As additional evidence that financial illiteracy is considered a severe impediment to saving, both the government and employers have promoted financial education programs. Most large firms, particularly those with DC pensions, offer some form of education program. The evidence on the effectiveness of these programs is so far very mixed. Only a few studies find that those who attend a retirement seminar are much more likely to save and contribute to pensions. Clearly, those who attend seminars are not necessarily a random group of workers. Because attendance is voluntary, it is likely that those who attend have a proclivity to save and it is hard to disentangle whether it is seminars, per se, or simply the characteristics of seminar attendees that explain the higher savings of attendees shown in the empirical estimates. However, a study by Bernheim and Garrett published in 2003 argue that seminars are often remedial, i.e., offered in firms where workers do little or no saving. Thus, the effects of seminars may have been underestimated.
My own work uses data from the Health and Retirement Study and confirms the findings of Bernheim and Garrett. Consistent with the fact that seminars are remedial, she finds that the effect of seminars is particularly strong for those at the bottom of the wealth distribution and those with low education. Retirement seminars are found to have a positive effect mainly in the lower half of the wealth distribution and particularly for those with low education. Estimated effects are sizable, particularly for the least wealthy, for whom attending seminars appears to increase financial wealth (a measure of retirement savings that excludes housing and business equity) by approximately 18 percent. Note also that seminars affect not only private wealth but also measures of wealth that include pensions and Social Security wealth, perhaps because seminars provide information about pensions and encourage workers to participate and contribute. This can be important because workers are often uninformed about their pensions.
In a series of papers, Robert Clark and Madeleine D’Ambrosio have examined the effects of seminars offered by TIAA-CREF to a variety of institutions. The objective of the seminars is to provide financial information that would assist individuals in the retirement planning process. Their empirical analysis is based on information obtained in three surveys: participants completed a first survey prior to the start of the seminar, a second survey at the end of the seminar, and a third survey several months later. Respondents were asked whether they had changed their retirement age goals or revised their desired level of retirement income after the seminar. After attending the seminar, several participants stated they intended to change their retirement goals and many revised their desired level of retirement income. Thus, the information provided in the seminars does have some effect on behavior. However, it was only a minority of participants who were affected by the seminars. Just 12% of seminar attendees reported changes in retirement age goals, and close to 30% reported changes in retirement income goals. Moreover, intentions did not translate into actions. When interviewed several months later, many of those who had intended to make changes had not implemented them yet.
Other papers find more modest effects of education programs. Duflo and Saez, in a paper published in 2003, investigate the effects of exposing employees of a large not-for-profit institution to a benefit fair. This study is notable for its rigorous methodology; a randomly chosen group of employees were given incentives to participate in a benefit fair, and their behavior was compared with that of a similar group in which individuals were not offered any incentives to attend the fair. This methodology overcomes the problem mentioned before that those who attend education programs may already be inclined to save. This is clearly important, and findings from this study show that benefit fair attendance induced participants to increase participation in pensions, but the effect on saving was almost negligible. Perhaps the most notable result of this study is how pervasive peer effects are: not only benefit fair attendees but also their colleagues who did not attend were affected by it, providing further evidence that individuals rely on the behaviors of those around them to make financial decisions.
Given the extent of financial illiteracy, it is not surprising that exposing individuals to a benefit fair or offering workers one hour of financial education does little to improve saving. To be effective, programs have to be tailored to the size of the problem they are trying to solve. While it is not possible to transform low literacy individuals into financial wizards, it is feasible to emphasize simple rules and good financial behavior, such as diversification, exploitation of the power of interest compounding, and taking advantage of tax incentives and employers’ pension matches. Another potential role of financial education is to help individuals assess their abilities to make saving and investment decisions and perhaps make them appreciate the value of financial advice or equip them with tools to deal effectively with advisors and financial intermediaries.
So, my answer is : yes, financial education works, but we can make it more effective.
Sunday, 10 February 2008
Tuesday, 29 January 2008
The Newly Created Advisory Council on Financial Literacy
President Bush announced last week the creation of the Advisory Council on Financial Literacy
More information is available on the White House web page:
http://www.whitehouse.gov/news/releases/2008/01/20080122-7.html
Operating under the guidance of the U.S. Treasury Department with the specific charge of keeping America competitive and assisting citizens in understanding and addressing financial matters, the 19-member council will focus exclusively on economic empowerment issues. Their duties will include advising the president and Treasury Secretary on such goals as improving financial education efforts for students and adults in the workplace, and establishing effective measures of
national financial literacy, and promoting effective access to financial
services, especially for those without access to such services.
