Wednesday, March 22, 2017

Should College Students Be Required to Take a Course in Personal Finance? YES: Ignorance Carries a High Price

This is an extract of an article which first appeared on the front page of the Personal Finance section of The Wall Street Journal on March 19, 2017. Read the full online version by clicking here

Think about driving. To ensure orderly traffic, we create speed limits and roadway rules. We erect signs to warn where turns are difficult or roads are treacherous. And before we allow someone behind the wheel, we make sure they understand the basics. That’s where a driver’s license comes in. We take those precautions to protect the drivers and to protect others.

It is time to extend that type of thinking to financial knowledge by making personal finance a required course at U.S. colleges and universities. For people—especially young people—to survive and thrive in today’s financial environment, knowledge of personal finance is a necessity.

We’re already seeing what happens when young adults juggle high-impact financial decisions without the benefit of financial knowledge. Take the well-known burden of student-loan debt. Student loans are the second-largest part of the consumer credit market, after mortgages. The lion’s share of that debt sits in the hands of millennials—and our research shows they worry about their ability to pay off those loans. As well they should. The default rate on student loans is sobering.

Multiple studies confirm that students have little understanding of how student loans work. Our analysis of the latest National Financial Capability Study, or NFCS, finds that more than half of millennials take on student loans without even attempting to calculate what their payments will be. Given that student loans are pursued to acquire an education, it seems only prudent to have that education include the knowledge needed to manage that debt.

But student debt is just one of the challenges. These young people will have to support long retirements on savings and investments managed throughout their careers. To accomplish that feat, they will depend on interest compounding—a basic concept that they don’t fully understand. They also struggle with two other critical concepts: risk diversification and inflation.

These are the ABCs of personal finance, the benchmarks by which we measure financial literacy. By age 40, when a majority of Americans have already made most of their important financial decisions, only 1 in 3 has mastered these concepts, according to the NFCS. Unless something changes, millennials will become part of that disturbing statistic.

Such courses must be well designed to be effective. There is mounting evidence that personal-finance courses with a rigorous curriculum and trained teachers are influencing behaviors of young people in matters such as debt and defaulting on debt. Teaching personal finance is not about describing financial products, it is about teaching the principles of financial decision-making so that people understand how financial instruments work. When people are knowledgeable, they also are better able to benefit from the services of financial advisers.

Those opposed to requiring personal-finance courses say that the main thing students should learn is skepticism about the financial industry and its products. Some skepticism is always warranted, and I teach my students about the potential conflicts of interest that financial advisers may have. But the purpose of a personal-finance course goes beyond those topics.

Financial literacy is about prevention. Regulators simply cannot keep up; they tend to come in when a problem already exists. This is why regulation is not enough.

The lack of financial literacy—just like the lack of a driver’s license—is more than a personal problem. It is dangerous for our country’s economic health. The Great Recession was driven by mortgages and loan terms consumers didn’t understand. The entire nation went into an economic tailspin as a result of that lack of understanding.

Looking ahead, will young people saddled with student loans be less likely to buy cars and homes? Will their ability to engage in transactions that require not just liquidity but good credit ratings be hampered? Will they veer away from starting their own businesses or pursuing advanced degrees? If they are not saving enough for retirement, will they have to be rescued from poverty in old age—and at what price to the country?

One of the basic lessons in personal finance is that time is money. But time is starting to run out. Young people are already behind the steering wheel of their financial decision-making. It’s time we step in to make sure they know how to navigate the highway ahead.

Thursday, February 2, 2017

Educazione finanziaria, costa di più non farla

A shorter version of this blog was published in Il Sole 24 Ore and can be found here.

Ci sono alcune somiglianze tra l’inizio del 2017 ed il 2016. Un anno fa si parlava di bail-in, ma anche di educazione finanziaria per salvaguardare i risparmiatori. Un anno dopo si parla di nuovo di decreto legge “salva banche” e di educazione finanziaria. Questa volta però, le indiscrezioni sul Dl banche sembrano autorizzare la speranza che il più trascurato dei due temi riceverà qualche attenzione in più rispetto al passato.

