(Digital Vision)
I’ve written on the woeful state of Americans’ financial literacy a few times in the past. There is probably no academic researcher more attuned to the problem than Annamaria Lusardi of Dartmouth. This week’s NBER e-mail blast describing the latest crop of economics working papers includes nine papers; of those, four are written or co-written by Lusardi on this topic.
Among the highlights (or, I should say, lowlights); the bolding is mine:
“Americans’ Financial Capability”
This paper examines Americans’ financial capability, using data from a new survey. Financial capability is measured in terms of how well people make ends meet, plan ahead, choose and manage financial products, and possess the skills and knowledge to make financial decisions. The findings reported in this work paint a troubling picture of the state of financial capability in the United States.
The majority of Americans do not plan for predictable events such as retirement or children’s college education. Most importantly, people do not make provisions for unexpected events and emergencies, leaving themselves and the economy exposed to shocks. To understand financial capability, it is important to look not only at assets but also at debt and debt management, as an increasingly large portion of the population carry debt. In managing debt, Americans engage in behaviors that can generate large expenses, such as sizable interest payments and fees. Moreover, more than one in five Americans has used alternative (and often costly) borrowing methods (payday loans, advances on tax refunds, pawn shops, etc.) in the past five years.
The most worrisome finding is that many people do not seem well informed and knowledgeable about their terms of borrowing; a sizable group does not know the terms of their mortgages or the interest rates they pay on their loans. Finally, the majority of Americans lack basic numeracy and knowledge of fundamental economic principles such as the workings of inflation, risk diversification, and the relationship between asset prices and interest rates.
As bad as Americans are, we aren’t alone:
“Financial Literacy around the World: An Overview”
by Annamaria Lusardi, Olivia S. Mitchell
In an increasingly risky and globalized marketplace, people must be able to make well-informed financial decisions. Yet new international research demonstrates that financial illiteracy is widespread when financial markets are well developed as in Germany, the Netherlands, Sweden, Japan, Italy, New Zealand, and the United States, or when they are changing rapidly as in Russia. Further, across these countries, we show that the older population believes itself well informed, even though it is actually less well informed than average.
Other common patterns are also evident: women are less financially literate than men and are aware of this shortfall. More educated people are more informed, yet education is far from a perfect proxy for literacy. There are also ethnic/racial and regional differences: city-dwellers in Russia are better informed than their rural counterparts, while in the U.S., African Americans and Hispanics are relatively less financially literate than others.
Moreover, the more financially knowledgeable are also those most likely to plan for retirement. In fact, answering one additional financial question correctly is associated with a 3-4 percentage point higher chance of planning for retirement in countries as diverse as Germany, the U.S., Japan, and Sweden; in the Netherlands, it boosts planning by 10 percentage points.
Finally, using instrumental variables, we show that these estimates probably underestimate the effects of financial literacy on retirement planning. In sum, around the world, financial literacy is critical to retirement security.
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The numbers here don’t really surprise me:
News flash! Half the population isn’t saving for retirement or college education, because they’re still struggling to pay the rent, put food on the table, or buy clothes!
Extra, extra! People in the bottom half of the economy won’t be paying their kids’ college tuition or dorm fees!
Read all about it! Kids working their way through college are using their income to pay tuition today, not to fund a retirement that is 50 years away!
Breaking news! People who count themselves lucky to hold onto a dead-end minimum-wage job figure they’ll be working until the day they die!
Personally, I’d be happy to see us phase in a small, mandatory, wage-based tax for retirement savings — with the money put into a personal, inheritable, tax-advantaged account like an IRA, and with zero “spend Mommy’s retirement on the kids’ college tuition” or “wager Daddy’s retirement on the housing market” options — but I don’t see any possibility of a less-coercive method resulting in reasonably universal retirement savings.
