In my previous post, I have announced the creation of a new Financial Literacy Center, a collaborative effort among Dartmouth, the Wharton School, and RAND. I would like to explain in more detail its mission and its purpose.
MOTIVATION TO BUILD A FINANCIAL LITERACY CENTER
Individuals and families are increasingly being asked to take command of their own financial well-being. They must determine not only where and how long to work, but also how much to save and how to allocate their pension assets, when to claim Social Security and pension benefits, and how to manage their assets throughout a potentially long retirement period. These decisions were always difficult, but they have become even more so today since increasingly intricate and hard-to-understand financial products are now accessible to many people who are actually quite ill-equipped to take on the task. As a result, widespread saving shortfalls and difficulties with debt are emerging as serious challenges to households already at risk. And without a doubt, the current financial crisis has underscored the reality that, as a nation, we are subject to deep systemic risk attributable in part to financial illiteracy. These facts threaten to undermine many Americans’ hopes for a rewarding retirement.
Our goal with the creation of the Financial Literacy Center is to harness creativity and ingenuity to generate rigorous quantitative analysis and build innovative and exciting products that will work effectively in real-world settings to better identify and resolve the challenge of financial illiteracy. A multidisciplinary approach is integral to understanding the problem, so as to formulate concrete steps that can be structured to conquer inertia and to test products to determine what works best. The Center includes several strong cross-disciplinary teams that draw from diverse but relevant fields, including traditional economics and finance, behavioral economics, social marketing, psychology, marketing science, and sociology. Working across disciplines and theoretical backgrounds encourages the creativity needed to foster unconventional but potentially effective designs, to test programs and products for effectiveness, and to articulate best practice in a variety of different settings under this common unifying theme. All these steps will be invaluable in helping Americans of all working ages better understand the role of Social Security benefits and the need to save and dissave sensibly over their lifetimes.
Our review of the existing literature leads to the following general observations relevant to the goals of the Center:
1. Financial illiteracy is widespread. Financial literacy cannot be taken for granted among the population, particularly among specific groups (including those with low education, women, and minorities). This raises the issue of how to communicate information effectively, particularly to those who need it most.
2. Financial education can work. The provision of financial literacy can be invaluable in enhancing saving and investment decisions, retirement planning, and retirement outcomes.
3. “One size fits all” does not work. Different segments of the workforce require appropriate tailoring in terms of message and delivery system for financial literacy.
4. The financially illiterate require both information and help with implementation. Building literacy requires products and programs that (a) inform workers of retirement goals; (b) give them concrete ways to begin to think about how to attain these; (c) offer simple approaches to attain their goals and overcome obstacles; (d) provide timely reminders and encouragement about how to meet the goals; (e) offer additional information if the client so desires.
5. A step-by-step approach is needed. Enhancing financial literacy requires a sequence of steps: (a) a baseline assessment of literacy shortfalls; (b) the development of material and tools, including implementation steps, appropriate to specific subpopulations; (c) the development of modes of communication and delivery systems attractive to the relevant subpopulation; (d) evaluation of outcomes.
6. It is essential to integrate a thorough and careful project evaluation to fill in the knowledge gap about what works in the financial literacy.
Saturday, October 17, 2009
Thursday, October 8, 2009
Our New Financial Literacy Center
I am very happy to announce the creation of a new Financial Literacy Center, a joint collaboration among Dartmouth College, the Wharton School, and the RAND Corporation. The press release is reported below:
http://www.rand.org/news/press/2009/10/07/financial_literacy.html
A new center dedicated to improving the financial literacy of the American public has been launched by the RAND Corporation, Dartmouth College and the Wharton School of the University of Pennsylvania.
The Financial Literacy Center will receive more than $3 million during its first year from the U. S. Social Security Administration to develop educational materials and programs that help foster saving and retirement strategies over the life cycle.
The new center will be hosted by RAND and led by Director Annamaria Lusardi of Dartmouth College and RAND, Associate Director Olivia S. Mitchell of the Wharton School and Associate Director Arie Kapteyn of RAND. Each of the leaders has an international reputation for their work on financial literacy.
"Americans are assuming increasing responsibility for decisions that will determine whether they have enough money to support themselves in old age," Lusardi said. "Unfortunately, they often lack the information and skills to make good decisions."
The Financial Literacy Center will empower different population groups by developing and testing innovative financial educational products that address their needs.
Besides researchers from RAND, Dartmouth and the Wharton School, the Financial Literacy Center team includes experts in multiple disciplines from the American Enterprise Institute, Cornell University, Doorways to Dreams Fund, FINRA Investor Education Foundation, Greenwald and Associates, Harvard University, Harvard Business School, ideas42, the National Endowment for Financial Education, the National Bureau of Economic Research and North Carolina State University, along with a range of corporate and nonprofit collaborators.