Tutti i sondaggi parlano chiaro. Il livello della conoscenza finanziaria in Italia è molto basso e molto più basso della maggioranza degli altri Paesi europei. L’analisi dei nuovi dati su un campione di dieci Paesi europei pubblicati proprio lo scorso lunedì in un rapporto di Allianz fatto in collaborazione con il Global Financial Literacy Excellence Center vede l’Italia fanalino di coda. Rispetto a Paesi come l’Austria, il Belgio, la Francia, la Germania, l’Olanda, il Portogallo, il Regno Unito, la Spagna e la Svizzera, l’Italia si colloca ultima o penultima in quasi tutte le domande che misurano i concetti base della finanza, l’abc della conoscenza finanziaria. Più del 30% degli Italiani non sa calcolare il 2% su una somma di 100 euro. La conoscenza più bassa si riferisce al rischio e alla diversificazione del rischio, un fatto di cui avevamo preso amaramente nota lo scorso anno guardando agli investimenti dei risparmiatori di Banca Marche, Banca Etruria, CariFe e Carichieti.

Altre indagini confermano gli stessi risultati. Il S&P Global Financial Literacy Survey, il Programma per la valutazione internazionale dell’allievo (PISA) dell’OCSE, e i dati della Banca d’Italia sono tutti concordi nel descrivere un Paese con pochissime conoscenze dei principi alla base delle decisioni finanziarie. Se per importanza economica l’Italia si colloca tra i Paesi del G7, per conoscenza finanziaria assomiglia invece alle economie emergenti, dove anche il Sud-Africa fa un po’ meglio dell’Italia. Purtroppo questo è vero anche per i giovani: nella valutazione della conoscenza finanziaria dei quindicenni in PISA, gli studenti italiani sono arrivati penultimi; fanno meglio solo della Colombia. Non possiamo quindi aspettarci che le generazioni future facciano meglio delle generazione odierne; il ciclo della bassa conoscenza finanziaria sembra destinato a ripetersi.

I costi dell’ignoranza finanziaria sono spaventosi. L’ignoranza è un po’ come quelle malattie silenziose che si annidano nel corpo senza particolari sintomi che siano visibili a occhio nudo, per poi esplodere al momento dei test, quando talvolta è troppo tardi per curarle. Il costo delle scelte sbagliate dei mutui negli Stati Uniti si è transformato in una enorme crisi finanziaria non solo per le famiglie ma per l’intera economia. Se ci riferiamo solo al comportamento relativo alle carte di credito, secondo le nostre stime, più di un terzo delle spese relative a interessi ed altri costi del credito—per intenderci più di 3.5 miliardi di dollari nel 2009—è dovuto alla mancanza di conoscenza finanziaria, ovvero a costi che potevano essere evitati. Sempre negli Stati Uniti, si è stimato che l’ammontare dei mancati rendimenti degli investimenti azionari dovuti a commissioni ed altre spese si aggira intorno ai 100 miliardi di dollari, e questi costi sono sostenuti soprattutto da chi ha bassi livelli di alfabetizzazione finanziaria.

I costi dell’ignoranza finanziaria sono alti anche nella semplice gestione del conto bancario, non di complessi portafogli. Secondo recenti stime, il mancato utilizzo di tecnologie come online banking, unito all’ignoranza finanziaria crea perdite di ricchezza anche nello strumento finanziario più semplice che tutti possediamo, ovvero il conto corrente.

In passato abbiamo creduto di poter risparmiare dei soldi rinunciando all’educazione finanziaria? Purtroppo anche l’ignoranza finanziaria costa. Non solo i costi ci sono, ma sono anche alti, e se non vengono pagati adesso, saranno pagati nel futuro. Se le risorse da investire nell’educazione dei cittadini non sono sufficienti dobbiamo intervenire anche noi. Ci sono varie organizzazioni in Italia che si stanno occupando di alfabetizzazione finanziaria, dalle organizzazioni dei consumatori, al Museo del Risparmio di Torino che è nato proprio per promuovere l’educazione finanziaria. Lavoriamo con loro. E possiamo fare molto nelle scuole e nelle università in modo che i nostri giovani siano meglio preparati a capire il nuovo mondo finanziario che si apre di fronte a loro, e per non creare nuove vittime e nuove povertà.

