Precautionary Savings and the Importance of Business Owners

Abstract

In this paper, we show the pivotal role business owners play in estimating the importance of the precautionary saving motive. Since business owners hold larger amounts of wealth than other households for non-precautionary reasons and also face highly volatile income, they induce a correlation between wealth and income risk regardless of whether or not a precautionary saving motive exists. Using data from the Panel Study of Income Dynamics in the 1980s and the 1990s, we show that among both business owners and non-business owners, the size of precautionary savings with respect to labor income risk is modest and accounts for less than ten percent of total household wealth. However, pooling together the two groups leads to an artificially high estimate of the importance of precautionary savings. New data from the Survey of Consumer Finances further confirms that precautionary savings account for less than ten percent of total wealth for both business owners and non-business owners. Thus, while a precautionary saving motive exists and affects all households, it does not give rise to high amounts of wealth in the economy, particularly among those households who face the most volatile stream of income. Our results also show that any study of household savings needs to properly account for differences in behavior between business owners and non-business owners.