This is a very important step. Financial literacy is sorely lacking in this country and it is urgent to address this issue. The hope is that the council will get to work right away!
More information is available on the White House web page:
http://www.whitehouse.gov/news/releases/2008/01/20080122-7.html
Operating under the guidance of the U.S. Treasury Department with the specific charge of keeping America competitive and assisting citizens in understanding and addressing financial matters, the 19-member council will focus exclusively on economic empowerment issues. Their duties will include advising the president and Treasury Secretary on such goals as improving financial education efforts for students and adults in the workplace, and establishing effective measures of
national financial literacy, and promoting effective access to financial
services, especially for those without access to such services.
This is a very important step. Financial literacy is sorely lacking in this country and it is urgent to address this issue. The hope is that the council will get to work right away!
Saturday, 19 January 2008
Finance Literacy and Women
The decision of how much to save for retirement is a complex one, as it requires collecting and processing information on a large set of variables including Social Security and pensions, inflation, and interest rates, to name a few, and also making predictions about future values of these variables. It is also necessary for the consumer to understand compound interest, inflation, financial markets, mortality tables, and more. Nevertheless, little research has asked exactly how households make saving decisions, how they overcome the difficulty of making those decisions, and whether they are financially literate enough to make well-informed choices. These topics are of paramount importance, particularly when older households are increasingly required to take responsibility for investing and allocating their pension wealth. This is a particular concern for women, who tend to live longer than men and have shorter work experiences and lower earnings.
To gain insight into how households make saving decisions, Olivia Mitchell and I devised a module on planning and financial literacy for the 2004 Health and Retirement Study. The module includes three questions on financial literacy, as follows:
1. Suppose you had $100 in a savings account and the interest rate was 2% per year. After 5 years, how much do you think you would have in the account if you left the money to grow: more than $102, exactly $102, less than $102?
2. Imagine that the interest rate on your savings account was 1% per year and inflation was 2% per year. After 1 year, would you be able to buy more than, exactly the same as, or less than today with the money in this account?
3. Do you think that the following statement is true or false? Buying a single company stock usually provides a safer return than a stock mutual fund.
The first two questions, which we refer to as “Interest Rate” and “Inflation,” help evaluate whether respondents display knowledge of fundamental economic concepts and basic numeracy. The third question, which we refer to as “Risk Diversification,” evaluates respondents’ knowledge of risk diversification, a crucial element of an informed investment decision
The responses to these three questions among a sample of 785 women age 50+ in the 2004 HRS module on planning and literacy indicate widespread illiteracy. Only 61.9 percent of women correctly answered the interest rate calculation question. This is a relatively easy question, so it is surprising that so many were unable to respond correctly, particularly because these older women have most likely made numerous decisions involving interest rates over their lifetimes (e.g. credit card rates, mortgage financing rates, etc). Respondents were more accurate about the inflation question, with 70.6 percent answering correctly. By contrast, only 47.6 percent of the women respondents knew that holding a single company stock implies a riskier investment than a stock mutual fund.
Note also that only less than half of all respondents could answer correctly both the interest rate and inflation questions. This is a remarkably low ratio, taking into account the complex financial calculations that households on the verge of retirement have almost surely engaged in over their lifetimes. Also disturbing is the fact that only 29 percent of respondents could answer all three questions correctly.
These findings raise concerns about the ability of women to make sound saving and investment decisions over a long retirement period. In an environment where individuals rather than employers and governments are charged with handing retirement finances, it is essential that consumers become more financially literate in order to be more successful at retirement.
To gain insight into how households make saving decisions, Olivia Mitchell and I devised a module on planning and financial literacy for the 2004 Health and Retirement Study. The module includes three questions on financial literacy, as follows:
1. Suppose you had $100 in a savings account and the interest rate was 2% per year. After 5 years, how much do you think you would have in the account if you left the money to grow: more than $102, exactly $102, less than $102?
2. Imagine that the interest rate on your savings account was 1% per year and inflation was 2% per year. After 1 year, would you be able to buy more than, exactly the same as, or less than today with the money in this account?
3. Do you think that the following statement is true or false? Buying a single company stock usually provides a safer return than a stock mutual fund.
The first two questions, which we refer to as “Interest Rate” and “Inflation,” help evaluate whether respondents display knowledge of fundamental economic concepts and basic numeracy. The third question, which we refer to as “Risk Diversification,” evaluates respondents’ knowledge of risk diversification, a crucial element of an informed investment decision
The responses to these three questions among a sample of 785 women age 50+ in the 2004 HRS module on planning and literacy indicate widespread illiteracy. Only 61.9 percent of women correctly answered the interest rate calculation question. This is a relatively easy question, so it is surprising that so many were unable to respond correctly, particularly because these older women have most likely made numerous decisions involving interest rates over their lifetimes (e.g. credit card rates, mortgage financing rates, etc). Respondents were more accurate about the inflation question, with 70.6 percent answering correctly. By contrast, only 47.6 percent of the women respondents knew that holding a single company stock implies a riskier investment than a stock mutual fund.