L’educazione finanziaria è un investimento per il futuro. In tutti i paesi i mercati finanziari sono diventati più complessi, i prodotti finanziari più numerosi e le scelte finanziarie, anche quando si riferiscono agli strumenti di base, sono più difficili rispetto al passato. Ogni cittadino si confronta con queste scelte. L’obiettivo dell’educazione finanziaria è quello di trasformare i risparmiatori non già in esperti ma solo in persone più consapevoli. Promuovere l’educazione finanziaria significa fare prevenzione invece di interventi drastici quando i problemi si sono protatti così a lungo che non sono nemmeno più curabili con semplici medicine. I costi allora sì che esplodono.

Il 2017 non deve diventare una triste continuazione del 2016. No grazie, non abbiamo tempo da perdere. Una cosa che ci insegna la finanza, è che il tempo è denaro. L’educazione finanziaria non può più aspettare.

Friday, January 20, 2017

Our hopes for the future

Many challenges await the new president, some of great urgency. In his inaugural address, he expressed a desire for action. There are many areas of action but one especially pernicious issue has several relatively simple solutions. That is the problem of financial illiteracy.

Our research shows that financially knowledgeable individuals make smarter financial decisions and achieve better outcomes; they are more likely to save, plan for the future, invest, and become contributing members of society; and less likely to take on expensive debt.

However, millions of Americans lack even a basic understanding of personal finance. In 2015, only 32 percent of Americans could answer correctly three basic questions on financial concepts like interest rate, inflation, and risk diversification. This “financial illiteracy” undermines their quest for a better future.

Consider debt. The number of student loan borrowers has nearly doubled in the past decade, and many borrowers do not understand the effects of that borrowing beforehand. According to our research, 54 percent of student loan holders did not try to calculate their monthly payments before borrowing, and 53 percent said that given the chance, they would do things differently. This debt causes financial stress: 37 percent of people with student loan payments due said they were late with a payment at least once in the last 12 months.
Debt is also a growing problem for older Americans, threatening their retirement security. And speaking of retirement, only 39 percent of Americans have even tried to determine how much money they will need in later life, a figure barely changed since 2009.
Financial fragility is another problem exacerbated by limited financial literacy. Some 34 percent of Americans said that they could not come up with $2000 if an unexpected need arose within the next month. We need to put in place policies that improve individuals’ financial security both in the long-term and the short term. We need to equip people with the knowledge to make quality financial decisions around debt, and we need ways to encourage American families to build “rainy day funds” for emergencies.
There is an urgent need for policy action to encourage the spread of financial education so that people in all walks of life can make savvy financial choices. Parents and teens would benefit from having a better grasp on how to pay for college. Millions of Americans would be more likely to build emergency savings if they realized their importance. People also would benefit from a better understanding of how to save for retirement. Our research shows that the mere act of planning for retirement is a strong predictor of retirement wealth.
Some schools already provide financial education for all students. Workplace financial education and financial wellness programs can also impart essential knowledge. Government incentives for both employers and schools to provide financial education could spur new solutions to the problem of low financial literacy.
If more schools and employers provided financial education, millions of American would have the tools to build better lives for themselves and for us all. This is a vision for the future we hope for.

Friday, January 13, 2017

Six Questions to Help Determine Your Financial Health

This blog post was also posted on the Wall Street Journal and can be found here

Many people, when thinking about their financial health, focus on a single indicator, such as whether they are saving enough for retirement or carrying too much student-loan debt. If personal finances were limited to--or fixed by--a single line item in the balance sheet, that approach would be fine.

But they aren’t.

During an annual physical exam, it is not possible to assess how well a patient is doing simply by checking the heart rate or blood pressure. Rather, a more comprehensive series of evaluations are needed. How well is the patient managing his or her health? Is the patient taking medicines as prescribed? Is the patient exercising and eating well?

The same is true of financial health.

Fortunately, there is a short financial checkup that effectively predicts what I think of as the key components of financial health--including short-term and long-term savings, management of financial products and financial literacy. The six-question test, which is based on a body of national and international research, evaluates four key areas: 1) ability to make ends meet, 2) advance planning, 3) management of financial products and 4) financial knowledge. (More in-depth questions from a national survey on financial capability, now in its third wave, are available online.)

