Two Financial Lessons We Should All Learn from the Pandemic
It’s a good opportunity to start an emergency fund and break the shopping habit.
Posted May 04, 2020
“This is the sharpest decline in consumer spending that we have ever seen.”– Luke Tilley.
A major, prolonged disruptive event, whether it occurs in our personal lives, or to everyone in a broad-based way, does two things to personal finances. First, it creates extraordinary challenges and exposes our vulnerabilities. Second, on the positive side, it provides a rare opportunity to assess, reset, and change our spending and saving behaviors.
Even as its effects continue to unfold, the Coronavirus pandemic has done both things. It has provided tangible evidence regarding just how financially vulnerable a significant fraction of American consumers is. And it has provided clues about how to reduce vulnerability through meaningful behavior change.
In this post, I want to discuss two significant lessons we can all learn about personal finances from our experiences of the past two months. Note that the discussion here is not new. Researchers and experts have pointed out both issues consistently for decades. What makes these two lessons particularly potent now is their urgency and the unique opportunity provided by the Coronavirus pandemic to act on them and reduce financial vulnerability.
Lesson 1. Build and maintain an emergency fund.
Most personal finance experts suggest building an emergency fund as one of the first steps to reduce financial vulnerability. This recommendation is not only commonsense, but it is also backed by psychological and economic research. For instance, consumer economists Dixie Porter Johnson and Richard Widdows explain the value of an emergency fund: “Households are vulnerable to financial crises as a result of events within the household and changes that occur in the economy. The importance of an adequate emergency fund to deal with these demands is [to be] stressed.” The events of the past two months attest to the truth of this assertion made back in 1985.
When millions of people lost their jobs because of the unexpected Coronavirus pandemic in March and April, a significant proportion of them started having difficulty with living expenses like paying rent and buying groceries within weeks. They had to resort to making bad financial choices like taking cash advances, or deferring rent payment and facing potential eviction. This is precisely the problem solved by an emergency fund. By saving anywhere from three to eight months of expenses (expert recommendations vary), an emergency fund cushions a sudden reduction or stoppage in income and gives breathing space. Obviously, for those who are unemployed, starting an emergency fund is infeasible until they start working again. But the current situation provides the impetus to start saving and building up an emergency fund as soon as possible.
Lesson 2. Break the shopping habit and adopt a lower-consumption, higher-savings budget.
Consumer behavior experts have noted that the buying patterns of Americans have changed dramatically since social distancing and self-quarantining began in mid-March. As one example, spending on two of the biggest discretionary categories, shopping and travel, fell by more than 50 percent. Consumers spent less because they couldn’t shop for clothes, shoes, accessories, perfume, and other discretionary items according to their usual patterns. Non-essential stores like department stores, and those selling clothing, shoes, and luxury goods were closed. Similarly, travel came to a virtual standstill, shutting down leisure and work trips.
As I’ve written before, the poor state of consumers’ personal finances can be attributed, in part, to buying far more than is needed, and habitual shopping behavior (and that includes habitual leisure travel). The shopping habit is hard to break. It eats up big chunks of discretionary income and makes it hard to save money consistently.
Research shows two factors help consumers to break entrenched habits: the disruption of environmental cues that trigger the habitual action and changes in social norms. First, habit researchers have noted that “Successful habit change interventions involve disrupting the environmental factors that automatically cue habit performance.” The Coronavirus pandemic has disrupted our routines for us very effectively. Two months of closed malls and suspended or delayed delivery of non-essential items means there’s been a long, abrupt pause to the shopping habit.
Second, changes in social norms also help to break strong habits. The classic example of this is cigarette smoking. People are less likely to take up smoking today because it is socially unacceptable to do so. Researchers exploring how to get people to change their travel behaviors point out that, “widespread, durable behaviour change… demands changes in collective customs.” Here, too, the pandemic has helped. It has made normal behaviors like window shopping and hanging out in malls socially unacceptable, even when restrictions are lifted.
This pandemic-spurred disruption of the shopping habit provides a unique opportunity to step back, reconsider the nature and frequency of discretionary purchases, and make a concrete plan to reduce them in the future. Many consumers have managed without discretionary purchases and have significantly reduced spending. Why not write a monthly budget that uses these lower values, and moves the surplus into retirement savings?