Kub's Den

Beware Income Volatility

Elaine Kub
By  Elaine Kub , Contributing Analyst
Risk management should be at the top of farmers' minds during the month of March, when crop insurance decisions are made and government reports typically spark market volatility. (DTN photo illustration by Elaine Kub)

Picture someone who works for a salary. Let's call him Jim, and let's say that Jim makes $52,000 per year. Incidentally, that's approximately the median salary of American workers. It means that every two weeks, after his employer has withheld some money for various taxes and what-not, the employer will direct deposit about $1,500 into Jim's bank account. Easy as that.

For reference, the median farm income from 1996 through 2013 was about $48,000. Farm *households* made more than that, because there was typically some off-farm income coming in as well, but from just the profits of agricultural production, $48,000 was the number. If we strip out livestock farmers and just look at crop producers, the median farm income was $71,223.

OK, so let's say Jim has a farmer brother, Joe, who's expecting to bring in about $71,000 of crop farming income in 2017, compared to Jim's $52,000 salary. Who has the better deal?

The obvious mathematical answer is that $71,000 is better than $52,000, but then you remember that salary workers typically receive a range of benefits -- anything from health insurance to tuition reimbursement to retirement savings. Maybe Jim's situation isn't so bad. On the other hand, more than half of farmers are also getting their health insurance covered by some employer. According to USDA's 2015 Agricultural Resource Management Survey, 89% of farmers had some form of health insurance, which was similar to the general American population. And 55.6% of farmers were covered by private, employment-based insurance, compared to 55.7% of the general population. So let's assume that Joe the Farmer has a wife, Nancy the Nurse, whose employer provides health insurance for the family. Now we're back to wondering if a person would rather receive a steady $1,500 every two weeks, or a larger total sum of $71,000 from annual crop sales.

The difference really comes down to volatility. Let's say Jim shows up to work one Wednesday and his boss calls him into the corner office and says, "Hey, Jim, I'm going to give you a 0.7% raise in your salary. It's not necessarily because of anything you've done well or badly, but just because I feel like it today." That less-than-1% raise would be equivalent to Jim earning an extra $14 per paycheck, or an extra $350 over the course of a year. Not enough to get real excited about, but maybe he can take the family out for dinner or buy his kids some school supplies. Awesome.

But then on the very next day, Thursday, the same boss calls Jim into the corner office again and tells him he's going to dock his pay back down and then some. Nuts. Now Jim will have $350 less to put in his yearly budget. If this continues every day, up or down by a few hundred dollars, then the chief attraction of Jim's steady $1,500 paycheck becomes nullified. He can't plan with certainty how much of his paycheck can go to a car payment, how much can go to a college savings account, etc.

Fortunately for salaried workers, that's not how it works. Their income is steady, not volatile.

Unfortunately for farmers, their income is volatile, not steady. The "boss" in Farmer Joe's scenario is the grain markets themselves. Recently, grain market volatility has been relatively low. Over the past six months, the average daily move in December corn futures prices has been 2.8 cents, either up or down. November soybean futures have tended to move about 6 cents up or down each day. In percentage terms, that's equivalent to Jim's $350 annual pay raise, or more like a $500 difference to Joe's $71,000 income, up or down each market day.

Be assured that there will be days and weeks and months when the grain markets move more wildly than that. If corn futures prices dropped by their daily trading limit (25 cents per bushel) and soybean futures prices dropped by their daily trading limit (70 cents per bushel), then that would be more like a 6.5% dock in pay, or $4,600 lopped off of Joe's $71,000 income (assuming his profit margins don't change). Yikes.

Last month, USDA's Economic Research Service published "Farm Household Income Volatility: An Analysis Using Panel Data From a National Survey,"* which showed, among other things, how off-farm income can smooth out farm household income volatility from one year to the next. But it's most alarming statistic, I thought, showed that the average magnitude of the change between consecutive years' median farm income was about $20,000! That means if Joe, representing the median American farmer, does happen to earn $71,000 in 2017, he really can't make a household budget and plan on receiving $71,000 in 2018. His expectation should be to receive maybe $91,000 ... or maybe $51,000.

So that's something to keep in mind with today (March 15) being the deadline to sign crop insurance forms and, more menacingly, with the annual Prospective Plantings report looming on the calendar (March 31). Corn futures prices have jumped by double digits on eight of the past 10 acreage report days, and double-digit drops have been as likely as double-digit gains. A couple of those years have seen the market lock limit-down or limit-up through the close of the session, but the average size of the move has been 4%, either up or down. Soybean futures have posted a similar history on the days that Prospective Plantings reports have been released, with a couple of limit-sized moves and an average expectation of 2% up or down, but they have also tended to follow up with another big move on the day AFTER the report.

One last warning -- before you get too tempted to gamble that the report-driven market move will be upward at the end of March this year, before Joe the Median Farmer gets too occupied planning what he'd do if he made $91,000 instead of protecting himself against making $51,000, remember there was a 2010 economics study by Daniel Kahneman and Angus Deaton that showed people's evaluations of their own lives tended to improve as their income rose toward $75,000, but didn't really improve as incomes rose past that level. Maybe the median American farmer, with his volatile income and risks and all, is sitting right near a sweet spot.

Elaine Kub is the author of "Mastering the Grain Markets: How Profits Are Really Made" and can be reached at elaine@masteringthegrainmarkets.com or on Twitter @elainekub.

* https://www.ers.usda.gov/…


Elaine Kub