People who have an unpredictable income may find budgeting is tougher task, but is it possible that the highest income earners among that group are leaving the most wealth potential on the table when it comes to financial planning?
A new research paper looks at how unpredictable income can negatively affect financial behaviour and, as you might imagine, households with the most unpredictable income have the greatest financial problems.
But if you think this is just a problem for low-income households you would be very wrong. Income predictability and income level are two different things. It’s possible to have a low income that is highly predictable, or have a high income that is highly unpredictable.
Unpredictability of income was associated with lower savings rates, lower asset accumulation, and lower confidence in the ability to handle unexpected expenses compared to households with predictable income.
Across all households, those with the most unpredictable incomes had accumulated almost 30 per cent fewer assets compared to households with the most predictable income, controlling for age, income level, and other socioeconomic factors. And when you separate households by income, the negative effects increase the more a household earns.
But a key finding in the research was that one possible cure for the ails of unpredictable income is the most fundamental, possibly most scorned, aspect of personal financial management: budgeting. Budgeting was shown to mitigate the negative effects of income unpredictability on multiple financial behaviours, and paradoxically, those who stood to benefit the most from budgeting were the least likely to do it.
The study found that the more unpredictable a household’s income is, the less likely that household will want to budget, but that almost 76 per cent of those with the most unpredictable income believe that they should. Two of the top reasons that households with unpredictable income don’t engage in budgeting are the amount of time it takes to budget and the difficulty in following that budget over time. If budgeting for someone with a steady paycheck is like playing darts, then budgeting for someone with a variable income is like playing darts with a board that is constantly moving. It’s a quantum leap more difficult.
It seems reasonable to assume that those earning less are most affected by this budget aversion, but that doesn’t appear to be the case. The researchers note that “the relative gap in financial well-being between those with low- versus high-income predictability is often driven by higher-income households.” They found that there may only be marginal differences in well-being across income predictability for the lowest-income households.
Income predictability is not just the domain of households with job-holders who had precarious work. Speak to enough business owners and self-employed Canadians and you’ll learn that unpredictable income is quite common. It could be a result of an undiversified customer base where any one client failing to renew a contract means a big proportional drop in revenue for a period. Many businesses are seasonal, and almost all are sensitive to the business cycle. Sometimes clients just fail to pay on time. There are myriad reasons why income can be lumpy for entrepreneurs.
The scope of this issue is large. Small businesses are often described as the lifeblood of an economy. In Canada, an alarming trend has been the recent decline in the overall share of workers in Canada who are self-employed. This could partly be explained by the pandemic lockdowns showing some people that they can enjoy the benefits of a more flexible work-from-home lifestyle combined with a steady paycheck. Stability is seductive.
But there are also those who turn to unpredictable income sources because they have no other option. Gig-economy workers, whether by choice or not, face a double whammy. They have unpredictable income in addition to generally lower income. And this group of workers appears to be increasing. According to Statistics Canada, 2023 saw a 48.1-per-cent increase in Canadians aged 16 to 69 providing app-based ride or taxi services over 2022. Delivery app workers also increased by almost 20 per cent during this time.
One of the key recommendations from this research is that the financial services needs to emphasize the role of budgeting geared to the reality of unpredictable income. Budgeting should not be regarded as a mere checklist item to tick. For high-income households, it can be a gateway to deeper financial planning engagement and higher wealth maximization.
Preet Banerjee is a consultant to the wealth management industry with a focus on commercial applications of behavioural finance research.
Preet Banerjee