Yet it seems that a large fraction of those who are now struggling would, not so long ago, spend money on oversized vehicles, RVs, power toys, designer-label clothes (the ones made in the same factories and to the same pattern as the generic, but priced 3X higher because they have the designer’s name embroidered on them), pricey cell phone contracts for adults & kids, 60″ plasma TVs with hundreds of channels of premium cable… While those few of us who spent on none of those things, but saved & invested instead, are doing quite well.
Maybe the secret is to lose a job in the middle of a recession, or become temporarily disabled, or suffer some similar hit to one’s earning capacity at a fairly young age, so that you learn that the good times can be swept away in a few moments, and the unprepared will struggle to deal with the consequences.
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But Jaaaaames, Americans are entitled to designer clothes, garish jewelry, SUVs with rims, big-screen HD TVs, and iPhones and iPads, even if they’re already living on taxpayers’ money via welfare, project housing, or food stamps.
But for real, you nailed it: “While those few of us who spent on none of those things, but saved & invested instead, are doing quite well.”
The people who were buying fancy clothes and 60″ plasma televisions aren’t the people who are being discussed here. Really: There’s this whole country in between the two coasts, see, where almost nobody gets stock options.
The 50% of Americans who aren’t saving for the future — ever, not just the ones who are long-term unemployed because of the current economic mess — are the median-and-below wage earners. It’s the husband that makes $16 an hour on his job, which is driving a delivery truck for the local ag industry, and the wife that makes $12 an hour (including tips) cutting hair, and they’re trying to raise two kids (finally school age, so child care costs have come down dramatically, for which Mom gives thanks every month). These people weren’t the ones buying the 60″ televisions and the enormous cars. They’ve got a used truck for Dad and the cheapest minivan on the market for Mom. More than half the kids’ clothes are hand-me-downs from their older cousins. The cable TV subscription is basic only and considered a luxury. The cell phones are prepaid, rarely used, and the kids aren’t allowed to touch them. Mom can tell you to the penny how much it costs her to put Kraft macaroni and cheese on the table for dinner, and she only puts in half the margarine (butter’s too expensive) that the box mix calls for to cut the costs, not to reduce the fat content.
That’s America’s actual middle-middle class, not those people with annual income of a quarter million dollars that the politicians talk about.
**Checks windows**
Have you been spying on us?
You should make an allowance for my $30 (+ tax) a month habit on the WalMart $5 DVD bin. No, scratch that, my $100 used computer and NetFlix have replaced that guilty pleasure for $9.99 (er, $10.81 w/ tax) a month, saving me $21.63 a month.
When I got laid off from my supervisor position, we lost most of what was left of the savings after my wife had been laid off from her job a year earlier. So, we’ve moved to a city where there were jobs (thank you, oil!), and my wife has found 2 jobs that were in her wheelhouse and can potentially be parlayed into even better opportunities. Unfortunately, because of the massive and irregular hours she works if she wants to have any chance of advancing, me getting a job would cause problems with finding a daycare provider for our two children under 5 (not to mention our 2 over 5) and wouldn’t be cost effective. (I went to college, but never finished my math degree so I’ve limited my opportunities somewhat.) Because of this, we have no plans to save for retirement at this time. Every dollar that goes into retirement is a dollar taken away from vehicle maintenance or groceries or another part of our micro managed budget and menu (Being an stay at home numbers guy has SOME advantages.) If my wife gets that opportunity she’s working for, we’ll have the money to start saving for retirement, but it will be a LONG time before retirement is “predictable”. So I guess you could say we’re planning, just not in Ms. Lusardi’s sense.