As requested by the Social Security Administration, projects in the first year will tailor materials for Americans at various stages of their working lives—young workers, mid-career workers and those approaching retirement—as well as current retirees who must manage the resources they have accumulated. The center will also provide financial literacy products for underserved populations, such as low income, young, and disabled workers, who are particularly vulnerable during periods of financial turbulence.
http://www.rand.org/news/press/2009/10/07/financial_literacy.html
A new center dedicated to improving the financial literacy of the American public has been launched by the RAND Corporation, Dartmouth College and the Wharton School of the University of Pennsylvania.
The Financial Literacy Center will receive more than $3 million during its first year from the U. S. Social Security Administration to develop educational materials and programs that help foster saving and retirement strategies over the life cycle.
The new center will be hosted by RAND and led by Director Annamaria Lusardi of Dartmouth College and RAND, Associate Director Olivia S. Mitchell of the Wharton School and Associate Director Arie Kapteyn of RAND. Each of the leaders has an international reputation for their work on financial literacy.
"Americans are assuming increasing responsibility for decisions that will determine whether they have enough money to support themselves in old age," Lusardi said. "Unfortunately, they often lack the information and skills to make good decisions."
The Financial Literacy Center will empower different population groups by developing and testing innovative financial educational products that address their needs.
Besides researchers from RAND, Dartmouth and the Wharton School, the Financial Literacy Center team includes experts in multiple disciplines from the American Enterprise Institute, Cornell University, Doorways to Dreams Fund, FINRA Investor Education Foundation, Greenwald and Associates, Harvard University, Harvard Business School, ideas42, the National Endowment for Financial Education, the National Bureau of Economic Research and North Carolina State University, along with a range of corporate and nonprofit collaborators.
As requested by the Social Security Administration, projects in the first year will tailor materials for Americans at various stages of their working lives—young workers, mid-career workers and those approaching retirement—as well as current retirees who must manage the resources they have accumulated. The center will also provide financial literacy products for underserved populations, such as low income, young, and disabled workers, who are particularly vulnerable during periods of financial turbulence.
Friday, October 2, 2009
Does Simplification Work?
One assumption behind recent policy proposals, including the new proposed regulation to protect consumers is the importance of simplifying decisions. But does simplification work and does it help consumers? The answer from two academic projects is a resounding “yes.” I describe each of them below.
James Choi, David Laibson and Brigitte Madrian, researchers from both Harvard and Yale, study the effect of Quick Enrollment, a program that gives workers the option of enrolling in the employer-provided saving plan by opting into a preset default contribution rate and asset allocation. Unlike defaults, workers have the choice to enroll or not, but the decision is much simplified as they do not have to decide at which rate to contribute or how to allocate their assets.
When new hires were exposed to the Quick Enrollment program, participation rates in 401(k) plans tripled, going from 5% to 19% in the first month of enrollment. When the program was offered to previously hired non-participants, participation increased by 10 to 20 percentage points. These are large increases, particularly if one considers that the default rate is not particularly advantageous: the contribution rate in the most successful program is set at only 2%, with 50% of assets allocated to money market mutual funds and 50% allocated to a balanced fund. Moreover, Quick Enrollment is particularly popular among African-Americans and lower income workers (those earning less than $25,000) who, as the research mentioned before shows, are less likely to be financially literate. Thus, changes in pension design can have a significant impact on participation. Most importantly, this is a low-cost program.
Another approach designed to simplify the decision to save and, in addition, motivate employees to make an active choice is the one we did at Dartmouth College (this was a joint collaboration with a professor of marketing at the Tuck School of Business, the Executive Vice President of Finance and Administration at Dartmouth, and myself). We designed a planning aid to help employees contribute to supplementary pensions. The planning aid displays several critical features. First, it breaks down the process of enrolling in supplementary pensions into several small easy steps, describing to participants what they need to do to be able to enroll online. Moreover, it provides several pieces of information, such as describing the low minimum amount of income employees can contribute (in addition to the maximum) and the pension carriers employees can choose from. Such a simple and low cost intervention lead to a large increase in contribution rates to supplementary pensions; contribution rates doubled after the introduction of the planning aid. This program was targeted to women and low income employees; in the survey we distributed among employees, many respondents told us “they did not know where to start.”
This program shares several features with other programs. First, while economic incentives, such as employers’ matches or tax advantages may be useful, they do not exhaust the list of available options. Given the massive lack of information and financial knowledge, there may exist other and more cost-effective programs that can induce people to save; in fact, simplification is a rather unexploited way to affect decision-making. Second, employees are more prone to decision-making at specific times. For example, the start of a new job makes people think about saving (often because they have to make decisions about their pension). Both the papers by Choi, Laibson and Madrian and our paper find that new hires are particularly open to making changes. Third, to be effective, programs have to recognize the many differences that exist among individuals, not only in terms of preferences and economic circumstances, but also in levels of knowledge and financial sophistication.
So, here is a recommendation: make it simple!
A copy of the paper is available at: http://www.dartmouth.edu/~alusardi/Papers/Lusardi_Keller_Keller.pdf
James Choi, David Laibson and Brigitte Madrian, researchers from both Harvard and Yale, study the effect of Quick Enrollment, a program that gives workers the option of enrolling in the employer-provided saving plan by opting into a preset default contribution rate and asset allocation. Unlike defaults, workers have the choice to enroll or not, but the decision is much simplified as they do not have to decide at which rate to contribute or how to allocate their assets.
