/A professor says Americans need surprisingly low emergency savings – Business Insider

A professor says Americans need surprisingly low emergency savings – Business Insider

  • Emily Gallagher, an assistant professor of finance at the University of Colorado Boulder, found that roughly one month of income — or $2,467 — is the minimum emergency buffer an average low-income household should hold.
  • In her empirically grounded research paper, Gallagher leans on the relationship between the probability of falling on financial hardships and liquid assets to bolster her thesis.
  • She also shares the best places to park your money once you’ve eclipsed that savings goal.
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There’s no denying that times are tight for Americans. 

Savings are paltry, fruitful investment opportunities are scarce, and statistics continue to demonstrate retirees‘ lack of preparedness as they enter their golden years.

Many are struggling just to make ends meet — a notion that was made explicitly clear after a recent Federal Reserve survey showed that four in 10 US adults couldn’t cover a $400 emergency expense. 

The dire state of Americans’ finances led Emily Gallagher, an assistant professor of finance at the University of Colorado Boulder, to dig deeper for answers. She specifically sought a concrete number that emergency savers could strive to achieve.

Her findings were surprising.

“The threshold point for experiencing any form of hardship is estimated to be $2,467 (in 2019 dollars) with a 95% confidence interval of $1,814-$3,011,” she wrote in a recent research paper. “This equates to roughly one month’s income for the average and median household in our sample, which is far less than the savings amounts implied from the existing rules of thumb commonly offered by financial advisors (typically 3-6 months of income).”

Her conclusion is clearly at odds with that conventional wisdom, but she has the data to back it up. It all comes down to liquidity and the probability of an expense shock.

“The size of a household’s liquidity buffers is a key predictor of its future probability of financial trouble,” she said.

The chart below depicts the relationship between the six-month future probability of falling on financial hardships — missing rent, bills, food, or needed medical care — juxtaposed with the amount of liquid assets a household has on hand. It comes as no surprise that those who have less saved are more likely to be financially stressed in the future.

liquid asset/probability of hardship

Emily Gallagher

This makes perfect sense, but the real takeaway is the nonlinearity of the relationship — especially around the $2,000 mark.

For households with low savings, any additional dollar socked away makes a material difference in the probability of falling on hardship. However, this relationship starts to deteriorate around the $2,000 threshold. That means any additional dollar saved doesn’t necessarily reduce the probability of being in a precarious financial position — and it’s the cornerstone of Gallagher’s thesis.

“You’re using the data to choose the location that best separates the low-savings, high-hardship regime from the high-savings, low-hardship regime,” she said. “More savings is generally good — you lower your level of hardship — but at a certain point, it’s not helping you very much.”

What’s more, she says large expenses — over $2,000 — are generally quite rare. However, smaller expenses — in the $100 to $200 range — are much more frequent.

She backs her thesis with more hard data.

The graphs below depict the density and cost of repairs and maintenance expenditures (left), and the density and cost of out-of-pocket health expenditures (right). The distribution mirrors that of the chart above.


Emily Gallagher

To be explicitly clear, by no means is Gallagher suggesting that households should be saving any less or holding less liquid assets. Her findings are speaking only to the relationship between liquid savings and the probability of experiencing a near-term financial hardship.

“It is important to note, however, that our estimates should not be interpreted as an optimal savings level,” she said. “We are not talking about how much you should be saving to achieve longer-term financial goals like: paying for college or buying a house.” 

Against that backdrop, she shares her best advice for those who have met and surpassed that key $2,647 threshold. 

“Once you have that, store it away,” she said. “Use the rest to pay down debt, and once you’ve paid down that debt — anything above that $2,467 — start investing.”

As far as places to park your money are concerned, Gallagher suggests varying the liquidity of your investments. Investment vehicles like money-market funds, US Treasurys, high-yield bank accounts, and even equities (if you have a longer-term time horizon) all fit the bill.

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