Liquid assets, often in the form of emergency savings, contribute substantially to financial wellbeing across income and demographic factors. For instance, liquid savings of a few hundred to a few thousand dollars have been shown to significantly buffer households from material hardship in the near-term. But what does that mean for long-term financial wellbeing? Relatively little research has examined the role of household liquidity to financial wellbeing over time. This paper is the first in a series authored by academic scholars in collaboration with the AARP Public Policy Institute that addresses this research question.
Key Findings: Households that achieved liquid savings of just $2,452 at any point are significantly less likely to experience extreme financial hardship up to three years later. When controlling for other financial and demographic factors, achieving this savings buffer at any point in a four-year period is associated with a 9.5 percentage point decrease in the likelihood that a household will experience extreme hardship three years later.
The study begins by defining what constitutes a “substantial” emergency savings buffer for the average low-income household, using the empirical relationship between liquid assets and whether such a household experiences any form of financial hardship over the next few months. A “substantial” buffer is defined as one that is at least $2,452, based on a 2019 finding that $2,452 is the level of household liquidity that is associated with the sharpest change in the conditional probability of entering into any form of financial hardship. This amount represents roughly one month of income for the average and median low-income household in this study’s sample.
Household financial hardship is measured by six variables, each of which is an indicator of distress:
- The food you bought did not last?
- Could not afford balanced meals?
- In the previous year, did you ever cut the size of your meals or skip meals because there wasn't enough money for food?
- Was ... unable to pay the utility bills?
- Was ... unable to pay rent or mortgage?
- During the month(s)...was not covered by any health insurance, did he/she go doctor, nurse, or other medical provider?
Results: During the studied period, the probability that a low-income household transitions from a high hardship to a low hardship state is 32 percent for households with more than $2,452 in savings. This estimate compares with an 18 percent probability for households with less than $2,452 in savings. In other words, high-hardship households that achieved the savings goal at any point in time over the period studied have nearly twice the likelihood of improving their financial wellbeing to low-hardship compared to households that did not achieve the savings goal. A liquidity buffer is also associated with significant improvements in a household’s financial wellbeing ranking, relative to its peers, over time.
It is important to note that this analysis speaks to correlation and not causation. It is possible that improvements in financial well-being – due to, for example, getting a more stable job – is the underlying factor that permits a household to both accumulate a savings buffer and also experience less hardship over time. If this were the case, the savings buffer may not be contributing to the long-term decline in hardship. Nonetheless, even in a situation of improved financial wellbeing, the act of building a savings buffer is a choice. A household could, instead, choose to consume any extra discretionary income.
Conclusion: These results point to the power of liquid assets in sustaining financial wellbeing over time. They also bolster other recent research findings that savings is a dynamic process of accumulation and decumulation. Low-income households that spend their liquid savings, presumably in the case of common unexpected events, can still be better off financially compared to similar households that never saved approximately one month of income. These are important takeaways for policy and product design to better meet people’s real financial needs.
Sabat, Jorge. Emily A. Gallagher. Does short-term emergency savings translate into longer-term financial wellness? Washington, DC: AARP Public Policy Institute. November 2020. https://doi.org/10.26419/ppi.00117.001
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