When new hires were exposed to the Quick Enrollment program, participation rates in 401(k) plans tripled, going from 5% to 19% in the first month of enrollment. When the program was offered to previously hired non-participants, participation increased by 10 to 20 percentage points. These are large increases, particularly if one considers that the default rate is not particularly advantageous: the contribution rate in the most successful program is set at only 2%, with 50% of assets allocated to money market mutual funds and 50% allocated to a balanced fund. Moreover, Quick Enrollment is particularly popular among African-Americans and lower income workers (those earning less than $25,000) who, as the research mentioned before shows, are less likely to be financially literate. Thus, changes in pension design can have a significant impact on participation. Most importantly, this is a low-cost program.
Another approach designed to simplify the decision to save and, in addition, motivate employees to make an active choice is the one we did at Dartmouth College (this was a joint collaboration with a professor of marketing at the Tuck School of Business, the Executive Vice President of Finance and Administration at Dartmouth, and myself). We designed a planning aid to help employees contribute to supplementary pensions. The planning aid displays several critical features. First, it breaks down the process of enrolling in supplementary pensions into several small easy steps, describing to participants what they need to do to be able to enroll online. Moreover, it provides several pieces of information, such as describing the low minimum amount of income employees can contribute (in addition to the maximum) and the pension carriers employees can choose from. Such a simple and low cost intervention lead to a large increase in contribution rates to supplementary pensions; contribution rates doubled after the introduction of the planning aid. This program was targeted to women and low income employees; in the survey we distributed among employees, many respondents told us “they did not know where to start.”
This program shares several features with other programs. First, while economic incentives, such as employers’ matches or tax advantages may be useful, they do not exhaust the list of available options. Given the massive lack of information and financial knowledge, there may exist other and more cost-effective programs that can induce people to save; in fact, simplification is a rather unexploited way to affect decision-making. Second, employees are more prone to decision-making at specific times. For example, the start of a new job makes people think about saving (often because they have to make decisions about their pension). Both the papers by Choi, Laibson and Madrian and our paper find that new hires are particularly open to making changes. Third, to be effective, programs have to recognize the many differences that exist among individuals, not only in terms of preferences and economic circumstances, but also in levels of knowledge and financial sophistication.
So, here is a recommendation: make it simple!
A copy of the paper is available at: http://www.dartmouth.edu/~alusardi/Papers/Lusardi_Keller_Keller.pdf
Tuesday, September 15, 2009
The New Initiative for Retirement Savings
President Obama recently announced a new initiative that will make it easier for Americans to save for retirement. This is an important step. The stock of personal U.S. savings took a big hit in the midst of the financial crisis, and many families have been left scrambling to make ends meet. Before the crisis, the saving rate had been hovering around zero. Depending on which definition is used, anywhere from a quarter to just over a third of Americans are asset poor. The importance of having savings cannot be overplayed. Having savings guarantees security after retirement and can provide a buffer against shocks. A recent survey, conducted by the market research firm TNS, revealed that almost half of Americans doubt that they could come up with $2,000 in 30 days—whether from savings, borrowing, friends, or family—to meet an unexpected financial need. But the good news is that American families seem to have recovered an appreciation for saving and this new initiative will help people continue to save.
There are four new and important components of this initiative. The first component uses the “make it simple” approach to retirement saving, using automatic enrollment to default workers into retirement saving plans, with the ability to opt out if an individual so chooses. Large companies have successfully used automatic enrollments for years, but this initiative will make it easier for small companies to offer the same benefit. An effort to simplify saving may seem to be common sense but, in fact, is a radical departure from what models of saving have traditionally focused on. Both academic research and policies to stimulate saving have overlooked and underplayed the difficulties that people face in making saving decisions, in devising a saving plan, and in implementing such a plan. The new initiative will make it possible for more people to easily enroll in pensions. By defaulting workers into a pension, saving becomes the rule rather than the exception. And when saving is made simple with automatic enrollment, research indicates that workers make the choice to stay enrolled in a pension plan.
The second new component of this initiative is to facilitate the saving of federal tax refunds, which 100 million American families receive. If tax filers have a retirement account, they can have their refund deposited directly into that account. Notably, filers will be able to check a box on their tax return to receive their refund as a savings bond. This is not just simple, it is brilliant! This idea was originated and tested by Peter Tufano of Harvard Business School and Doorways to Dreams (D2D), the not-for-profit he founded in 2000. In 2007, the Federal government distributed $250 billion in 2006 tax year refunds to Americans, of which nearly $115 billion went to families with incomes under $40,000. Households or individuals with adjusted gross incomes under $40,000 received refunds of approximately $1,679. Research has shown that families, including low income families, aspire to save at least a portion of their tax refund. Yet, until now, there has been no simple way for them to do so. Savings bonds offer many attractive features. They comes in small denominations, charge no fees, generally pay a competitive rate, guarantee no principal loss, and are exempt from state and local taxes. Moreover, many people seem to know about savings bonds. According to Tufano’s research, as many as 89% of individuals in low income families are familiar with savings bonds. Multi-year research work in this field and pilot studies offering savings bonds to tax filers have demonstrated that such an initiative makes it possible for low income families to save (for more information about this research, visit http://www.d2dfund.org/). Now, every family that receives a tax refund has a simple way to put that money away: as simple as the stroke of a pen.