Taken together, the questions below--and their answers--provide a starting point for people to better understand and improve their personal finances.

1. How confident are you that you could come up with $2,000 if an unexpected need arose within the next month?
-  I am certain I could come up with the full $2,000.
-  I could probably come up with $2,000.
-  I could probably not come up with $2,000.
-  I am certain I could not come up with $2,000.

This first question of the test assesses financial fragility--or the ability to mobilize resources when facing a shock. It is a rich measure that goes well beyond availability of or access to liquid assets, taking into consideration that one could deal with a shock by borrowing, by relying on the help of family and friends, by selling possessions or through other strategies. Moreover, it is a summary measure of the balance-sheet situation (not just assets) even as it addresses how one manages resources. Research links the lack of resources or the inability to access them when facing a midsize shock (specifically, answering this question with either of the last two responses) with indicators of financial distress.

2. Have you ever tried to figure out how much you need to save for retirement?

This question measures advance planning by examining the longer-term horizon and whether one has made plans for the future. While simple and intuitive, the question looks yet again at the state of personal finances and, in particular, at the steps taken to accumulate retirement savings, which can take many forms, including keeping within a budget. Academic research shows that those who answer affirmatively to this question have up to three times the amount of wealth as they near retirement as those who have not made any plans.

3. On a scale from 1 to 7 (where 1 = strongly disagree and 7= strongly agree), how strongly do you agree or disagree with the following statement: I have too much debt right now.

The third question turns to the liability side of the balance sheet. There are many opportunities to borrow and a multitude of options for doing so. Many young employees today start their working life in debt. The answer to this question reveals both the extent of the respondent’s debt burden and his or her management of finances. Those who choose value above the median (value 4 ) are found to carry not only several forms of debt, both short term and long term, but also to use high-cost methods of borrowing, such as payday loans.

The next three questions measure understanding of the ABCs of personal finance. They apply to the many financial decisions people have to make and that, ultimately, shape their finances and ability to achieve financial security in the short and long term. The questions address fundamental concepts--interest compounding, inflation and risk diversification--that underlie financial decisions, from day-to-day money management, to saving and investing for retirement, to borrowing.

Those who correctly answer the three questions reported below (the correct answers are the end) are not only less likely to be financially fragile and over indebted, but they are also more likely to plan for the future and to engage in many other behaviors conducive to higher retirement savings.

4. Suppose you had $100 in a savings account and the interest rate was 2% per year.  After five 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
-  Don’t know

5. Imagine that the interest rate on your savings account was 1% per year and inflation was 2% per year. After one year, with the money in this account, would you be able to buy…
-  More than today
-  Exactly the same as today
-  Less than today
-  Don’t know

6. Do you think the following statement is true or false? Buying a single company stock usually provides a safer return than a stock mutual fund.
Rather than looking at a single behavior--an approach that usually is inadequate for evaluating how someone is doing financially--this test provides an encompassing measure of financial capability. It also identifies the areas where help may be needed.  Even more, it allows individuals to compare their results to those of the average American. The findings for each question are available here.

As employers and others look for ways to help employees become financially fit, this test may provide them with a tool to measure, assess, and reconsider what they are doing. Perhaps it is something to add to employee benefits in 2017.

(Answers: 4. More than $102;  5. Less than today; 6. False.)

Friday, April 1, 2016

Happy Financial Literacy Month!

This is a slighly modified blog that was published in Forbes. The link is here: http://www.forbes.com/sites/pensionresearchcouncil/2016/04/01/happy-financial-literacy-month/#517158ee5308
April is Financial Literacy Month. You might suspect there is a problem with financial literacy in America, if an entire month is dedicated to it! And you would be right.

The S&P Global Financial Literacy Survey released last fall showed that only 57 percent of adult Americans know basic financial literacy concepts such as interest compounding, inflation, and risk diversification. And high school students do no better: the Programme for International Student Assessment (PISA) reported that 18 percent of US students do not reach the baseline level of proficiency in financial literacy. Moreover, Millennials don’t learn much about financial literacy after they leave high school, according to the National Financial Capability Study.