Note also that only less than half of all respondents could answer correctly both the interest rate and inflation questions. This is a remarkably low ratio, taking into account the complex financial calculations that households on the verge of retirement have almost surely engaged in over their lifetimes. Also disturbing is the fact that only 29 percent of respondents could answer all three questions correctly.
These findings raise concerns about the ability of women to make sound saving and investment decisions over a long retirement period. In an environment where individuals rather than employers and governments are charged with handing retirement finances, it is essential that consumers become more financially literate in order to be more successful at retirement.
Tuesday, 8 January 2008
Where do presidential candidates stand in terms of policies for financial literacy?
As people in New Hampshire cast their votes today, it is important to know where presidential candidates stand in terms of financial literacy policies. To that aim, together with the Networks Financial Institute we have sent the following letter to all presidential candidates:
Dear Presidential Candidate:
In recent days, the state of the economy has surpassed the war in the Iraq as the number-one concern of American voters. Networks Financial Institute at Indiana State University, in collaboration with Dartmouth College professor Annamaria Lusardi, is writing to ask how you, as President, would take steps to help more Americans make sound financial decisions.
The need to improve our citizens' financial literacy has gained recognition as Americans save less, spend the majority of their disposable income, and incur rising levels of debt. Data at both the national and state levels indicate that consumer financial knowledge is at an all-time low, which suggests our nation is now facing a financial literacy crisis. Consider the following:
i) the U.S. savings rate has been extremely low for several years;
ii) home foreclosures nationwide are rising very rapidly and are expected to continue to do so for the next year;
iii) the average American with at least one credit card owes nearly $9,000.
Aggravating the situation are a host of business and social factors including vigorous growth in the sub-prime lending industry, a proliferation of “pay day lending” companies and even an increasing array of credit products marketed to the “tween” demographic market. Our educational system has assumed that students will learn the necessary financial skills from their parents, while statistics show that the majority of our nation's adults lack sound financial skills themselves. Given these circumstances we would like to pose the following questions for your response.
First, the economic well-being of Americans increasingly depends upon making good decisions about complex subjects such as student loans, retirement saving, home ownership, and many others. Do you believe that the federal government has a role in improving the financial literacy of our citizens?
Second, educational research has shown that the foundation for learning core subjects like reading and math occurs during the early grades. Our research revealed that only 38% of elementary school teachers and only 52% of teachers in all grades across the nation address financial literacy in their classrooms, citing a lack of time and educational standards as their main obstacles. Do you support the development of national financial literacy standards to help educators prepare the next generation of consumers?
Thank you for addressing these questions.
Sincerely,
Elizabeth Coit
Networks Financial Institute
Annamaria Lusardi
Dartmouth College
I will post the replies as soon as we receive them.
Dear Presidential Candidate:
In recent days, the state of the economy has surpassed the war in the Iraq as the number-one concern of American voters. Networks Financial Institute at Indiana State University, in collaboration with Dartmouth College professor Annamaria Lusardi, is writing to ask how you, as President, would take steps to help more Americans make sound financial decisions.
The need to improve our citizens' financial literacy has gained recognition as Americans save less, spend the majority of their disposable income, and incur rising levels of debt. Data at both the national and state levels indicate that consumer financial knowledge is at an all-time low, which suggests our nation is now facing a financial literacy crisis. Consider the following:
i) the U.S. savings rate has been extremely low for several years;
ii) home foreclosures nationwide are rising very rapidly and are expected to continue to do so for the next year;
iii) the average American with at least one credit card owes nearly $9,000.
Aggravating the situation are a host of business and social factors including vigorous growth in the sub-prime lending industry, a proliferation of “pay day lending” companies and even an increasing array of credit products marketed to the “tween” demographic market. Our educational system has assumed that students will learn the necessary financial skills from their parents, while statistics show that the majority of our nation's adults lack sound financial skills themselves. Given these circumstances we would like to pose the following questions for your response.
First, the economic well-being of Americans increasingly depends upon making good decisions about complex subjects such as student loans, retirement saving, home ownership, and many others. Do you believe that the federal government has a role in improving the financial literacy of our citizens?