The third new component of this initiative is to enable workers to convert their unused vacation or other similar leave into additional retirement savings. In other words, it will now be possible for employees to put payments for unused vacation and sick days into their retirement plan if they wish. Another simple way to help people save!
The fourth component of this initiative is the guide that the Treasury and the IRS will put together to help workers and their employers better understand the available options for tax-favored retirement saving. Again, this will be written in simple and clear language. This is an important innovation. People need to have a reputable source of information to rely on, and they need to know where to go to access that information. The importance of such a guide should not be underestimated. Automatically enrolling people in a pension plan is a great way to foster retirement savings, but workers could make the decision to withdraw or borrow from a retirement account, sometimes incurring tax penalties, or individuals might fail to roll over a pension into another tax-advantageous account when leaving a job. My hope is that the guide will not limit itself to offering information about retirement savings; people are dealing with a lot of financial decisions and all of these decisions are interrelated. For example, it may not be wise for a worker to contribute to a retirement account if he/she carries a lot of high-interest credit card debt. And, judging from some of the behavior that the recent financial crisis exposed, some debt management tips should be included in the guide, too.
Our society has made it easy to consume, now this policy makes it easy to save!
There are four new and important components of this initiative. The first component uses the “make it simple” approach to retirement saving, using automatic enrollment to default workers into retirement saving plans, with the ability to opt out if an individual so chooses. Large companies have successfully used automatic enrollments for years, but this initiative will make it easier for small companies to offer the same benefit. An effort to simplify saving may seem to be common sense but, in fact, is a radical departure from what models of saving have traditionally focused on. Both academic research and policies to stimulate saving have overlooked and underplayed the difficulties that people face in making saving decisions, in devising a saving plan, and in implementing such a plan. The new initiative will make it possible for more people to easily enroll in pensions. By defaulting workers into a pension, saving becomes the rule rather than the exception. And when saving is made simple with automatic enrollment, research indicates that workers make the choice to stay enrolled in a pension plan.
The second new component of this initiative is to facilitate the saving of federal tax refunds, which 100 million American families receive. If tax filers have a retirement account, they can have their refund deposited directly into that account. Notably, filers will be able to check a box on their tax return to receive their refund as a savings bond. This is not just simple, it is brilliant! This idea was originated and tested by Peter Tufano of Harvard Business School and Doorways to Dreams (D2D), the not-for-profit he founded in 2000. In 2007, the Federal government distributed $250 billion in 2006 tax year refunds to Americans, of which nearly $115 billion went to families with incomes under $40,000. Households or individuals with adjusted gross incomes under $40,000 received refunds of approximately $1,679. Research has shown that families, including low income families, aspire to save at least a portion of their tax refund. Yet, until now, there has been no simple way for them to do so. Savings bonds offer many attractive features. They comes in small denominations, charge no fees, generally pay a competitive rate, guarantee no principal loss, and are exempt from state and local taxes. Moreover, many people seem to know about savings bonds. According to Tufano’s research, as many as 89% of individuals in low income families are familiar with savings bonds. Multi-year research work in this field and pilot studies offering savings bonds to tax filers have demonstrated that such an initiative makes it possible for low income families to save (for more information about this research, visit http://www.d2dfund.org/). Now, every family that receives a tax refund has a simple way to put that money away: as simple as the stroke of a pen.
The third new component of this initiative is to enable workers to convert their unused vacation or other similar leave into additional retirement savings. In other words, it will now be possible for employees to put payments for unused vacation and sick days into their retirement plan if they wish. Another simple way to help people save!
The fourth component of this initiative is the guide that the Treasury and the IRS will put together to help workers and their employers better understand the available options for tax-favored retirement saving. Again, this will be written in simple and clear language. This is an important innovation. People need to have a reputable source of information to rely on, and they need to know where to go to access that information. The importance of such a guide should not be underestimated. Automatically enrolling people in a pension plan is a great way to foster retirement savings, but workers could make the decision to withdraw or borrow from a retirement account, sometimes incurring tax penalties, or individuals might fail to roll over a pension into another tax-advantageous account when leaving a job. My hope is that the guide will not limit itself to offering information about retirement savings; people are dealing with a lot of financial decisions and all of these decisions are interrelated. For example, it may not be wise for a worker to contribute to a retirement account if he/she carries a lot of high-interest credit card debt. And, judging from some of the behavior that the recent financial crisis exposed, some debt management tips should be included in the guide, too.
Our society has made it easy to consume, now this policy makes it easy to save!
Sunday, July 26, 2009
Where Do People Get Financial Information?
