How Financial Volatility Can Give Good Budgets a Bad Day

Do you ever feel like your wallet is stuck in an endless game of ping pong?

If so, you're far from alone. Many Americans have trouble keeping up with their month-to-month expenses, and it's not just about income or spending habits. It's also about financial volatility, because the average bank account fluctuates a lot over the course of a year.

And most of us aren't well prepared for it.

"Expense volatility" is an accountant's way of talking about the unexpected costs that hit a household, like a parking ticket or needing to replace your phone. It can pose a huge threat to household finances because it flips the table on personal budgeting. The average person plans his money out on a month-by-month basis; having to suddenly divert funds into something unforeseen can throw that into chaos.

Income can provide some buffer, and certainly high-earners are better prepared to deal with the unexpected in life than those who live paycheck-to-paycheck. That said, one truth about money is that expenses tend to rise with income… someone who makes more will spend more, and will usually have higher potential expenses.

Really, coping with volatility is all about how close to the bone a household lives. This is the area of personal finance that involves emergency funds and savings accounts, and to a small degree most people can take on some additional unexpected expenses. Minor volatility is little more than an inconvenience and a chance to gripe about the vagaries of municipal enforcement (or, perhaps, your city's catastrophically ill-advised decision to privatize the parking meters).

Hits to the tune of four figures and up, though, those can make a difference in a lot of households' financial stability. Most of us can weather an unexpected $200 bill. A surprisingly small amount of us could handle adding another zero to that.

In part, it's because most Americans simply don't have enough money set aside to handle the unexpected. Per a new study by JP Morgan Chase:

"Americans across the income spectrum experience tremendous income and expense volatility, and this volatility has been on the rise… In Weathering Volatility, we estimated that median-income families needed $4,800 in liquid assets to weather 90% of the income and expense volatility observed, but that they had only $3,000—a shortfall of $1,800."

Make no mistake, volatility is a huge problem. Even the most careful of households can suddenly find themselves relying on credit cards to get through the month if something unexpected crops up, and it's not just an "if" anymore. Volatility is increasingly real for the average individual.

What's worse, it's gotten predictable.

"Very big picture," said Fiona Greig, Director of Research with the JPMorgan Chase Institute, "we're seeing high levels of expense volatility across the income and age spectrum to the tune of almost 30 percent, which is like adding or subtracting a mortgage every month."

"We zoomed in on what we characterized as 'extraordinary payments,'" she said about her team's most recent research. "Almost four in ten families had made some kind of extraordinary payment on medical services, auto repair or tax. We chose those three categories not because they're the biggest, but because they're the hardest to predict."

It bears repeating: the average household's expenses fluctuate by almost a third every month.

This will probably resonate with most people. Almost everyone has, sooner or later, had to deal with a bill from the doctor or the mechanic. Among business owners and the self-employed, a complicated tax code and complete dereliction of duty on Congress's behalf means that sooner or later the IRS almost always comes knocking.

In fact, car repairs, medical expenses and tax bills make up the three biggest sources of volatility for the average individual specifically because they occupy a perfect storm of scope and commonality. Bigger expenses can blindside you on an idle Tuesday, but they're more uncommon.

In fact, the three expenses identified by JPMorgan Chase's report are so common that almost four in every ten families will make an extraordinary payment on car, medical or tax bills each year.

And while lots of more common points of volatility exist, most are day-to-day expenses that even a tight budget can absorb (an unexpected dry cleaning bill, for example). Any of these three extraordinary payments, on the other hand, will usually cost $1,000-plus, enough to seriously impair the average household's savings.

If the money is there at all.

Financial volatility is, ultimately, a complicated term for a very basic fear. Most people worry about that big expense that sets them back on their heels, whether that tax bill drains the vacation fund or leaves them leaning on credit just to make rent, and it can take a long time to rebuild from something like that.

According to Greig, households that endure a major shock take more than a year to recover, during which time they have more credit card debt and get to spend less on nonessentials. "It was only the top income quintile that had sufficient reserves to offset the level of volatility we observed in our data," she said. "That cash buffer, the liquid assets, was the primary source of funding for families to make that extraordinary payment."

It isn't easy, but households need to find a way to scrape together an emergency fund and keep it safe. Skimping on Starbucks for a while might be rough, but sooner or later something will happen. Someone will lose their job or need an operation, or the car will melt down on the freeway.

The only way to make that bad situation worse is to panic over how you're going to pay for it, because the numbers say that sooner or later it'll happen to us all.

In fact, nearly half of us will probably see something like that this year.

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