For this reason, April is an opportune time to look at three efforts that may have a chance to combat financial illiteracy. These are chosen because of their scalability and capacity to make a real difference for financial literacy in America.

Financial literacy in school: According to the Council for Economic Education, only 19 states require schools to offer a personal finance course. This does not bode well, considering that the student loan market has now surpassed $1 trillion, and student loans are a deep worry for many young adults.

Teaching kids about financial matters in school can help. For instance, students exposed to a rigorous financial literacy program are much less likely to get into trouble with debt after they graduate, according to recent research. We don’t need a federal or state mandate to add financial literacy in schools: parents can simply ask their school districts for such courses. After all, nations around the world have now agreed: financial literacy is essential to participate in society in the 21st century.

Financial literacy in the workplace: Many companies today offer defined contribution pensions, which put workers in charge of deciding both how much to save and how to invest their pension assets. And health plans also require participants to be more financially savvy, to manage high deductibles, copays, and Health Saving Accounts, and to compare prices for medical care.

For this reason, workplace financial education programs are often provided to educate employees on how to manage these decisions. Yet employers can benefit as well, since the stress generated by money problems can translate into lower worker productivity, higher absenteeism, and more turnover. In our tightening labor market, an employer who offers help with money management or debt can readily attract and retain workers. Some firms have even stepped up to help relieve employees of student loan obligations, which can improve worker loyalty.

Financial literacy in the community. One particularly noteworthy program, both for its potential impact and scalability, comes from the American Library Association. Every community, big or small, has a library—a place where anyone, young or old, can go to learn, including via easy access to the Internet. As hubs for knowledge and information, libraries are ideal venues in which to provide financial education. Through the Association, programs that prove especially effective in one place can be extended nationwide. Libraries can also complement school or workplace financial literacy programs.

Financial literacy won’t change overnight, nor in a month or even a year. Yet initiatives taken in schools, workplaces, and in communities add up. My hope is that someday, in the future, the month of April can be re-dedicated to another topic!

Sunday, February 7, 2016

Looking for a Super Bowl cheer that lasts a lifetime

This a slighly modified version of the blog I wrote for the Wall Street Journal in collaboration with Colin Camerer. The WSJ blog is posted here : http://blogs.wsj.com/experts/2016/02/05/the-sad-financial-future-that-awaits-many-nfl-players/