The financial decisions people have to make today are quite complicated, and the financial markets we interact with have made finances even more complicated. So, in such a complex world, where do people turn to for advice when making financial decisions? Survey after survey show that one of the primary sources of information are family members. Colleagues and friends are another common source. This is an important finding. A lot of financial transactions happen within the family and family members naturally exchange information and advice. Moreover, we spend a lot of time at work and the workplace is a natural environment in which to get information and exchange ideas. However, is it a good idea to rely mainly on family and friends for financial advice? Because there is inherently asymmetric information in this type of exchange (those who ask know less than those who provide information), it may be hard to know whether the advice one is receiving is sound. We trust family members to do right by each other, and it might be possible to know whether someone has made good decisions and trust that it is safe to follow in their footsteps. I have an older sibling and I have learned a lot by simply following some of the decisions she has made. But financial acumen is not always verifiable. We cannot always know whether our friends have chosen the best mortgage, how they invest their retirement wealth, and what they do with their credit cards. People do not go around with financial statements around their necks and the fact that someone has a nice house and a nice car might be an indication of a lot of debt rather than a lot of savings. Trust is important when it comes to financial information, but should trust trump expertise? If people around us are not really more knowledgeable in finance than we are, do we improve our knowledge by seeking advice from them? Ask yourself: would you trust a family member who is not a health care professional for medical advice? Finance is no less complicated than health, and the consequences of bad financial decisions can be as dire as taking the wrong medicine or leaving an illness untreated.
I am always intrigued by how much people like to dispense financial information and financial advice. Because I have been traveling a lot in the past few months, I have gotten a good deal of financial information and financial advice from taxi drivers, strangers at the airport, and hairdressers. One participant at a conference told me that in his town, everybody gets financial advice from the butcher. I will keep this in mind when I buy my steaks. I like that people are paying so much attention to finance and financial matters these days, and it’s interesting to hear what people are talking about. Some of the suggestions and theories I have heard are brilliant, some are odd, but others are just plain wrong. Finance and financial principles are grounded in theory: they follow laws that do not change based on who is in power or which state you live in; the power of interest compounding is no different in Florida than in California, and it does not change depending on whether the president is a Republican or a Democrat.
If we are so eager for financial information, there is a clear role for a provider of information—a reputable, independent, and expert source. For example, Social Security started to send around statements about Social Security benefits in 1995. This is a laudable initiative and studies have shown that these statements have changed people’s behavior. The Department of Labor is hard at work to find ways to improve and streamline the information provided by pension plan providers. The Securities and Exchange Commission is looking for ways to better inform investors.
I have my own recommendation to offer. If you need financial information, use www.mymoney.gov. It was built by experts to provide financial advice for citizens. It is from a reputable institution that cares about people making good decisions.
Let’s not mix roles. There is a joke in Italian that goes approximately like this: In heaven, the Italians are the cooks, the Germans build cars, and the Swiss are in charge of running the trains. In hell, the Germans are the cooks, the Swiss build cars, and the Italians are in charge of running the trains. As you can see, we Italians like to poke fun at ourselves. But the same principle applies here: ask taxi drivers for directions, hairdressers for a good shampoo, butchers for a good sausage, and your government for good financial advice! You would not ask a taxi driver for a haircut or send to the Treasury for sausage, would you?
I am always intrigued by how much people like to dispense financial information and financial advice. Because I have been traveling a lot in the past few months, I have gotten a good deal of financial information and financial advice from taxi drivers, strangers at the airport, and hairdressers. One participant at a conference told me that in his town, everybody gets financial advice from the butcher. I will keep this in mind when I buy my steaks. I like that people are paying so much attention to finance and financial matters these days, and it’s interesting to hear what people are talking about. Some of the suggestions and theories I have heard are brilliant, some are odd, but others are just plain wrong. Finance and financial principles are grounded in theory: they follow laws that do not change based on who is in power or which state you live in; the power of interest compounding is no different in Florida than in California, and it does not change depending on whether the president is a Republican or a Democrat.
If we are so eager for financial information, there is a clear role for a provider of information—a reputable, independent, and expert source. For example, Social Security started to send around statements about Social Security benefits in 1995. This is a laudable initiative and studies have shown that these statements have changed people’s behavior. The Department of Labor is hard at work to find ways to improve and streamline the information provided by pension plan providers. The Securities and Exchange Commission is looking for ways to better inform investors.
I have my own recommendation to offer. If you need financial information, use www.mymoney.gov. It was built by experts to provide financial advice for citizens. It is from a reputable institution that cares about people making good decisions.
Let’s not mix roles. There is a joke in Italian that goes approximately like this: In heaven, the Italians are the cooks, the Germans build cars, and the Swiss are in charge of running the trains. In hell, the Germans are the cooks, the Swiss build cars, and the Italians are in charge of running the trains. As you can see, we Italians like to poke fun at ourselves. But the same principle applies here: ask taxi drivers for directions, hairdressers for a good shampoo, butchers for a good sausage, and your government for good financial advice! You would not ask a taxi driver for a haircut or send to the Treasury for sausage, would you?
