Households would be better off keeping $1,000 in the bank than using it to pay down $2,000 on a high-interest credit card, according to research from the Federal Reserve Bank of St. Louis.
The cash can help in case of emergency, the researchers concluded, after analyzing 5,000 low-to-medium income households during two different periods over a six-month timespan. Keeping the money in the bank greatly reduced the chances that a family would miss a rent or mortgage payment, be unable to afford food to eat, or be forced to skip needed medical care.
“Our findings suggest that households should be encouraged to maintain at least a small buffer of liquid savings, even if the cash in that buffer is not being used to pay down high-interest debt,” said Emily Gallagher and Jorge Sabat, the researchers for the project.
In many cases, the expenses that pop up in a financial emergency can not often be paid off with a credit card. Maintaining an emergency cash reserve, in those cases, can help offset the shock of a financial crisis, the researchers concluded.
The researchers found that families that had an emergency cash reserve encountered lower risks, while those with more debt were more likely to be waylaid by a financial crisis.
“The most striking finding is how similar the balance-sheet patterns of estimated effects are across the four measures of hardship,” the researchers wrote. “For example, having liquid assets or other assets always predicted lower risk of encountering hardship of any kind. Having debts generally increased the risk of hardship.”
