I regularly receive e-mails from people who recognize the terrible need for improving financial literacy among young people. Most of the people who write say they want to volunteer their time and teach financial literacy in high school. I am very impressed by how strongly people feel about financial literacy and I have been thinking of ways of harnessing that willingness to help and the generosity of volunteers. Financial literacy is much in need of promoters and organizers. It is a very important issue and we need to work for it.
While I want to encourage everyone to get involved with the schools, I am reluctant to recommend that individual volunteers teach financial literacy in schools, for three main reasons.
1. Contrary to popular belief, it is very hard to teach. I have been at Dartmouth for eighteen years now and I can tell you that every year I have to do a lot of preparation to be able to stand in front of my students and engage them. The first day of class normally ends with a room full of students with baseball caps expertly placed so that I can’t tell whether they are listening or are sound asleep, and a few anxious faces who have been checking their watches for the last 61 minutes of the 65-minute class, and who exit the classroom faster than Speedy Gonzales. And these are the economics students who have elected to be in these classes! It takes a while to filter through the stone faces beyond the first row, and even after years of grueling practice, I barely manage to get through the first half of the term without witnessing a decimated class. It does help to have an Italian mamma instinct, to be armed with limitless patience and unbounded optimism, and to be able to resist the temptation to hang myself from the maple tree outside the window after explaining a concept five different ways and realizing that it is still unclear. If somebody thinks they can just show up in the classroom and teach, I can assure you, it hardly works this way. If you want to teach, you have to be prepared to be well trained or the students will “train” you (meaning you will feel like a train has run over you by the end of the class).
2. Individuals seem to have many different ideas about how to approach the instruction of financial literacy. As I have mentioned in previous blogs, financial literacy is a topic grounded in economic and finance theory and it should be taught accordingly. But what I often hear suggested are topics like how to balance a checkbook or how to buy stocks. We need to stay away from these narrow “how to” lessons of financial literacy, as the objective here is to prepare people to understand and navigate a world of complex and changing financial markets. We can’t just tell students how to get from point A to point B; we need to teach them to use a compass. This is no small task and in my view we need a curriculum that teaches the fundamental principals that combine to make one financially literate. Such curriculum development is best done at the national level; inflation does not decrease the value of money differently in Vermont than it does in California or Texas. And while Vermont is much colder than the southern states, it does not freeze how prices work. Once we have developed such a curriculum, there might be a way to engage volunteers in the instruction of it.
3. It’s not always clear how well qualified individuals are to teach financial literacy. In several cases, I have found that college freshmen have set up web pages to teach financial literacy and are eager to go to high schools to offer some classes, even though they may have taken only one introductory course in economics. This is the curse of economics. I have found that many people feel very confident about their views of how the economy works even if they have never read an economics textbook. In other cases, I’ve gotten the impression that people are intent on delivering wisdom and strong values acquired over many years of experience. On the one hand, I am very attracted by the passion that this topic engenders, on the other hand, the dissemination of a sound and consistent knowledge base should be our first priority.
I do not want to discourage anyone who is interested in the pursuit of improving financial literacy in schools. Quite the opposite! Please be involved; do not let the school in your own district not pursue financial literacy, not teach these courses! But perhaps the best role is to be an “ambassador of financial literacy”; be an advocate for financial literacy without going directly to the blackboard. We normally do not let strangers into the classroom, in any course, not just financial literacy. In my view, teaching financial literacy requires a deep knowledge of economics, solid training, and a fair dose of humility. My students would also say that a thick Italian accent helps keeps you awake, but in this case, even that might not be enough!
Wednesday, February 3, 2010
Wednesday, January 20, 2010
Three Reasons to Teach Financial Literacy in Schools
On December 15, 2009, U.S. Department of the Treasury Secretary Tim Geithner and U.S. Department of Education Secretary Arne Duncan met with students, educators, and community leaders to promote strengthened financial capability among the nation’s youth. They outlined programs to encourage financial education in schools across the country. The need for financial education cannot be overstated. There are at least three compelling reasons to require financial education in schools.
First, it is important to be financially literate before engaging in financial contracts and not after. Yet findings from the Jump$tart Coalition for Personal Financial Literacy, which surveys high school students, and from the National Longitudinal Survey of Youth, which surveys young adults, show that young Americans lack knowledge of basic concepts of economics and finance. This is worrisome as it means that young people are borrowing without understanding, for example, the power of interest compounding and are choosing their investments, including investment in their own education, without knowing rates of return. Young people face many financial decisions, from how to use credit cards to how to buy a car or start a business. Of course, one of the most important decisions that students face right out of school is how to finance their education—an important investment decision both personally and financially. Also, an early grounding in financial literacy sets the stage for engagement in financial education later in life.