Friday, July 3, 2009
How to Build a Successful Website for Financial Literacy
At an international conference in Washington, D.C., on financial literacy last year, the Retirement Commissioner from New Zealand stood up and stated that New Zealand has the best website in the world to promote financial literacy and financial education. I liked her instantly; you need to have a lot of guts to make that statement in front of an international audience of academics and policymakers, and possibly a good website. I checked out that website and good it is! It is called “Sorted,” a term that New Zealanders use to mean figuring things out and getting ready (http://www.sorted.org.nz/). The website is very well organized and provides information for financial decisions at every stage of life. One can find information about managing debt, mortgages, investment, and planning for retirement. And there is a variety of calculators as well to help people figure out the interest payments on their credit cards, how wealth can grow with the power of interest compounding, how much to save for retirement, and much more. On the website one can also take a money personality test “to help you work out your financial strengths and possible blind-spots.” I went through the questions and was told (among several other things) that when it comes to money matters, I am cool and dispassionate! I like that, too.
As I have argued before, citizens in every country could use one reliable, accurate source of information for managing their financial decisions. However, what really puts New Zealand's website over the top is the fact that it is so engaging. The information is not provided in those sterile graphs and statistics that even people with advanced degrees understand only after a bit of head scratching. One can watch a movie about investment, saving, and retirement. The soundtrack is so good that it made me play the movies a couple of times to listen to it again. One can also listen to stories and follow the journeys of Liz, Carl and Jess, Rochelle and Junior, and Raeanna and learn how they used the tools available on the website to help organize their finances. It is not just about information and simplifying decisions, but also about implementation. The website describes the steps that one has to take, for example, to set goals and to do a budget. And there are tips on a variety of topics, including how to cope with today’s financial climate. The information provided online is also available in booklets that can be downloaded or ordered for free.
According to a survey that was just released in June 2009, one-third of New Zealanders had either visited the website of the Retirement Commission or read one of the booklets, and a quarter had done so within the past twelve months (http://www.financialliteracy.org.nz/.) This is an extraordinary result. In my view, there are several reasons for this success. First, the Retirement Commission is an autonomous entity with the mission to “educate and inform New Zealanders from age 5 to 105 about managing their personal finances to ensure adequate provision for retirement.” Thus, the citizens of New Zealand know where to go to get a reliable source of information. We do not need many web sites, we only need one! And both the website and the work of the Retirement Commission are well advertised in the media and New Zealanders know about it. Most importantly, as the Retirement Commissioner remarked, it is a good website!
I visited the Retirement Commission last week to speak at their Financial Literacy Summit. I discovered that they designed a survey of financial knowledge in 2005, well before other countries. The development of a national strategy to lift New Zealanders’ financial literacy was announced at the inaugural Financial Literacy Symposium in Wellington in December 2006 and launched in 2008. And if the new survey in 2009 is any indication, 43 percent of New Zealanders are now scoring high on financial knowledge, and women and low income households are among the groups with the biggest improvements since 2006, when data from the first survey was collected. At the conference last week, the Secretary for Education announced that financial education will become part of the curriculum in schools throughout New Zealand. Moreover, the advisory committee for the National Strategy for Financial Literacy (composed of the Governor of the Reserve Bank of New Zealand, the Chair of the Securities Commission, the Chair of the Investment, Savings and Insurance Association, the Secretary for Education, the Associate Dean for Mâori and Pacific Development at the University of Auckland Business School, and the Retirement Commissioner) will now report to the Minister of Finance twice a year on progress in implementing the strategy.
As you may know, New Zealanders are also called “Kiwis.” The Kiwi is a flightless bird. As the story goes, Tane Mahuta, the lord of the forest, was surveying his ferny domain and became concerned that his children, the trees, were ill from being eaten by bugs. He called the birds together to ask if any might be prepared to eat the bugs, which would entail living on the dark, damp forest floor. The Kiwi put himself forward. As a reward it became the best-known and most-loved bird of all.
It is good to have such a symbol in a country so hard at work to improve financial literacy. Can they improve financial literacy? The answer I heard at the conference was: Yes, we can!
As I have argued before, citizens in every country could use one reliable, accurate source of information for managing their financial decisions. However, what really puts New Zealand's website over the top is the fact that it is so engaging. The information is not provided in those sterile graphs and statistics that even people with advanced degrees understand only after a bit of head scratching. One can watch a movie about investment, saving, and retirement. The soundtrack is so good that it made me play the movies a couple of times to listen to it again. One can also listen to stories and follow the journeys of Liz, Carl and Jess, Rochelle and Junior, and Raeanna and learn how they used the tools available on the website to help organize their finances. It is not just about information and simplifying decisions, but also about implementation. The website describes the steps that one has to take, for example, to set goals and to do a budget. And there are tips on a variety of topics, including how to cope with today’s financial climate. The information provided online is also available in booklets that can be downloaded or ordered for free.
