financial fragility

Quick question: If you were to face a $2,000 unexpected expense in the next month, could you get the funds you need?

Answer: (a) certainly able

(b) probably able

(c) probably not able

(d) certainty not able

If you answered (a), kudos! Answering (b) isn’t too bad, but (c) or (d) have me worried.

Nationally, 24.9% of respondents answered (a), 25.1% answered (b), 22.2% answered (c), and 27.9% answered (d). So almost exactly half of all respondents would have trouble meeting an unexpected financial expense (see the WSJ article that summarizes just how fragile US households are).  These findings are summarized in a report by the National Bureau of Economic Research based on a survey from 2009. I’ve heard that an unexpected financial crisis that would lead to someone filing for bankruptcy is small (less than $2000!).  This is depressing.

Why am I bringing this up on an OR blog? Well, I am also an OR educator who firmly believes that part of my job as an educator is to teach students how to be better citizens.  Good citizens, in my opinion, are savers (among other things).  I’m not alone: my PhD advisor frequently shared advice on saving for retirement and on reducing travel expenses.

I’m not sure OR students would necessarily avoid making financial mistakes that could lead to bankruptcy, even with high-paying jobs.  The researchers who wrote the aforementioned report find that:

  • 9.8% of respondents making more than $150K per year would certainly not be able to cope with an unexpected $2K expense, with an additional 4.7% probably not able to cope.
  • 10.8% of respondents making $100-150K per year would certainly not be able to cope, with an additional 12.9% probably not able to cope.
  • 11.3% of respondents with graduate education would certainly not able to cope, with an additional 11.6% probably not able to cope.

It could be worse. This is a list of respondents in various countries that would certainly not be able to cope:

  1. UK = 35.5%
  2. Portugal = 32.1%
  3. Germany = 28.9%
  4. USA = 27.9%
  5. Netherlands = 18.9%
  6. France = 18.8%
  7. Canada = 15.9%
  8. Italy = 9%

At the end of each semester, I tell students the seven things I want them to really learn from my class (see the blog post here), one of which is to “Do not live outside of your means, even on a graduate student stipend.” Maybe I should expand that bit of advice but not to the point of preaching.

How do you give financial advice to students?

Related posts on frugality:

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4 responses to “financial fragility

  • Paul A. Rubin

    Perhaps you can turn this into an application of stochastic processes. Money comes in somewhat predictably (but not in a deterministic manner, viz. layoffs) and goes out in a somewhat less predictable (but not totally random) manner. Savings represent an inventory that buffers against randomness.

    It’s good that you bring it up in class. I’m sure a portion of the students roll their eyes, but your class might be one of the few places (in or out of school) where they hear about self-control and the perils of instant gratification. (Although that may change: I learned about saving from my parents, who survived the Great Depression. Perhaps the survivors of the Great Recession will pass along a similar message.)

  • iamreddave

    Freakonomics radio had a really interesting podcast related to this a few weeks ago
    http://www.freakonomics.com/2010/11/18/freakonomics-radio-could-a-lottery-be-the-answer-to-americas-poor-savings-rate/

    Their suggestion was to have a prize bond system so that money spent on lotteries would actually act as savings. I think a prize linked savings system like this could really help a very poor and very lottery obsessed country like Haiti
    http://liveatthewitchtrials.blogspot.com/2011/02/no-lose-lottery-would-help-haiti.html

  • anonymous

    I think one of the most useful ways to learn about financial tools is to try things, and to fail gracefully when you make a mistake. That is, it can be much more useful to make a $1000 mistake now at an early age (and learn from it) than it is to make a $100,000 mistake later when time is much more of a constraint. Failure or mistakes I believe are often underrated as a learning tool. Sometimes mistakes may be phrased as “experience” however :).

    Examples:
    -Get your first credit card (I remember the first time I read all the terms and conditions… >95% made no sense to me whatsoever! Nowadays >95% makes a decent amount of sense)
    -Buy $1000 worth (real or fake money) of stock/mutual funds/index funds/bonds to see how the process works. Just doing that enables you a front row seat at tracking how company news and the economy changes your hard earned cash, how you feel after you lose 20% of that money in a week, or gain 10% in a day (risk tolerance!). Track how much you gain or lose (after commissions of course), and go through the wonderful process of filing taxes on capital gains/losses. If you have a large class, and use fake money, there could be some interesting performance distributions at the end of the semester…

    Granted, I’m biased coming from an analytic background, but teaching to analytic college students, many of them may enjoy those types of “real world” financial exercises. Not for everyone, but definitely appropriate for the interested.

  • Laura McLay

    Anonymous, your advice is excellent. I will take it to heart when my kids are old enough to make financial decisions. We just started my 6YO on an allowance this year. It drives me crazy when she buys candy, but our discussions about shopping are great opportunities to teach her the value of a dollar. I’m collecting good ideas as I go. This weekend, my husband and I joked about how we should spring the $2000-sudden-expense question on future boyfriends that our daughters will bring home to weed out problems.

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