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Three steps that can help vulnerable Americans overcome financial fragility

Annamaria Lusardi, Economist
Financial problems
Anchiy | E+ | Getty Images

The unemployment rate sits at an all-time low of 3.7%, the memory of the last financial crisis is dissipating, and the stock market is up more than 300% since 2008. Yet, nearly a third of Americans lack the resources to weather a mid-size shock.

The latest edition of the National Financial Capability Study finds that 31% of Americans last year could not come up with $2,000 to address an unexpected need within a month. They would have been unable to manage a major auto repair, a home-front emergency, or an unplanned medical bill.

In 2008, as many as half of Americans were unprepared for a financial shock, so the latest findings show improvement over the decade. But too much financial fragility remains.

A deeper look at the study reveals large and troubling differences within sub-groups of the population. Up to 36% of women, versus 25% of men, are financially fragile. As many as 35% of Millennials aged 18 to 35 are financially fragile. And neither full-time employment nor a solid income guarantees financial security. Many of those in the middle class, in term of income, are financially fragile.

Our idea originally was to measure financial fragility on the cusp of the financial crisis. Our research has shown that the measure we use is particularly rich and informative. It assesses not only a lack of assets but also high debt and difficulties with debt. In other words, it measures the state of the balance sheet rather than simply reporting whether one has precautionary savings.

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This measure also takes into consideration the many avenues within which people can address a shock, beyond relying on savings. For example, people could turn to their network of family and friends. They could work extra hours or take on a second job.

In fact, these strategies are what surfaced during focus groups with some of the most vulnerable populations in three American cities: Baltimore, Austin, and Cincinnati. Most low-income families facing a sudden shock would work more, often in second jobs driven by the gig economy.

Reporting such statistics is important because financial fragility can exact a debilitating toll on household well-being. At no time was this more visible than during the government shutdown in January. Within two weeks of being furloughed, many government employees were lining up at food banks or turning to charities for emergency help.

Our research also shows that financial fragility is not just a short-term problem. It can carry long-term ramifications. People unable to manage a shock, for example, are much less likely to plan for retirement.

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How to make a budget

In the personal finance course I teach at the George Washington University, we discuss a few potential safeguards against financially fragility:

  1. Have a budget. Use a simple income-and-expense statement to track your income each month and how much money you spend. This helps you manage your liquidity.

    Set a goal of saving each month, even if it is just a very small amount. Not only do small amounts add up to sizeable savings over time, but even small amounts can prove useful in emergency situations.
  2. Keep track of your debt. Short-term borrowing, including on credit cards, usually incurs high interest rates. This is especially true if the cardholder hits the limit or is unable to pay the minimum due each month. Taking on more debt may provide liquidity, but it can turn into an expensive solution in emergencies.

    Debt also carries long-term implications. Maxing out credit cards in an emergency or failing to pay cards and bills damages credit scores. That, in turn, makes debt more expensive now and in the future.
  3. Review your balance sheet. Are your assets and debt holdings allocated according to your needs? Do you have a cushion against shock? If you do not, what is your capacity to raise funds in a short period of time?

Simple actions, such as these three steps, are a move toward better outcomes. The first benefits they reap may be short term but the bigger picture — long-term financial security — will follow.

Annamaria Lusardi is an economist and the Denit Trust Distinguished Scholar and Professor of Economics and Accountancy at The George Washington University School of Business, where she also serves as the Academic Director of the Global Financial Literacy Excellence Center. She is also a member of the CNBC Financial Wellness Council.

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