According to a survey that was just released in June 2009, one-third of New Zealanders had either visited the website of the Retirement Commission or read one of the booklets, and a quarter had done so within the past twelve months (http://www.financialliteracy.org.nz/.) This is an extraordinary result. In my view, there are several reasons for this success. First, the Retirement Commission is an autonomous entity with the mission to “educate and inform New Zealanders from age 5 to 105 about managing their personal finances to ensure adequate provision for retirement.” Thus, the citizens of New Zealand know where to go to get a reliable source of information. We do not need many web sites, we only need one! And both the website and the work of the Retirement Commission are well advertised in the media and New Zealanders know about it. Most importantly, as the Retirement Commissioner remarked, it is a good website!
I visited the Retirement Commission last week to speak at their Financial Literacy Summit. I discovered that they designed a survey of financial knowledge in 2005, well before other countries. The development of a national strategy to lift New Zealanders’ financial literacy was announced at the inaugural Financial Literacy Symposium in Wellington in December 2006 and launched in 2008. And if the new survey in 2009 is any indication, 43 percent of New Zealanders are now scoring high on financial knowledge, and women and low income households are among the groups with the biggest improvements since 2006, when data from the first survey was collected. At the conference last week, the Secretary for Education announced that financial education will become part of the curriculum in schools throughout New Zealand. Moreover, the advisory committee for the National Strategy for Financial Literacy (composed of the Governor of the Reserve Bank of New Zealand, the Chair of the Securities Commission, the Chair of the Investment, Savings and Insurance Association, the Secretary for Education, the Associate Dean for Mâori and Pacific Development at the University of Auckland Business School, and the Retirement Commissioner) will now report to the Minister of Finance twice a year on progress in implementing the strategy.
As you may know, New Zealanders are also called “Kiwis.” The Kiwi is a flightless bird. As the story goes, Tane Mahuta, the lord of the forest, was surveying his ferny domain and became concerned that his children, the trees, were ill from being eaten by bugs. He called the birds together to ask if any might be prepared to eat the bugs, which would entail living on the dark, damp forest floor. The Kiwi put himself forward. As a reward it became the best-known and most-loved bird of all.
It is good to have such a symbol in a country so hard at work to improve financial literacy. Can they improve financial literacy? The answer I heard at the conference was: Yes, we can!
Friday, June 19, 2009
Protecting Consumers: Regulation is not Enough
This week, the Obama administration laid out a financial reform plan that included the creation of a Consumer Financial Protection Agency. This and the Credit CARD Act of 2009, which was passed in Congress last month, are important steps toward improving consumer protection in the marketplace—but without a renewed focus on promoting financial literacy and financial education programs, these initiatives will fall flat.
Financial literacy is an essential tool for consumers trying to navigate today’s world, where they engage in a myriad of financial transactions in an increasingly complex financial marketplace. Consumers require financial literacy to make decisions related to saving, retirement planning, managing credit card debt, and acquiring mortgage loans. The transition in recent decades from defined-benefit to defined-contribution pension plans has meant that the responsibility for securing late-life financial well-being is now placed on the shoulders of consumers. Just like the fundamental skills of reading and writing, financial literacy is a key ingredient for economic success.
Promoting “transparency, simplicity, fairness, accountability, and access,” as the White House report touts, is certainly an essential goal for any effective consumer regulatory regime. However, the mere provision of accurate and clear information is often inadequate to achieve good consumer decision-making. For instance, the Truth in Lending Act of 1968 was designed to protect borrowers by requiring the disclosure of critical loan terms, such as the annual percentage rate (APR); but in fact many consumers do not understand the workings of interest rates. Without knowledgeable consumers, transparency is not enough.
And lack of financial knowledge is alarmingly widespread. In a survey of Americans that Peter Tufano of Harvard Business School and I conducted with the market research firm TNS Global, we found strikingly low levels of financial knowledge across the U.S. population. Only one-third of respondents were able to apply concepts of interest compounding to everyday situations or understand the workings of credit cards. While many American families use credit cards and carry balances, only a minority of respondents knew that borrowing at an interest rate of 20 percent, compounded annually, will lead to a doubling of debt in fewer than five years. Lack of financial literacy is particularly severe in groups that are already financially vulnerable: women, the elderly, minorities, and those who are divorced or separated. And the less financially knowledgeable pay dearly for their ignorance: the credit card fees paid by a low-knowledge individual are 50 percent higher than those paid by an average cardholder.
The Credit CARD Act of 2009 makes important strides in that it requires credit card companies to include, in the billing statement, the number of months it will take a consumer to pay off the balance if he or she makes only the minimum monthly payment. Making it easier for consumers to process information is an effective way to aid in financial decision-making.
Simplification can be taken much further: an example is the auto-enrollment IRA, one of the initiatives that the White House pushes for in its report. Automatic enrollment in pensions has been a way to substantially increase workers’ participation in defined-contribution pensions. However, this can fall short of securing retirement needs. Workers who carry credit card balances should reduce their debt rather than enroll in a pension. And automatic enrollment in pensions and IRAs is not a substitute for retirement planning; workers need to ensure they are saving for a retirement that meets their needs and goals, an objective that a one-size-fits-all automatic enrollment program might not achieve.
