You May Be Shocked at How Volatile Household Income Can Be

On this Motley Fool Answers episode, Robert Brokamp is on his own to interview Rachel Schneider, a senior VP at the Center for Financial Services Innovation, and professor Jonathan Morduch, who teaches public policy and economics at NYU, about their new book, The Financial Diaries: How American Families Cope in a World of Uncertainty. For the study behind the book, their team tracked essentially everything about the finances of 235 families in five states for a full year, giving them deep insights into where we are succeeding, where we're not, and what obstacles are most commonly in our paths.

And a big one, as they discuss in this segment, was volatility: If your salary is fairly consistent, you're lucky. On average, the families had five months out of the year where their income was either 25% more or 25% less than their average. And spending, less surprisingly, can fluctuate widely as well, though often not in sync with income.

A full transcript follows the video.

This video was recorded on Sept. 26, 2017.

Robert Brokamp: At this point you may have heard about the stat from the Federal Reserve that almost half of American households don't have enough cash to cover a $400 emergency and there's no shortage of other statistics about the struggles of lower and middle-income Americans. But have you ever wondered about the stories behind the statistics?

If so, I've got the book for you. It's called The Financial Diaries: How American Families Cope in a World of Uncertainty. It's written by Rachel Schneider, a senior vice president of the Center for Financial Services [Innovation], and Jonathan Morduch, a professor of public policy and economics at NYU; and today we're lucky to have them both in the studio with us. Welcome Rachel and Jonathan.

Jonathan Morduch: Thank you.

Brokamp: Let's get into the study behind the book and why you did it. You and your team tracked the finances of 235 families across, if I remember correctly, five states for about a year from the period of 2012-2013 and you looked at everything. Spending. Saving. Borrowing. Even in-kind types of financial transactions. How did you choose these people and how did you monitor their finances? Was it an actual diary?

Rachel Schneider: I wish it were as simple as having given people diaries. That would have been more straightforward. What we did, actually, is we had field researchers in each of the areas of the country that we were working in, and they both recruited the families and then they went and met with them every few weeks. They were really collecting this data in person, which is what gave us such an amazing depth; a richness around understanding not just the numbers that we were collecting, but what was going on in these families' lives.

Brokamp: And it wasn't just lower-income households, although many of them were.

Morduch: In the communities, we weren't catching the very poorest or the very richest. [About one-third of the households were below the poverty line]. Most [were] between the poverty line and twice the poverty line [maybe $50,000]. But then another group above the median in their communities, so kind of solidly middle class. But the key for all the families was that everybody had a worker. Everybody had some form of employment; at least one member. And so we were trying to capture households that were working. They're trying to move ahead. And watching them over the year gave us a chance to see where they were succeeding, where they were falling behind, and where the obstacles were coming from.

Brokamp: I'm a certified financial planner, and like every financial advisor you want to help people plan for the future. But to do that, you have to know how much money you're going to make and to me that's one of the most surprising things of your book; is how volatile income is for these people.

Schneider: Yes, it really was. The way we looked at volatility is we calculated the monthly incomes and then we compared spikes and dips -- moments when the income was 25% more or less than the average monthly income. And what we found in our sample was that, on average, families had five months out of the year where their income was either 25% more or 25% less than their average; and even that number really understates it, because when we look at how big those spikes and dips were, they actually were closer to 50% than 25%. We were just using 25% as [a] benchmark that's far enough from the average that it must matter. It must make a big enough difference in your spending.

So what you see is people are really having to budget month by month, or week by week. One of my most memorable moments in the study was talking to a couple that said, "Every Sunday night when we get our schedule for the week we sit down and we figure out how much we're going to earn that week and then we figure out which bills we can pay."

Brokamp: One of the things I like about the book is that you actually get to meet some of these people, although you've changed the names. To me one of the most interesting people is a woman named Janice Evans. This is a woman who's been working at a casino for 20 years. She works every night from 8:00 p.m. to 4:00 a.m. Makes $8.35 an hour. Hopes to double that with tips but it doesn't always happen and it varies based on the time of year, the weather.

And to me it was surprising that it depends on whether it was an even or odd year because certain years Mississippi State plays a home game against Alabama and LSU. Those people come to the state of Mississippi and they gamble on the way back. That determines how much money she's going to make in any given year.

Morduch: Yes, Janice is really amazing. She works really hard. She's a very religious person. She doesn't actually like gambling, herself. She doesn't touch it. But her life is bound up with the gamblers and when they're winning, because she depends on tips, she's winning. When they're losing, she's losing. And when the casino empties out in the winter and fall [football season comes to Mississippi and everyone's home watching the game instead of being at the casino], she sees that in her paycheck.

So part of her is like, "That's great! They should be home with their kids and their families and saving their money." But another part is she really sees it in her paycheck. You can see that the summers are big. The winter and the fall are really down, and that's a real challenge for her. And you wouldn't see it in her average income, which is pretty good for that part of Mississippi, but September to November she's actually having to cut back on groceries and food, so it's a really different story when you're following week by week how her family is doing.

