Working Paper

The Smart Money is in Cash? Financial Literacy and Liquid Savings Among U.S. Families

Abstract: Most financial advisors recommend storing three to six months of expenses in liquid assets in case of an emergency. Yet we estimate that more than half of U.S. families do not have at least three months of their non-discretionary expenses in liquid savings. We find that financial literacy is strongly predictive of having three months of liquid savings, controlling for income, income variability, and even parental resources. We also find that financial literacy predicts liquid savings across the income distribution. These results indicate that accumulation of an emergency fund is not simply a function of income. Finally, financial literacy is predictive of liquid savings even among high illiquid wealth households. This suggests that the phenomenon of "wealthy hand-to-mouth" families may reflect financial mistakes rather than portfolio optimization. Our paper highlights the importance of financial knowledge in explaining families' preparedness to deal with unexpected expenses or disruption in their income.

Keywords: Financial Literacy; Savings; Liquidity; Household Wealth; Household Finance;

JEL Classification: D14; D91; G50; G51; G53;

https://doi.org/10.17016/FEDS.2021.076

Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: Finance and Economics Discussion Series

Publication Date: 2021-11-29

Number: 2021-076