Increasing regulation of consumer financial products and circumscribing the set of products available to consumers, either by requiring businesses to provide “plain vanilla” financial products or by outlawing products that are deemed manipulative or misleading, as the White House outlines in its report, can be effective in limiting the scope of financial mistakes that consumers can make. However, these measures are not enough to promote long-term financial well-being.
Consumers engage in such a varied and increasingly complex array of financial transactions that it is not feasible to circumscribe and regulate all possible actions in every possible financial area, nor is it desirable. Instead, policymakers need to equip consumers with enough financial knowledge to make them capable of effective financial decision-making.
To this end, the Obama administration’s plan deserves praise for recognizing the importance of promoting financial education: the White House report envisions the Consumer Financial Protection Agency taking a “leading role” in educating consumers about finance. Consumer protection is a two-way street: it requires not just regulation and oversight of businesses but also ensuring consumers are adequately equipped to confront the array of financial choices available to them. Navigating today’s financial markets is not unlike navigating busy roads: putting up more road signs, increasing patrolling, and restricting traffic can limit accidents but if people do not know how to drive, they are still going to crash. Promoting financial literacy needs to remain not just an afterthought, but a top priority.
Financial literacy is an essential tool for consumers trying to navigate today’s world, where they engage in a myriad of financial transactions in an increasingly complex financial marketplace. Consumers require financial literacy to make decisions related to saving, retirement planning, managing credit card debt, and acquiring mortgage loans. The transition in recent decades from defined-benefit to defined-contribution pension plans has meant that the responsibility for securing late-life financial well-being is now placed on the shoulders of consumers. Just like the fundamental skills of reading and writing, financial literacy is a key ingredient for economic success.
Promoting “transparency, simplicity, fairness, accountability, and access,” as the White House report touts, is certainly an essential goal for any effective consumer regulatory regime. However, the mere provision of accurate and clear information is often inadequate to achieve good consumer decision-making. For instance, the Truth in Lending Act of 1968 was designed to protect borrowers by requiring the disclosure of critical loan terms, such as the annual percentage rate (APR); but in fact many consumers do not understand the workings of interest rates. Without knowledgeable consumers, transparency is not enough.
And lack of financial knowledge is alarmingly widespread. In a survey of Americans that Peter Tufano of Harvard Business School and I conducted with the market research firm TNS Global, we found strikingly low levels of financial knowledge across the U.S. population. Only one-third of respondents were able to apply concepts of interest compounding to everyday situations or understand the workings of credit cards. While many American families use credit cards and carry balances, only a minority of respondents knew that borrowing at an interest rate of 20 percent, compounded annually, will lead to a doubling of debt in fewer than five years. Lack of financial literacy is particularly severe in groups that are already financially vulnerable: women, the elderly, minorities, and those who are divorced or separated. And the less financially knowledgeable pay dearly for their ignorance: the credit card fees paid by a low-knowledge individual are 50 percent higher than those paid by an average cardholder.
The Credit CARD Act of 2009 makes important strides in that it requires credit card companies to include, in the billing statement, the number of months it will take a consumer to pay off the balance if he or she makes only the minimum monthly payment. Making it easier for consumers to process information is an effective way to aid in financial decision-making.
Simplification can be taken much further: an example is the auto-enrollment IRA, one of the initiatives that the White House pushes for in its report. Automatic enrollment in pensions has been a way to substantially increase workers’ participation in defined-contribution pensions. However, this can fall short of securing retirement needs. Workers who carry credit card balances should reduce their debt rather than enroll in a pension. And automatic enrollment in pensions and IRAs is not a substitute for retirement planning; workers need to ensure they are saving for a retirement that meets their needs and goals, an objective that a one-size-fits-all automatic enrollment program might not achieve.
Increasing regulation of consumer financial products and circumscribing the set of products available to consumers, either by requiring businesses to provide “plain vanilla” financial products or by outlawing products that are deemed manipulative or misleading, as the White House outlines in its report, can be effective in limiting the scope of financial mistakes that consumers can make. However, these measures are not enough to promote long-term financial well-being.
Consumers engage in such a varied and increasingly complex array of financial transactions that it is not feasible to circumscribe and regulate all possible actions in every possible financial area, nor is it desirable. Instead, policymakers need to equip consumers with enough financial knowledge to make them capable of effective financial decision-making.
To this end, the Obama administration’s plan deserves praise for recognizing the importance of promoting financial education: the White House report envisions the Consumer Financial Protection Agency taking a “leading role” in educating consumers about finance. Consumer protection is a two-way street: it requires not just regulation and oversight of businesses but also ensuring consumers are adequately equipped to confront the array of financial choices available to them. Navigating today’s financial markets is not unlike navigating busy roads: putting up more road signs, increasing patrolling, and restricting traffic can limit accidents but if people do not know how to drive, they are still going to crash. Promoting financial literacy needs to remain not just an afterthought, but a top priority.
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