Household finance is hardly discussed by academics despite its size. Yet there are useful insights into the credit cycle and lifetime wealth relevant to you.
I recently read an article that I think has a few worthwhile points to share. If you have the time and inclination, I recommend reading it: Household Finance: An Emerging Field.
As a field, household finance is the study of how households use financial tools. It's also the study of how households actually act, outside of pristine "optimal" models. People are people, after all, with all the untidy mess and chaos and mistakes that brings.
Household finance is important because of how big US households are in terms of assets. The household finance article quotes $72 trillion dollars in 2010, which spread across the 2010 census' measure of 116.7 million households gives us an average net worth of $617k – although this is a poor measure, given how disproportionately wealth is distributed.
To put that in scale, the authors of the paper compared that to assets of corporations, totalling only $28 trillion dollars. A little less than half as much!
There's also a lot more households than there are businesses though, so that wealth is spread out amongst many millions of individuals. That means household assets are diffuse among the populace. Despite this, there's still a lot of crowd-think that causes households to create similar financial patterns.
Which is to say, household finance is important because consumers drive spending seasons.
There's obvious patterns like Black Friday, ice cream cones during hot summer days, or the seasonality of real estate. The seasonality of real estate is complex and depends on the area, but a lot of the time it has factors like "people settle down for the cold winter and don't buy" or "people wait until school is out of session before moving."
Then other spending patterns, such as consumer spending related to credit cycles. Easy access to credit leads to a short-term surge in spending, but is then followed by a slowdown (contraction) as the realities of debt payments roll in. When times are good it's all too easy to spend, but when things downturn again finances get tight with all those debt obligations.
For example, after coming out of a recession there can be a rush of people going out and leasing cars with their newly restored access to credit. Then for the following months or years there's a slowdown in capital velocity due to all the people paying off their cars. These widespread, simultaneous decisions of the masses have measurable effects on the market.
Obviously it's better for households to stay disciplined to not get loaded with unnecessary debt, but that's one of those key points of household finance. People don't act rationally all the time, people make mistakes, and people have other priorities in life rather than "optimum" financial decisions.
Take the latte factor, for example. Spending a token amount of money each month on luxuries is much maligned in the frugal community – it's suboptimal to spend money when it can instead be used to, say, pay off student loans or invest. Yet for many people, these small luxuries have a huge impact on their happiness. Their priority is to have relief or comfort, not to pinch every penny.
On that note, I shall call to your attention this fantastic article by Bitches Get Riches:
Another place priorities often differ from what is considered "optimal" is in paying off primary home mortgages. For some people, their interest rates might be low enough that they could theoretically get a better return by investing instead of paying off the mortgage.
Yet many people prefer to live mortgage-free instead, sacrificing those investing opportunities in favour of the peace of mind of owning their home free and clear.
That behaviour is not "irrational," it's simply inspired by different rules than maximising gains. I'm always a firm believer that when we study human behaviours, we need to check our assumptions at the door. The reality of people is so much more marvellously messy and complicated than any model academics can come up with.
One place reality differs from expectation is in the financial advice people take. This 2003 IRS publication mentions that a lot of educators give advice that boils down to "pay your bills on time and track your budget." Yet most families use informal budgets, if any. It seems to me that making a budget is more often a mindfulness exercise than a robust personal finance tool.
That same publication also found that cash flow management correlated with greater financial knowledge. Indicators of good cash flow management include paying off bills in a timely fashion (including automatic bill paying), financial record keeping, tracking expenses, short-term & informal budgets, and having a checking account.
I'm a huge proponent of tracking your cash flow and expenses, and invite you to check out this post I have on the practicalities of the subject:
You might be surprised that having a checking account is an indicator, too. Doesn't everyone have a bank/credit union account already?
Well... yes, up to a point. The FDIC reports in its 2019 survey that 5.4% of US households (7.1 million) are still unbanked. This is an improvement over the past decade. It should be self-evident why lack of access to modern financial tools like a checking account will limit your cash flow management ability. Paying bills with cash, a cashier's cheque, or a money order is tedious.
A solid foundation in financial knowledge is great, as evidenced by smoothly handling your cashflow. Yet there's more to the application of knowledge than that. What about becoming wealthy? The "Household Finance: An Emerging Field" article has great lessons for that too.
Your lifetime wealth is your accumulated wealth plus your remaining human capital.
What is that human capital anyway? In short, it's your ability to turn your skills and labour into money. Human capital depends on how many working years you have in your lifetime, so it peaks at an early age and diminishes as you near retirement.
Human capital can also grow with experience and education. It's easy to understand that getting a university degree increases your starting salary. Yet this begins to bump into the problem with human capital: it's hard to quantify. There's too many uncertainties about the future, individual career paths, and especially health. That said, the article places a loose estimate of $3 million for a college graduate's human capital.
Health is probably the biggest factor in your lifetime wealth, for a typical person. It dictates how many years you have available to work. In the US especially medical conditions come with huge price tags to receive adequate medical care. What's especially problematic is that health issues tend to crop up as you age, so your highest earning later years tend to be the ones lost, doubling up on the effect of lost potential.
It's a nice thought that when you're young college grad and full of potential, you have the opportunity to become a self-made millionaire... so long as you don't run into any problems. Health issues, other people's prejudices, systemic problems, or plain rotten luck can sour such a dream.
Which is why it's so important to save early and to hold onto what wealth you can accumulate. You never know when your working career will be cut short, and in this country you need your wealth to take care of yourself first.
It's also important to do the rote basics of finance, such as managing your cashflow tidily, tracking your assets, and refreshing your financial literacy. With such attention to detail, you better the odds of growing your wealth.