– May 19, 2016 Reading Time: 3 minutes

We often think of savings as putting money away for big long-term goals, such as a child’s education or our own retirement. But a lack of shorter-term “emergency” savings threatens many Americans’ abilities to make ends meet every year. Small-to-medium sized financial shocks (unexpected expenses such as medical bills or a car breaking down) happen regularly, but the majority of households do not plan as such. Much like the phenomenon of overspending we looked at last month, this lack of planning doesn’t stem from a single flaw in our economy or culture, but shows how human nature can lead many of us financially astray.

In an excellent three-part study, the Pew Charitable Trusts show how deeply entrenched this problem is. As defined above, 60 percent of American households experienced a financial shock last year, with a median cost of $2,000. 47 percent of households reported “struggling to make ends meet” after a shock. This is not surprising, given the median household earning less than $50,000 a year has less than two weeks’ income in liquid savings. It’s worth stepping back to wrap one’s head around that last statistic: more than half of these households would not be able to replace two weeks of income without taking greater measures such as going into more debt, selling possessions, or borrowing money from friends or family.

Publications and personal finance bloggers urge their readers to build resilience against these financial shocks by keeping a dedicated savings account with the equivalent of one, three, or even six months of household income. And households agree: over 90 percent of Pew’s respondents said people like them should have at least three months’ income available for emergencies.

Yet 80 percent of those same respondents didn’t have the level of savings they personally recommended. These respondents run the full gamut of income, so many of these people should have the means to figure this problem out. Why, then, haven’t they?

Simply put, households are trading savings and security later for more consumption now. As we covered last month, the desire for instant gratification is probably part of human nature, and the ability to buy more now makes it very hard to stick to a savings plan. Economists call this phenomenon “time-inconsistent preferences”: decisions we make in the moment often differ from those we would make if we could lock ourselves in when planning ahead. The idea has been used to explain why people join a gym and never go, or keep planning to quit smoking “tomorrow.”

The most telling result from the Pew report is that making a household budget had no significant effect on a household’s level of emergency savings. Even planning to put more away at the beginning of the month is no guarantee of success. That latte or extra dinner out doesn’t sound that great when you’re planning three weeks ahead, but when the day arrives…time-inconsistent preferences strike again.

While there aren’t easy answers, it might be helpful to educate people to expect the ways they’ll depart from a rational budget. A potential tool might ask people to plan a month’s worth of spending and saving and then go on about their business, tracking actual behavior not to adhere to the original budget but to demonstrate how real behavior departs from the plan due to day-to-day choices. Learning from these results, people might begin to anticipate their realistic behavior, and learn to fit in savings in more than just an idealized way.

These problems don’t have single quick fixes, and likely need more comprehensive solutions such as the economic wellness initiative we’re planning at AIER. But any understanding or solution to the problem must account for the types of “mistakes” that are likely as a result of human nature.

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Max Gulker

Max Gulker

Max Gulker is an economist and writer who joined AIER in 2015. His research focuses on two main areas: policy and technology. On the policy side, Gulker looks at how issues like poverty and access to education can be addressed with voluntary, decentralized approaches that don’t interfere with free markets. On technology, Gulker is interested in emerging fields like blockchain and cryptocurrencies, competitive issues raised by tech giants such as Facebook and Google, and the sharing economy.

Gulker frequently appears at conferences, on podcasts, and on television. Gulker holds a PhD in economics from Stanford University and a BA in economics from the University of Michigan. Prior to AIER, Max spent time in the private sector, consulting with large technology and financial firms on antitrust and other litigation. Follow @maxgAIER.

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