Second, educational research has shown that the foundation for learning core subjects like reading and math occurs during the early grades. Our research revealed that only 38% of elementary school teachers and only 52% of teachers in all grades across the nation address financial literacy in their classrooms, citing a lack of time and educational standards as their main obstacles. Do you support the development of national financial literacy standards to help educators prepare the next generation of consumers?
Thank you for addressing these questions.
Sincerely,
Elizabeth Coit
Networks Financial Institute
Annamaria Lusardi
Dartmouth College
I will post the replies as soon as we receive them.
Sunday, 9 December 2007
The case for improving financial literacy
The mixed evidence on the effectiveness of financial education programs has led some to question whether it is worth trying to improve financial literacy. In fact, it is not clear there is even a choice. As it was impossible to live and operate efficiently in the past without being literate, i.e., knowing how to read and write, so it is very hard to live and operate efficiently today without being financially literate. Given the complexity of current financial instruments and the financial decisions required in everyday life, from comparing credit card offerings, to choosing methods of payments, to deciding how much to save, where to invest, and how to get the best loan, individuals need to know how to read and write financially.
Note that, as with reading and writing, the objective of a policy for financial literacy should be basic knowledge. While it may not be feasible to transform financially illiterate people into sophisticated investors, it may be possible to teach them a few principles about the basics of saving and investing. Moreover, as illiteracy was not eradicated with a handful of lessons or in a matter of months, so financially illiteracy cannot be eradicated with a few seminars or one benefit fair.
Set in this framework, it is clear that some standards for financial literacy are needed. What do people need to know? What should be the pillars of financial literacy programs? Setting these standards will be the backbone of devising financial education programs. There are obvious benefits of having one institution that presides over or establishes those standards, and the Treasury Department seems an obvious candidate for this role.
Technology makes it possible to use interactive methods to teach. Thus, “students of financial literacy” do not necessarily have to attend classes at school, but can learn from courses on-line (or from CDs or DVDs) from their home. Courses can also be customized and tailored to the different needs and levels of financial knowledge. Moreover, as the evidence on the effectiveness of the stock market game in high schools seems to suggest, it may be important to find ways to make courses engaging and to stimulate interest in acquiring financial literacy.
Note that, as with reading and writing, the objective of a policy for financial literacy should be basic knowledge. While it may not be feasible to transform financially illiterate people into sophisticated investors, it may be possible to teach them a few principles about the basics of saving and investing. Moreover, as illiteracy was not eradicated with a handful of lessons or in a matter of months, so financially illiteracy cannot be eradicated with a few seminars or one benefit fair.
Set in this framework, it is clear that some standards for financial literacy are needed. What do people need to know? What should be the pillars of financial literacy programs? Setting these standards will be the backbone of devising financial education programs. There are obvious benefits of having one institution that presides over or establishes those standards, and the Treasury Department seems an obvious candidate for this role.
Technology makes it possible to use interactive methods to teach. Thus, “students of financial literacy” do not necessarily have to attend classes at school, but can learn from courses on-line (or from CDs or DVDs) from their home. Courses can also be customized and tailored to the different needs and levels of financial knowledge. Moreover, as the evidence on the effectiveness of the stock market game in high schools seems to suggest, it may be important to find ways to make courses engaging and to stimulate interest in acquiring financial literacy.
Thursday, 15 November 2007
Baby Boomer Retirement Security: The Importance of Financial Literacy
They say that pyramids are a bad thing, but I like this one. Today, it was announced that my paper with Olivia Mitchell, "Baby Boomer retirement security: The roles of planning, financial literacy, and housing wealth," was awarded the Fidelity Research Institute Pyramid Prize for academic work on improving lifelong financial well-being.
Here's an overview of the paper:
With the first wave of 76 million Baby Boomers on the cusp of retirement, the authors sought to understand how financially prepared this large and influential cohort is for the next phase of their lives. Using the Health and Retirement Study for their analysis1, Lusardi and Mitchell explore the links between financial literacy, planning and retirement savings adequacy. They conclude that individuals who plan for retirement (planners) arrive close to retirement with much higher wealth levels and display higher financial literacy than non-planners. Their analysis shows that planning can actually jump-start the retirement savings process and that even a small amount of planning can go a long way towards boosting wealth holdings. Their estimates suggest that those who plan accumulate nearly 20% more in net worth versus those who don't plan for retirement.
Lusardi and Mitchell further conclude that from a policy standpoint, for financial literacy initiatives to be effective in complimenting legislation like the Pension Protection Act of 2006 which was intended to enhance overall retirement savings, that a one-size-fits-all approach is unlikely to do much to build retirement wealth. They contend that instead, targeted efforts will be needed and will be most useful if focused to particular subgroups in the economy that are most at risk of not preparing adequately for their retirement.
