Last week the Federal Reserve Board of Governors released the results of its triennial “Survey of Consumer Finances (SCF).” Last conducted in 2010 and published every three years, the SCF offers a fascinating look at changes in household income and net worth. Officially titled, “Changes in U.S. Family Finances from 2007 to 2010: Evidence from the Survey of Consumer Finances,” this year’s survey results are based on 6,492 completed interviews of U.S. households.
Reading through the 80-page report this morning, I noted a few interesting results. In particular, when asked about the motive behind their savings plan, participants most frequently cited liquidity-related concerns (35.2%). In the Federal Reserve survey, liquidity savings is interpreted to “include ‘emergencies,’ the possibilities of unemployment and illness, and the need for ready money (footnote 16, page 15).” Saving for liquidity purposes actually ranked ahead of saving for retirement (30.1%), future purchases (11.5%), and education (8.2%).
Perhaps more interesting was the follow up question, which asked what level of precautionary or emergency savings was adequate. These results are summarized in Table 3.1 and displayed below.
Table 3.1 (page 16): "Changes in U.S. Family Finances from 2007 to 2010: Evidence from the Survey of Consumer Finances," Federal Reserve Bulletin, vol. 92, no. 2, June 2012
According to the data, the median household felt that $5,000 was an adequate level of precautionary savings. The desired level of emergency reserves increases proportionally to income, as one would expect. However, when calculated as a percentage of household income, the precautionary savings level is relatively consistent across household income levels, with a median liquidity savings target of just 10.8% of annual income. To put this level in perspective, 10.8% of one’s annual income would represent an emergency reserve of just 1.3 months worth of income.
Is only 1.3 months of cushion enough to survive the loss of a job, a medical emergency, or an unexpected cost to repair a vehicle or home? Most likely not.
In our wealth management courses, John Spitzer and I typically recommend that a good savings plan begin with liquid emergency reserves to cover at least 3-6 months living expenses, with 6-12 months serving an even better target. We like these emergency funds to be held in a separate, liquid account (savings account, money market, CD ladder, etc.) that can be quickly tapped if necessary, but not so easily that they might be used to fund a “rainy day” purchase.