The winners of this Sunday’s Super Bowl will have much to celebrate. In addition to their team victory, the players will see substantial financial bonuses, including potentially richer contracts and future sponsorships. Even the players who lose at football will be financial winners. After all, they, too, made it to the Super Bowl, one of the world’s most-watched sporting events.
The 2016 championship game may mark the career finale for some of these extraordinary players. Will Peyton Manning retire after this year? Will anyone else leave football? If they do, sad to say, they may be in for some bad news. Our research shows that a surprising number of NFL players declare bankruptcy not long after they retire.
For our research published last year in the American Economic Review, we collected data on more than 2,000 players—all of those who were drafted by the NFL from 1996 to 2003—and followed them until 2013. We were interested in seeing how well football players do, financially, after they leave the game. Because it is very hard to find out how much they earned and spent after they retire, we looked at a simple measure of financial distress which is publicly available: bankruptcy filings. And we found that things did not go well at all.
Football players, even those with short careers, usually earn more than what most college-educated workers earn during a lifetime. Because NFL careers are so short, the players’ post-NFL retirements can be long. Many get other jobs, but only a tiny percentage end up with coveted high-salary jobs such as sportscasting. Following all the players together as a group, as they retire, players start going bankrupt.  After 12 years in post-NFL retirement, more than 15 percent of the players we followed had declared bankruptcy. We also found that bankruptcy does not depend on how much an NFL player earned in their career or how long he plays. Amazingly, higher income or longer careers seem to offer little protection against bankruptcy.
These findings have been documented, with some variation, by other sources. There are numerous news stories and interviews describing instances where players have lost all the money they earned. Unfortunately, we continue to witness this phenomenon each year.
We offer three recommendations that could help keep these professional athletes celebrating financial success long after the Super Bowl. These guidelines apply to anyone who finds himself/herself with a lot of money earned in a very lucrative short-lived career.
First, become financially literate. Exposure to basic financial knowledge helps young people understand not just the workings of interest rates and financial markets, but it also builds healthy habits around money and money management. The opportunity to become financially literate before contracts are signed and large sums of money are earned is probably the best medicine for the financial health of these high-earning young professionals.
Second, learn to manage money. Money-management training could be a key part of contract signings or receipt of bonuses. Athletes are used to the kind of training that requires enormous discipline, and they are very good at it. Comprehensive money-management training could offer information that goes beyond simple recommendations for investments or rookie camps. Players could get training that helps them to figure out how far into the future their money can last, how to build a budget that allows them to achieve their objectives, and how to help their families and friends without putting themselves at financial risk. An extra benefit is that managing their own money well makes them into financial role models in addition to athletic role models. The same traits that make players successful on the field—practice, persistence, and the ability to overcome setbacks—can make them successful in managing their finances.
Third, choose a pay structure wisely. Financial advisors often tell big lottery winners to arrange their winnings to be paid over decades, rather than in one tempting lump sum.  How about a system that offers remuneration as a series of payments over a long period of time? This option could generate a stable standard of living for those players who prefer not to engage in complex money management decisions. It also has the benefit of showing how far the money that athletes receive in a single contract can, indeed, go.  After all, the income earned by college-educated people who are not professional athletes is distributed over a lifetime. And it is a way to tie ones’ hand and resist the temptation to spend it all. A lot of research has shown that these types of commitment devices work like wonder.
Wouldn’t it be something if the winners in this year’s Super Bowl could wear their Super Bowl ring proudly for the rest of their lives, rather than having to sell it some day to stay afloat?
Colin Camerer is a neuroeconomist and the Robert Kirby Professor of Behavioral Economics at the California Institute of Technology. In 2013, he was awarded the MacArthur Fellowship

Friday, January 22, 2016

Understanding the Implications of an Interest Rate Hike

This is a slightly modified version of the blog I wrote for Forbes.

Pundits keep a close watch on the U.S. Federal Reserve as it meets to raise interest rates after seven years of effectively zero rates. Yet the reality is that many Americans know little about interest rates, and much less about the implications of a rate hike for their finances!  This was one key finding from the recently released S&P Global FinLit Survey, gathered with the support of McGraw Hill Financial.

The goal of the international study was to compare adult financial literacy levels across more than 140 nations. Financial literacy was measured using questions assessing basic knowledge of four fundamental concepts: numeracy or capacity to do simple calculations in the context of interest rates, interest compounding, inflation, and risk diversification. Respondents were deemed “financially literate” if they could correctly answer three of the four questions. The Global Financial Literacy Excellence Center helped design the survey and analyze the results.

Staggeringly, we found that only one in three adults is financially literate around the world. While Americans far a bit better, only a little more than half of US adults scores this well, a finding that bodes ill for one of the world’s most advanced financial markets.

More importantly, our research has also identified what people don’t know about their finances. One giant void has to do with compound interest, despite the fact that many are quite vulnerable to interest rate changes. For example, when combining information with the Global Findex data, we find only 66% of Americans who hold credit cards understand interest compounding. In Brazil, Latin America’s largest economy, only about half of credit-card holders can accurately answer our interest-compounding question. Similar results apply to borrowers elsewhere. The logical implication is that, whatever the Federal Reserve decides, most people will snooze through the news. This, of course, can be dangerous to debtors everywhere.

There are a few financial concepts that people do tend to understand, particularly inflation. Naturally, this topic is one where experience matters: having struggled mightily with hyperinflation in the late1980s and early 1990s, two-thirds of Argentinians can answer an inflation question accurately. Similar patterns are observed in Georgia, Bosnia and Herzegovina, and Peru, all of which also suffered under hyperinflation in the past. By contrast, only half of Japanese adults understand the corrosive power of inflation, having suffered deflation over the past few decades. In the U.S., the figure is just shy of two thirds (63%).

Monetary policy affects households and household finances, yet what people know about some of its levers is limited. As interest rates start rising, some people will learn about interest compounding. But this begs the question: should experience alone be our teacher?