There is a reason I mention all this. About two months ago, my wife recently got a new job replacing one of the two she had earlier that put us a little closer to “the dream” of her ideal job and income. She’s proud she’s supporting the family and takes it seriously (and just in case you’re wondering, I supported the family when she was having a hard time finding suitable work. We share.). Unfortunately, an incompetent manager never turned in her W-4 paperwork and what have you to HR, so she hadn’t gotten paid for 4 weeks. Well, out of shame of her ability to take care of the situation herself she never told me. I kept our budget ship-shape, but it was based on her actually getting paid for work. Well, when I found out our rent check bounced, causing late fees we hadn’t planned, the circumstances of our finances all came out. We had 4 days to resolve our money problems before we would be evicted, in addition to our normal bills and next month’s rent (er, security deposit if thing’s didn’t work out). The solution: A loan from the relatives? Maybe we’d get a couple hundred, but not nearly enough to cover rent, and it would generate bad will (trust me). A loan from our bank? No, they don’t do that micro-lending. Sell the van? No, we needed that so my wife could get to work. Sell my car? No, the kids wouldn’t get to school as my wife would have the van at work. Selling the computer or my DVDs? Nah, it wouldn’t be enough and my DVD habit would just get more expensive again as some of the movies were hard to replace. We ended up taking out a title loan on the car. The interest was about $350 for a month long loan.
And so we became one of the 20% of Americans who took an “alternative loan”. Was it financial illiteracy that caused us to take a loan? No. It was circumstance and psychology.
The good news is a couple of weeks ago my wife just got the *dream* job she wanted a couple weeks ago (and the company who owed her money finally paid up after a complaint to the appropriate state agency, putting us back in the black, less interest on the loan and late fees incurred.). It pays more than the last two jobs she was working combined (And it’s cash! No incompetent manager to deal with!). So now we get to transition back to being people who have a retirement account and health insurance. And I may actually get to go back to work, or maybe even better, finish my degree. A year from now, you probably won’t recognize us from this story.
But because of these events, I have to say that I look at Ms. Lusardi’s statement in a new light. What is being claimed as financial illiteracy is not always so and it’s almost necessary that at some point claims of illiteracy be verified on a case by case level.
Sounds like a good idea. So good that it’s already been done – in 1992, Australia (where I’m from) introduced the superannuation guarantee, which mandated that employers pay a percentage of their employees’ salary into a superannuation fund (chosen by the employee). The contribution rate started at 3% of salary but has risen to 9%.
It’s led to Australians having a growing pool of savings for their retirement – according to Wikipedia (which is never wrong), “Australians now have more money invested in managed funds per capita than any other economy.”
http://en.wikipedia.org/wiki/Superannuation_in_Australia
And when it comes to paying for college, Australia introduced a pretty good alternative to relying on saving up and then repaying student loans, too…
“Personally, I’d be happy to see us phase in a small, mandatory, wage-based tax for retirement savings…
Um, yeah. And we could call it Social Security, and have it pay negative returns after adjusting for inflation.
A possible cause is the moral hazard created by the social safety nets — existing and implied.
For example, I know folks who do not take as much interest in their retirement arrangements because they figure they will make-due on Social Security.
I know folks who weren’t very careful with their mortgage terms because they figure if things went south, there’d be a way out.
There is nothing wrong with that. One major problem with China is that because it has no social safety net the population has very high saving rates. If it weren’t for the West buying all their stuff China would be suffering from severe economic stagnation. People need to find the proper mix of consumption and savings least we fall victim to the Paradox of Thrift ( http://en.wikipedia.org/wiki/Paradox_of_thrift ). As much as people hate being told what to do, the Government has a critical role in getting people into the savings/consumption sweet spot. Social Security allows older workers to take risks like starting a business or at least not have to freak out, start hoarding all their cash subsisting on a diet of canned soup.
But what exactly is wrong with economic stagnation? It seems better than the squirrel-cage economy, in which everyone is working frantically to keep up the payments on all the consumer bling they had to have but can’t enjoy because they’re too busy working frantically…
Economic stagnation means people losing their jobs, people losing their jobs means less sales, less sales means less production, less production means people losing their jobs…
One cause is almost certainly the poor state of our public education system. Most students finish high school with only a passing acquaintance with basic economic theories (such as the laws of supply and demand), and without the math skills needed to effectively evaluate the myriad financial options that confront them as adults (or heck, even as 18-year-olds). Many districts do not even teach economics any more, and virtually all allow students to graduate with woefully substandard math skills.
