The Power of Predictable Paychecks

Even people in the middle class can worry as much about month-to-month swings in income as they do about their annual earnings.

A bank teller counts money.
Rick Wilking / Reuters

While it’s well documented that income inequality and wealth gaps have been widening in the United States, there is another sort of economic inequality that is just as worrisome but harder to see. It has less to do with the total amount of money that people have, and more to do with how that money moves through their lives: Increasingly, financial stability is only enjoyed by a few.

This type of inequality lurks underneath the reams of official economic data that’s regularly collected and widely reported. It’s about whether workers can reliably predict the size of their next paycheck, how much of a financial cushion they can build, and whether or not they can do something as simple as set up automated bill payments without worrying about overdrafting or making ends meet.

As we undertook a study of Americans’ household finances, we came to understand how this instability manifests itself. For the study, called the U.S. Financial Diaries, we followed 235 low-income and moderate-income households that had at least one working member, tracking every dollar they earned, spent, saved, borrowed, or gave away for a full 12 months. The households we followed were diverse—urban, rural, white, black, Hispanic, Asian, recent immigrants, families that have been in the U.S. for generations, single mothers, inter-generational households—and located in five different states (New York, Mississippi, Kentucky, Ohio, and California). When we started the study in 2012 we didn’t know how pervasive or persistent financial instability would be. But we found that many Americans, even some squarely in the middle class, worry as much about swings in income and expenses from month to month as they do their overall earnings.

Most financial surveys gather aggregated information such as annual income, or they provide snapshots such as the total amount owed on credit cards or held in retirement accounts. While useful in a macro sense, the standard measures of economic well-being—poverty and unemployment rates, the level of consumer debt—obscure what’s happening day to day. We had the chance to see how money moved through a family’s life over time. And, because our team collected the data in person, we got to ask why households made the choices they did.

Their stories often centered on the struggle to create stability amidst financial volatility. One family we met lives in a small town in Ohio, outside of Cincinnati. The husband (we’ve withheld the identity of study participants to protect their privacy) was the primary breadwinner, and he worked full-time, fixing long-haul trucks. During the year of the study, he was paid just over $40,000, enough in their town to support his wife and four children, albeit living modestly. Yet on one afternoon when we met with his wife, she was worried about whether or not to pay their mortgage bill. She had the money in hand, and she was eager to get it done. But she was worried that her husband’s next paycheck might be, in her words, “crap.” If so, she’d have to borrow money from her sister, and she didn’t want to have to do that.

There was a possibility that her husband’s next paycheck would be small because what he took home each month depended in part on what he earned on commission. Business is better for long-haul-truck mechanics in winter and summer than in fall and spring—trucks are more likely to break down in extreme weather—and this was October. Sunny, clear, and temperate, it was a perfect day for trucks to run smoothly and a poor day for the wife of a truck mechanic to feel confident about making a mortgage payment.

Many working families are familiar with this dilemma. On average, households in the Financial Diaries study had more than five months a year when the income they earned was at least 25 percent more or less than their average monthly income. But even that understates the volatility: The average monthly spike raised income to 52 percent higher than the mean, and the average monthly dip made it 46 percent lower than the mean. To put it another way, a family might earn $5,000 seven months out of the year, but those months might be interspersed with two great months of $9,000 and $7,000 and three tough months of $3,000 each. The annual total—$60,000—would be reported in surveys. That’s a notch above the median family income in the U.S., but it hides the fact that for at least three months of the year, money is very tight.

This type of volatility isn’t reserved for people like the Ohio family we met, whose incomes vary with the seasons. Workers who depend on tips and commissions experience it; the success or failure of the business falls partly on their shoulders. Workers who are self-employed or part of the gig economy do, too. Even full-time employees paid hourly wages, who account for over half of American workers, can face substantial fluctuations in the number of hours assigned each week. Many do not get paid leave, so a few days staying in with the flu or a child home sick from school can make a dent in people’s paychecks. Just 2 percent of the families in the Financial Diaries study had relatively steady income during the year, experiencing no spikes or dips of 25 percent or more.

The obvious advice is to save during the $9,000 month and the $7,000 month so that there’s an ample cushion during the $3,000 months. But that advice is far easier to dole out than it is to follow. What if the $3,000 months come three in a row, early in the year, right after Christmas spending, before the easy $9,000 month appears? What if a $3,000 month happens to coincide with the dying days of a clunky old car on its last miles?

Saving is also made difficult by the fact that inflation-adjusted incomes have stagnated for working families, even while the costs of housing, education, health care and transportation have risen. It’s not altogether surprising that families had a hard time saving the “extra” $4,000  from a $9,000 month for a rainy day. Instead, that $4,000 went to pay overdue bills, fees, and credit-card payments that had piled up during the low months.

The Ohio mechanic’s wife came up with her own solutions to these ups and downs. When her husband’s paycheck was small, she cleaned houses to pick up some extra income. She also clipped coupons and stocked the family’s pantry and her freezer whenever she saw a good deal. She knew that depositing money into a bank account would make more sense, but it had been hard to stop withdrawing from it for day-to-day expenses. So, by putting her savings toward filling the freezer, she was eliminating the temptation to spend frivolously when money was good, and lost less sleep wondering if her family would have to cut back on necessities when it wasn’t.

This system worked for her, and, over and over again, we saw households devise similar strategies. These families could not necessarily explain the standard ideas taught in financial literacy courses, like the power of compound interest, but they knew where the best deals could be found or which bills had the lowest late fees. More importantly perhaps, they could often identify human impulses that had to be managed in order to mitigate the ill effects of volatility. One woman in Mississippi parked her savings in a credit union an hour’s drive away and cut up her ATM cards, so that she would only withdraw the money for things she categorized as “really, really needs.” She cut up her checkbook too, so that she wouldn’t be tempted by high-priced payday loans (which typically require a signed check as collateral).

These kinds of strategies worked, but imperfectly. They were time-consuming and, despite being clever, didn’t prevent bad outcomes or errors. Over the course of our study, one-third of the families were threatened with (or actually experienced) eviction, the disconnection of utilities or cable, or repossession of an asset, most often their vehicles. Nearly half of those with bank accounts had at least one overdraft. Households were making only the minimum payment on about half of the credit cards that we tracked, which they’d often pay for dearly down the line.

Volatility is much easier to deal with for people with ample savings, access to good credit and insurance products, and/or social networks that can afford to lend a hand. But these coping mechanisms are currently reserved primarily for those with higher incomes—people who need them less. Those with low incomes are losing out in multiple ways. They are also more likely to have jobs with unpredictable incomes, and less negotiating power to change that. They are less likely to have access to low-priced credit to manage an emergency or invest in education or a home, and less likely to have friends and family with enough money to help out. Those with the most difficult financial lives are also the least able to get good financial advice.

As a result, a large share of people, even if they’re employed and even if they budget and plan, are financially unstable. It’s no wonder many people are frustrated by where the economy has left them, given that they’re doing a lot of things right and still struggling.

Conversations about inequality often miss something essential, something that the families we met felt strongly: The financial problem they were most immediately focused on wasn’t about relative earnings or wealth. It was about their ability to create stable lives in our uncertain world. Shortly after our regular data collection ended, the family in Ohio decided that attaining stability demanded a change. The husband switched jobs. He still fixes long-haul trucks, but now his wages are not dependent on commission and he has a guaranteed minimum number of hours. But to get that stability, he had to take on a longer commute, and he now actually earns less on an annual basis than he did when he worked on commission. It’s a hefty price, but one that he and his wife decided was worth paying.