Here's How Unpredictable Income Impacts People's Ability To Save Money
Here's How Unpredictable Income Impacts People's Ability To Save Money
How cash savings help smooth consumption
A lot of personal finance advice is written for people with a stable salaried job.
However, many people have incomes that fluctuate from month to month. This can pose a host of challenges when it comes to budgeting and saving.
Today, I will review research that shows that people with unpredictable incomes actually save more than people with predictable incomes. I’ll discuss what the researchers found and why people with predictable incomes might not save as much as they could—or should.
It turns out that people with unpredictable incomes make the rational choice to save more
The research paper titled “Income volatility and saving decisions” looked at how having an uncertain or fluctuating income affects people's ability to save money. The researchers wanted to understand if having unpredictable income makes people more cautious and save more, or if it makes them more impulsive and spend it quickly.
To test this, the researchers did a series of experiments with over 700 participants. They gave these participants hypothetical incomes that either stayed the same (no volatility), changed a little (low volatility), or fluctuated a lot (high volatility). The participants then had to decide how much to save or spend, knowing that at some point, a financial emergency would happen, but they weren’t sure when or how much it would cost.
They found that when people have highly unpredictable incomes, they tend to save more as a precaution. In the experiment, participants whose income fluctuated the most saved about $1,924 more than those with steady, predictable income. This suggests that when people aren't sure how much they'll make next, they're more likely to set money aside to prepare for potential financial emergencies. So, if your income is all over the place, you might naturally start saving more to cover unexpected expenses down the road.
This is, exactly the rational choice. If this month you had a particularly good month—but you know other months you don’t make as much, you should absolutely be saving more money than usual this month.
Having cash on hand helps a person with a volatile income smooth their consumption—which is a fancy way of saying that having savings allows you to spend about the same amount of money in bad months without going into debt.
One surprising finding was that income volatility didn’t seem to make people more financially impatient.
Some studies suggest that when your income is unstable, you might become more likely to take quick, immediate financial rewards instead of saving for the future.
But in this case, the participants didn’t show a big change in their preference for short-term rewards, even when their income was highly volatile. This suggests that saving in response to volatility might not necessarily be linked to impatience or impulsive spending but more about wanting to protect yourself from future uncertainty.
The takeaway here is that if your income fluctuates a lot, it’s extremely important for you to be a good saver and take advantage of the months when you're making good money.
People with good job security and a predictable paycheck can get away (at least in the short term) without saving much money. If the same amount hits your bank account every two weeks—and that is enough to cover your bills—it’s easy to get complacent about saving.
But if you make $15,000 this month and know that you might not make any money next month, it’s damn important for you to put some cash aside right now.
Think of a realtor who just closed a big commission but knows they don’t have any deals closing next month. This research suggests that they would probably do the smart thing, which is to put some money aside to cover the bills until their next deal closes.
And if your income is unpredictable, what kind of problems has that caused you in the past?
This article is for informational purposes only. It should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any significant financial decisions.
I have a friend, an entrepreneur, who learned the hard lesson of running out of money he should pay in taxes. He was due to pay some $20k to a local tax office but invested the money instead. The trade went against him. Long story short, he had to work more to make what he'd lost. Now he has a stable job.