Family Finances

Five Lessons About Financial Well-Being

May 15, 2020  • Genevieve Melford & Financial Security Program

As part of her Esther Peterson Consumer Policy Forum lecture at the American Council on Consumer Interests (ACCI) 2020 Conference, Genevieve prepared this article to share some of her career learnings with the greater financial security research community.

Money is power.  Power to keep yourself and your family safe, and to make choices with dignity and freedom.  Money provides a springboard, a soft landing, and the resources to enjoy life.  And as such, money provides the financial underpinning of human thriving.   At its most simple, financial security is having the money you need when you need it. And truly widespread financial security – when everyone has the resources they need to thrive – is a necessary condition for a just, free and prosperous society.

But what are the building blocks of “financial security?”  And what does it take for households to achieve it?  That is what I have spent my career trying to learn.  From 2012 to 2018 I led a strategic research agenda at the Consumer Financial Protection Bureau (CFPB) designed to understand what financial well-being really is, and what supports it.  During that time and since, many other researchers, funders, and policy and research institutions – including the Aspen Institute Financial Security Program (FSP) and our network of research partners  – have contributed to building a shared understanding of these issues.

Late last year, I spent some time synthesizing some of the emerging research and really taking stock of what it meant. Then COVID-19 happened, and I stepped away.  Now, weeks into the crisis, I revisited my list, and I’m astounded – because the research that was bubbling up is just the research that we’ll need to stabilize our economy – and rebuild the essential financial security tools that households across America need for the decades to come.

Five key insights stand out to me across this growing body of research:

1. People understand their financial lives better than you think– and cash flow is their foundation.
Financial well-being is an inherently subjective concept – it means the extent to which a person feels that their financial situations provides them with security and freedom of choice.  And when we started this line of research, many people raised concerns that perhaps people’s perceptions were not aligned with reality and therefore we should put no stock in what people “said” about their financial well-being.

What we have learned from multiple studies is that in fact the objective facts of a person’s financial life drive their sense of financial security and well-being.  Prior research using cross-sectional data suggested that this would be true, but as of 2019 we now have longitudinal data from researchers at USC, Washington University in St. Louis, and the Financial Health Network confirming that changes in a person’s objective financial situation – both income and expense shocks – are associated with changes in their sense of financial well-being, in the expected ways.

Gaining employment, a raise or promotion, or simply more predictable and less volatile income were the key factors found to increase financial health and well-being. On the other hand, losing a job or having hours reduced or facing a major medical or other expense were the key predictors of declining financial health and well-being.

These findings are consistent with that of Aspen FSP’s Consumer Insights Collaborative that higher, more consistent income, paired with manageable cost-of-living expenses (income higher than expenses), is the critical foundation for financial stability and longer-term security.  Yet even before the economic fallout of the coronavirus pandemic, only 41% of Americans had household income that exceeded their expenses in 2018.

2. Financial data sets don’t tell the whole story.
People’s knowledge of their own financial situation goes beyond observable financial data. It includes knowledge of personal context such as household needs and resources like social capital, personal knowledge of risks and upcoming opportunities, and of course, personal preferences.  We see this in research that shows that financial well-being, though highly correlated with objective metrics like credit score, income, and banking data, is still a distinct concept that tells us more about the true state of financial security than financial data alone.

3. Liquid savings are a key barometer of financial well-being and the first line of defense against more limited volatility.
That being said, liquid savings are a particularly valuable barometer of financial well-being. Prior research by the CFPB found that liquid savings is the single variable most highly correlated with financial well-being. This makes intuitive sense, as savings can be seen as both an outcome of having routinely positive cash flow (which is in itself a foundation of financial security), and a key form of financial stability in its own right. Not only do readily accessible savings protect against material hardship (such a housing or food insecurity, or being unable to pay for needed medical care), but they also provide the material resources and mental bandwidth for people to be able to weather smaller financial shocks without getting knocked off track from working toward longer terms and more robust financial security.

Building on this result, three new studies utilizing longitudinal data (USC, Washington University in St. Louis, and Financial Health Network) find that having higher levels of liquid savings protects against declines in financial health and well-being in the face of relatively limited expense shocks, as do other financial cushions such as higher income and access to the safety net of family and friends.

The JPMorgan Chase Institute’s recent careful analysis of administrative banking data for more than 6 million families finds that families “need roughly six weeks of take-home income in liquid assets to weather a typical and simultaneous income dip and expenditure spike,” but “sixty-five percent of families lack a sufficient cash buffer to do so.”

4. Money management behavior matters.
When people have enough income to pay for essentials, how they manage their money impacts the savings and financial cushions they can build. The USC and Financial Health Network studies find that certain money management behaviors – planning ahead, having a habit of saving regularly, spending less than income, maintaining a manageable debt load – are associated with higher levels of financial health and well-being in the present and in the future.

These findings are remarkably consistent with prior research using structural equation modeling to study the relationship between financial behavior – controlling for income – and a person’s objective financial situation, using only point-in-time data.  And with findings from similar studies conducted in other countries.

5. But people cannot fully insure themselves all the time. Safety nets are essential.
While liquid savings and other personal safety nets are incredibly valuable, they can’t protect against larger or more persistent shocks, such as job loss or major medical expenses.  One recent study found that even the most financially responsible people are no more protected against loss of financial well-being than everyone else when major financial shocks hit.  And another found that higher levels of liquid assets and social networks don’t protect people from loss of financial well-being in the face of negative income shocks, which tend to be relatively larger and longer in duration than typical expense shocks.

This implies that the broader safety nets provided by government, employers, and other institutions are a necessary complement to the personal safety nets people develop through their own ingenuity, efforts, and access to income producing opportunities.  I wrote these words to myself six months ago, but the relevance of this point is clearly enormous today, in the midst of the highest unemployment since the Great Depression.

Two Implications for Researchers, Policymakers, and Leaders

So what does this all add up to?  To me, there are two key implications:

First, that people’s financial well-being rests on three pillars:

  • Stable and sufficient income relative to cost of living;
  • Effective money management and personal resources, including liquid savings; and,
  • Social safety nets, both private and public.

These are the building blocks of financial security, and without all three of them America won’t have a financially secure and healthy population.  They are where we should look to diagnose the roots of financial challenges facing US households, and where we should look as we design and scale solutions.

Second, we need to ask people about their financial lives and what they need to be successful.  The lived experience and personal knowledge of US households are critical resources that must be tapped to design the income, savings, and safety net solutions that will put America on a path to widespread security, prosperity and well-being.

As the United States continues to wade through the health crisis of COVID-19, and as policymakers continue to grapple with how to rebuild our economy, I encourage all of us – city, state, and national leaders; businesses; foundations and civic leaders – to remember that people form the center of our nation’s well-being.  If we neglect to build smart policies that enable all people to thrive, if we forget to rebuild household financial security for those who have lost it and to help those who never had it achieve it going forward, if we omit taking equity into account, we will be far worse off as a nation.  Our macro-economy can never recover if we don’t build it on the foundation of healthy, financially secure households.