For the great majority of working Americans, their biggest and most complex financial goal will be preparing for retirement and this comprehensive research helps to advance our understanding of the connection from financial literacy to planning activity and from planning activity to wealth accumulation. These findings highlight the need to develop and integrate creative approaches to improving financial literacy for Americans to complement the development of other innovative initiatives such as auto enrollment, auto increases, and appropriate default investment options to improve the financial security of current and future retirees.
And here's a link to the paper.
Saturday, 3 November 2007
International Evidence on Financial Literacy
In my previous blog, I showed that financial illiteracy is widespread in the United States. Evidence from outside the United States on financial literacy is no more comforting. In 2005, the ANZ Banking Group conducted an extensive survey on the financial practices of consumers in Australia and New Zealand. The Australian survey of some 3,500 randomly chosen respondents age 18+ evaluated understanding of topics ranging from investment fundamentals, retirement planning and financial records, to basic arithmetic. In the Financial Terms section of the survey, 67% of respondents said they understood compound interest, but a mere 28% were rated as having a “good level” of comprehension when faced with an actual problem to solve. As in the United States case, those with low levels of financial literacy also had low education and income. This survey also confirmed the gender gap, with women concentrated in the lowest 20% of the literacy distribution. In the New Zealand survey of respondents age 18+, similar results obtained. Some 54% of respondents believed that fixed income investments would provide higher returns than stocks over an 18-year period, and again financial literacy was strongly positively correlated with socio-economic status.
The results extend to Europe. For example, a report commissioned by the UK Treasury showed that UK borrowers display a weak understanding of mortgages and interest rates. The UK Financial Services Authority also concluded that younger people, those in low social classes, and those with low incomes were the least sophisticated financial consumers. Other researchers, using data similar to the US Health and Retirement Study, documented that respondents in several European nations scored low on financial numeracy and literacy scales.
Meanwhile, on the other side of the Pacific, a Japanese consumer finance survey showed that 71% of adult respondents knew little about equity and bond investments, and more than 50% lacked any knowledge of financial products. A Korean youth survey conducted by the Jump$tart coalition in 2000 showed that young Koreans fared no better than their American counterparts when tested on economics and finance knowledge, with most receiving a failing grade. Again, a positive correlation was detected between family income and education, and the students’ performance on the financial literacy test.
While financial knowledge is weak, it is also the case that people tend to be more confident in their abilities than should be warranted. For instance, a German survey conducted by Commerzbank AG in 2003 found that 80% of respondents were confident about their understanding of financial issues, but only 42% could answer half of the survey questions correctly. Similar patterns are consistent in the United States, the United Kingdom, and Australia. Indeed, consumers’ overconfidence regarding their financial knowledge may be a deterrent to seeking out professional advice, thus widening the ‘knowledge gap’.
If you like to read more on this topic, please consult my article “Financial Literacy and Retirement Preparedness. Evidence and Implications for Financial Education,” published in Business Economics in January 2007 and posted on my web page. Also read “Improving Financial Literacy: Analysis of Issues and Policies,” published by the OECD in 2005.
The results extend to Europe. For example, a report commissioned by the UK Treasury showed that UK borrowers display a weak understanding of mortgages and interest rates. The UK Financial Services Authority also concluded that younger people, those in low social classes, and those with low incomes were the least sophisticated financial consumers. Other researchers, using data similar to the US Health and Retirement Study, documented that respondents in several European nations scored low on financial numeracy and literacy scales.
Meanwhile, on the other side of the Pacific, a Japanese consumer finance survey showed that 71% of adult respondents knew little about equity and bond investments, and more than 50% lacked any knowledge of financial products. A Korean youth survey conducted by the Jump$tart coalition in 2000 showed that young Koreans fared no better than their American counterparts when tested on economics and finance knowledge, with most receiving a failing grade. Again, a positive correlation was detected between family income and education, and the students’ performance on the financial literacy test.
While financial knowledge is weak, it is also the case that people tend to be more confident in their abilities than should be warranted. For instance, a German survey conducted by Commerzbank AG in 2003 found that 80% of respondents were confident about their understanding of financial issues, but only 42% could answer half of the survey questions correctly. Similar patterns are consistent in the United States, the United Kingdom, and Australia. Indeed, consumers’ overconfidence regarding their financial knowledge may be a deterrent to seeking out professional advice, thus widening the ‘knowledge gap’.
If you like to read more on this topic, please consult my article “Financial Literacy and Retirement Preparedness. Evidence and Implications for Financial Education,” published in Business Economics in January 2007 and posted on my web page. Also read “Improving Financial Literacy: Analysis of Issues and Policies,” published by the OECD in 2005.
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