Precautionary Savings and the Importance of Business Owners*

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. * We would like to thank Rob Alessie, Chris Carroll, John Cochrane, Luigi Guiso, David Romer, Paola Sapienza, Karl Scholz, Richard Thaler, James Ziliak and participants to the NBER Monetary Economics Summer Institute, the macroeconomics and microeconomic workshop at the Graduate School of Business of the University of Chicago, the macroeconomic seminar at the Federal Reserve Bank of Chicago, the public economics seminar at the University of Wisconsin, the workshop on “Household Choice of Consumption, Housing and Portfolios” at the University of Copenhagen, and the macroeconomic seminar at the Dutch Central Bank for suggestions and comments. Any errors are our responsibility. This paper was written while Lusardi was visiting the Graduate School of Business of the University of Chicago and its hospitality is gratefully acknowledged. Hurst acknowledges financial support from the Charles E. Merrill Faculty Research Fund at the Graduate School of Business of the University of Chicago. Torralba acknowledges financial support from the Bank of Spain. The opinions expressed in this paper do not necessarily reflect the views of the Board of Governors of the Federal Reserve System or the Bank of Spain.