Monday, May 30, 2011

Quantifying "Financial Fragility"

How much do you think it would take to be less "financially fragile" than 50% of all Americans? According to a recent study, it may not be as much you would think.

In a paper published by the National Bureau of Economic Research, Annamaria Lusardi of the George Washington School of Business, Daniel J. Schneider of Princeton University, and Peter Tufano of Harvard Business School, nearly half of Americans say that they definitely or probably couldn’t come up with $2,000 in 30 days, an indication of the rising financial fragility of households in the US.

In the study, respondents were asked: “How confident are you that you could come up with $2,000 if an unexpected need arose within the next month?” The results show that half of Americans would probably or certainly be unable to cope with such an emergency: specifically, 22.2% say that they would probably be unable to cope and 27.9% say that they certainly would be unable to cope. According to the authors, "the $2,000 figure reflects the order of magnitude of the cost of an unanticipated major car repair, a large co-payment on a medical expense, legal expenses, or a home repair." Also, the authors clarify that respondents were asked whether they could “come up with” the funds and not whether they have them in the form of savings, an important distinction since "individuals may not rely on saving only in dealing with shocks."

So if you can come up with $2,000, or around 86,600 in today's peso, in 30 days, it means that you are better equipped to face financial emergencies than 50% of Americans. Better still, if we adjust the figure to reflect differences in the cost of basic goods and services in the US and the Philippines (using the latest Big Mac Index, for example) we should get a more manageable figure: 50,846 pesos, to be exact.

Until a similar study is done in the Philippines, we would have to make do with our rough estimate above; it means that we would have to ensure that we are capable of coming up with at least 51,000 pesos within 30 days for financial emergencies. While it does not necessarily mean that you should maintain that amount in your savings account as your emergency fund, to make things simple and to minimize uncertainty I suggest that you do just that. Of course, the bigger your household is, the bigger the figure should be. In my opinion, 100,000 pesos would be a much more ideal target for most households.

So you see, financial security is not as unattainable as it may seem. All it takes are a few sacrifices, a bit of self control, and maybe a dash of EQ. :)

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