Brokamp: One term from the book that I learned was "episodic poverty." So over the course of the year, someone might be above the poverty line, but depending on when they realize their income, they have these periods of where they're below the poverty line.

Schneider: Absolutely true. We have this idea that people will simply save during the up months, or borrow during the low months and smooth it out for themselves, but that's really ambitious when what you're doing is operating at breakeven. Like that's a completely reasonable strategy for those of us who can keep a cushion or a checking account, because then we'll just fluctuate up and down around some basic amount that allows us to avoid fees and access low-cost credit.

But if you're fluctuating up and down around zero, sort of the way Janice is, then what you're going to find is you have some months where you are technically poor and where you really just can't make rent or can't, as Janice says, buy the same groceries you would during other parts of the year.

Brokamp: And the spending is also very variable, and it would be great if it went in the same direction as the income, but it didn't. And if I remember correctly, something like 60% of the spending spikes were not accompanied by an income spike, as well.

Morduch: Yes, everyone's juggling, so there are expense spikes that are hitting. Some of them are medical needs. Some of them are your car breaks down. Your roof needs fixing. You've got that going on at the same time as not knowing what hours you're going to get at the shop or with Janice not knowing how good a night she'll have on a Thursday, or what have you. That's the real challenge.

And so a lot of the financial advice that we dole out -- which makes sense for households that are basically stable [automate your savings, and plan and budget] -- just falls apart for these families. They're working really hard and they're budgeting any way they can, but the financial advice we have just doesn't fit their situation.

Brokamp: A lot of people might think of this as more of a lower-income problem, but apparently that's creeping up into the middle-income areas. I think one of the lines from your book was that we all hear about income inequality, but income variability is actually rising faster and it is affecting more people. Why is that? Is it the gig economy? Is it the change from a manufacturing-based economy to a service-based economy? Why are we seeing more of this volatility?

Schneider: The things you mentioned are a part of it, and the gig economy is the phrase I think that's getting the most traction in explaining this, but it's only part of the story. But it's a useful, illustrative part of the story. So if you think about the gig economy, what's happening is that people are working for themselves, or they're doing a job that is somehow outsourced by the company. The company is no longer bearing the risk of the ups and downs.

Uber is a good example. Uber, the company, bears relatively little risk that more or fewer people will want to use their services. They've passed that risk entirely onto their workforce. And the drivers are the ones who feel it if fewer people want to use the service. They feel it directly.

But that's happening in all sorts of companies. So retailers, both large and small, flex the workforce that's onsite-based on demand for their services. And as companies have gotten more efficient [and] more productive, what that means is they're able to use analytics to carefully calibrate how many people they're going to want on the floor helping customers Tuesday at 4:00 p.m. relative to Friday at 6:00 p.m.

So a lot of people who have full-time work nonetheless are sharing in the ups and downs of demand for the services of their employer in the way that we associate with tips. We knew restaurant workers experience that, but the fact is about half of American workers work hourly and a lot of those hourly jobs come with the right of your employer to flex the number of hours you get up and down.

So there's really a broader trend in the labor market around shifting to putting more risk onto the worker relative to the firm, and that's really the more global explanation versus just describing it as the gig economy.

Brokamp: You talk briefly in the book about just the mental tax of income volatility and cited some studies that found that people are more interested in income stability than more income. You used an example of a guy whose job was to fix trucks. He chose a job farther away that was more stable. It probably results in lower income, but he was willing to do that because it was easier for him to plan that way and there's a peace of mind that comes with knowing how much money you're going to have a month from now.

Morduch: Yes, one spring the truck mechanic was visiting and talking to his wife, and she was just in a bad mood. And he asked, "What's going on? It's a beautiful spring day." And she knew that in the spring the trucks weren't breaking down so her husband wasn't getting so many hours and they were going to see that in the paycheck. And she had a mortgage payment to make.

She had the money in hand, and she wasn't sure whether she should actually put it in the mail because she didn't know what was going to happen in the next paycheck. And she was just carrying that weight with her in a way that most people wouldn't even think about. You just send it off. But when you're living that life, everything becomes contingent and you're always waiting and juggling. And it took us having to spend time with families to see the costs of that.

And as you were saying, Jeremy eventually moved to a job that was 45 minutes away. He had a longer commute and worse pay on average; but steadier hours, guaranteed hours, and it started to change everything for them.

Brokamp: That was an interesting story for me, too. Talking about shifting risk onto the employees -- he earned a commission based on how many trucks he could repair. So he could go into the garage, wait for a truck to break down, and not make as much money, just because that night it just so happened that no trucks broke down.

Morduch: Yes, it was all on him. Sometimes over an eight-hour shift he'd have one truck to fix the whole time. So winter and summer he'd do better, but he was bearing the risk of seasonality in that case.