Federal Reserve Bank of St. Louis and Washington University in St. Louis.
Schneider attributes a portion of income volatility to shifts in the labor market, or “the great job shift.” Broader than simply a drop in manufacturing, she describes a decline in middle-skill jobs, coupled with an increasing amount of variability and volatility in work schedules, resulting in income spikes and dips. With more than half (58.7 percent) of wage and salary workers in the U.S. paid hourly in 2016, according to the Bureau of Labor Statistics, this volatility is especially pronounced for low-income workers and those in jobs most affected by just-in-time scheduling.
In about half of the months during the study, pay was 25 percent more or less than the average month, and the average spike and dip was actually 50 percent, which turns on its head the idea that budgeting is what really matters, especially when budgets are typically based on fixed incomes. Layering spending that was just as volatile as earning was very surprising.
While flexibility in the workplace can have benefits for both workers and firms, the real concern is around the locus of control; in lower-wage jobs, unlike those of higher-wage counterparts, a variation in schedule is often the choice of the employer and not the employee, who is least equipped to deal with this variability.
The authors—anchored on a core financial model of a lifecycle arc that frames thinking around how to guide savings and inform tax subsidies and investment strategies—challenge the conventional model of poverty that is based on an annual income line. They assert that, in addition to looking at income and assets, a third element—cash flow—is an important addition and provides what Schneider calls “a new lens for understanding poverty.”
Case in point: Jeremy and Becky, a couple featured in The Financial Diaries, are not poor according to standard poverty measures. Yet for six months of the year, when Jeremy’s commission-based income wavered, their income dipped below the local poverty line; thus, they were what Schneider and Morduch refer to as “sometimes poor,” a condition they say is increasingly common. In fact, almost a third (32 percent) of households whose annual incomes are two times higher than the supplemental poverty measure spent at least one month below it during the year. This instability, coupled with the lack of liquidity or coping method, constitutes a major challenge to low-income families.
Families in the USFD study employed strategies for managing their financial lives amidst this volatility, processes the authors referred to as coping and smoothing. Less about having a certain amount of money, “It’s about having the right money at the right time,” Morduch says.
The authors noted three different phases of expenses that families save for: those incurring now, soon and later. It’s in the middle phase—soon, such as holiday shopping, returning to school or fixing a roof—where families often face the hardest choices. Some resort to self-imposed barriers to maintain control (e.g., purposely forgetting account numbers or cutting up bank cards). Another popular strategy is to employ “bank of far away,” which aims to increase savings by intentionally making it less convenient to withdraw money from a particular account (e.g., opening multiple accounts at banks far from home, opting to forgo access tools outside of visiting in person). Morduch attributes the success of strategies like these to having the “optimal level of inconvenience.”
While financial coaching can be an effective strategy, researchers could provide better guidance about what people really need to hold in reserve. There is an opportunity cost to saving—it is money that’s not used to pay down debt, not being invested in education, not being used to replace a car that could be breaking down.
Even broadly promoted wealth-building strategies, such as automated savings, should be evaluated in this context. Many people feel like they are paying another bill, even if they are paying themselves. Morduch agrees that such decisions should be made case by case. “It’s a good way to save if you already have a buffer, but it doesn’t work for everyone. Behavioral economics is often about locking up your money so you can’t touch it. But what we saw, because of the instability, is that this often backfires; [people are] looking for ways to have structure but also flexibility.”
While income volatility affects approximately 30 percent of white households, it affects 40 percent of black households and 41 percent of Hispanics, according to the Federal Reserve’s Survey of Household Economics and Decisionmaking report. But there’s another facet of inequality that Schneider also describes through the example of Sarah, profiled in the Financial Diaries, who pursued additional education to get a better-paying job. Like many, Sarah had to make a choice—take a risk—to earn less in the short term and take on additional debt in order to seek mobility. The math one has to do to decide about whether this risk is worth it is really complicated.
“If you want people to take the risks of striving for mobility, then you need to help them solve for stability now,” Schneider said. “We want to think that mobility is a right of all Americans, but the reality is that the ability to take this risk is not equally distributed in our society.”
Social service organizations are helping individuals like Sarah take this risk, stepping in to provide a safety net of support services, such as affordable child care and emergency payments to help mitigate common risks and overcome barriers for those seeking transitional steps like educational opportunities. Social networks are also very important.
Schneider is “very optimistic about what technology can do,” citing innovations such as Homebase (a mobile app that gives employees more control over their schedules) and Even (a bank app that helps balance variable paychecks), adding that we are on the verge of an increased use of data, improved analytics and expanded use of artificial intelligence to better assess people’s well-being.
Schneider credits co-sponsors Ray Boshara, senior adviser and director of the St. Louis Fed’s Center for Household Financial Stability, and Michael Sherraden, director of the Center for Social Development at Washington University in St. Louis, with being pivotal in influencing her career. “The idea that wealth would matter as much as income completely changed my way of thinking about the world,” Schneider said, adding that she and Morduch wanted to build on work that was already known. Morduch added that St. Louis “is the place in which some of the hardest, most important thinking about the financial lives of poor households and assets has taken place.”