For example, one of the biggest financial decisions a person has to make in their lives is where to go to college and how to pay for it, yet most 18-year-olds don’t have the skills needed to do a basic cost-benefit analysis of the various options confronting them. They cannot calculate the net present value of a stream of interest payments (the basic calculation used to help determine whether or not to take on debt for a purchase), and therefore often find themselves in over their heads in terms of debt before they even reach their mid-twenties.
I taught HS social studies (including economics) for several years at a school district in the heart of Silicon Valley that is considered to be on of the top 100 districts in the country, and even then I was astounded by how poor many students’ math and reasoning skills were.
Financial illiteracy is the effect…poor math and reasoning skills the two major causes.
The problem is the students, not the schools. Poor intelligence and a sub-culture that denigrates learning will lead to poor math and reasoning skills which will lead to financial illiteracy.
“Many districts do not even teach economics any more, and virtually all allow students to graduate with woefully substandard math skills.”
My public school district did, and there were tons of kids that graduated with substandard math and economic skills. They just couldn’t handle it conceptually or didn’t care to.
“They cannot calculate the net present value of a stream of interest payments (the basic calculation used to help determine whether or not to take on debt for a purchase), and therefore often find themselves in over their heads in terms of debt before they even reach their mid-twenties.”
Perhaps your expectations are too high, just as a mathematician might be astounded you or I aren’t able to proof the Bernstein conjecture even at 3 dimensions.
True, but irrelevant: Of all the places on the planet, the Silly Valley does not have “poor intelligence and a sub-culture that denigrates learning”.
No, but just like everywhere else, they have kids who have become overreliant on calculators. The problem isn’t just with basic math skills, it’s the fact that kids do not learn how to properly set up problems in the first place. That’s why they have some much difficulty using math in the real world, where the problem is not precisely defined for them.
Yes, the education system is the problem when teachers use terms like “net present value of a stream of interest payments” and then are baffled when 16-year-olds don’t comprehend. I’m surprised that living in Silicon Valley has not taught you the frustration most ordinary people have with techno-babble.
That’s not technobabble…Net Present Value is the most basic calculation anybody trying to manage their own finances has to make. You can’t make an informed decision about anything related to using credit without it (i.e. taking out a student loan, buying a car, buying a house, using a credit card, etc.). Given that many 18-year-olds (i.e. HS seniors) already have credit cards and are also having to figure out how to pay for college, what is so unreasonable about expecting someone to have taught them (and them to have learned) how to use some of the basic tools needed to make such decisions.
Maybe the fact that so many people like you think it’s “technobabble” is why so many Americans are in over their head in debt with personal finances that are a complete mess!
Finance and high tech have one thing in common: both use complexity to obfuscate and confuse. Calling someone financially illiterate for not learning finance industry jargon and internal workings is the same as calling someone computer illiterate for not learning Border Gateway Protocol.
Financial illiteracy persists because it is advantageous to banks and financial institutions. It took literally an act of Congress to force credit card companies to put a simple statement on credit card bills, “if you make the minimum payment, you balance will be paid off in X years”.
Financial literacy also persists because educators try to pass off memorization of mathematical formulas as literacy. It is folly to teach traditional finance theory to people for whom finance will always be a tiny part of their lives. Educators need to have the vision to provide tools and techniques appropriate for the vast majority of non-finance people to make good financial decisions. Where is the equivalent of Apple Computer for personal finance?
I taught a record keeping class with 67 students, 9-12. One of my main goals was to teach simple interest. The lesson was taught 5 times, approximately 4.5 hours with 100 problems assigned. Yesterday I gave the final and only 25% of the students could correctly calculate the answer. I could be a horrible teacher, but the results are not encouraging. Students don’t understand the concepts of financial literacy, don’t care, or see the relevance. It should be noted at over 50% of our student population is on free and reduced meals.