The second reason it is important to teach financial education in schools is that financial knowledge is based on scientific concepts—for example, the law of interest compounding and the concepts of risk and risk diversification—and the groundwork for this sort of conceptual understanding is best laid in a formal educational setting. Financial concepts are not necessarily best learned through experience over time or on the advice of friends, family, and colleagues who are not, themselves, financial experts. Some of the most important financial decisions individuals make are not made repeatedly over time. We do not retire many times or buy many houses. Risk management or rates of return are rarely explained to us in easy-to-understand terms; more likely they are reported in long and complex statements printed in 6-point fonts! And financial experiences can be difficult to decipher without some basic knowledge: For example, what is one supposed to learn from the current economic crisis?
The third reason that financial literacy should be taught in schools is to give everyone the chance to learn it. The surveys from Jump$tart Coalition show that the small groups of students who are deemed to be financially literate are disproportionately white males from college educated families. Similarly, data from the most recent wave of the National Longitudinal Survey of Youth show that the young adults (23–28 years old) who are financially literate have college educated mothers and have parents who had stocks and retirement savings when these young adults were teenagers. While this is good news for this limited demographic group, everyone—even those without highly educated and financially sophisticated parents—is faced with financial decisions and we all need the skills to make sound decisions. Some have argued that financial literacy is relevant only if one has wealth. This is a very narrow view. Individuals must make decisions not only about assets but also about debt. And debt is present, even pervasive, across all income strata.
For those of us who believe so much in the value of financial education, seeing Secretary Geithner and Secretary Duncan together on December 15, 2009, was an historical moment. When I look back at 2009, that day—December 15—was one of the best days of a bleak year. For me, it marks the day where we started making progress on an important topic like financial education. I feel better and more optimistic for the new year!
First, it is important to be financially literate before engaging in financial contracts and not after. Yet findings from the Jump$tart Coalition for Personal Financial Literacy, which surveys high school students, and from the National Longitudinal Survey of Youth, which surveys young adults, show that young Americans lack knowledge of basic concepts of economics and finance. This is worrisome as it means that young people are borrowing without understanding, for example, the power of interest compounding and are choosing their investments, including investment in their own education, without knowing rates of return. Young people face many financial decisions, from how to use credit cards to how to buy a car or start a business. Of course, one of the most important decisions that students face right out of school is how to finance their education—an important investment decision both personally and financially. Also, an early grounding in financial literacy sets the stage for engagement in financial education later in life.
The second reason it is important to teach financial education in schools is that financial knowledge is based on scientific concepts—for example, the law of interest compounding and the concepts of risk and risk diversification—and the groundwork for this sort of conceptual understanding is best laid in a formal educational setting. Financial concepts are not necessarily best learned through experience over time or on the advice of friends, family, and colleagues who are not, themselves, financial experts. Some of the most important financial decisions individuals make are not made repeatedly over time. We do not retire many times or buy many houses. Risk management or rates of return are rarely explained to us in easy-to-understand terms; more likely they are reported in long and complex statements printed in 6-point fonts! And financial experiences can be difficult to decipher without some basic knowledge: For example, what is one supposed to learn from the current economic crisis?
The third reason that financial literacy should be taught in schools is to give everyone the chance to learn it. The surveys from Jump$tart Coalition show that the small groups of students who are deemed to be financially literate are disproportionately white males from college educated families. Similarly, data from the most recent wave of the National Longitudinal Survey of Youth show that the young adults (23–28 years old) who are financially literate have college educated mothers and have parents who had stocks and retirement savings when these young adults were teenagers. While this is good news for this limited demographic group, everyone—even those without highly educated and financially sophisticated parents—is faced with financial decisions and we all need the skills to make sound decisions. Some have argued that financial literacy is relevant only if one has wealth. This is a very narrow view. Individuals must make decisions not only about assets but also about debt. And debt is present, even pervasive, across all income strata.
For those of us who believe so much in the value of financial education, seeing Secretary Geithner and Secretary Duncan together on December 15, 2009, was an historical moment. When I look back at 2009, that day—December 15—was one of the best days of a bleak year. For me, it marks the day where we started making progress on an important topic like financial education. I feel better and more optimistic for the new year!
Sunday, January 10, 2010
Wishes for the New Year
I am back in Hanover after a term where part of every week was spent working in Washington, D.C., and I am looking forward to the new year. The beginning of a new year raises hopes and expectations; we expect the upcoming year to be different from the previous one and for things to be better. Our wishes often do not materialize but I have, nevertheless, three wishes for 2010.
In December, the findings from the new Survey on Financial Capability were released. They paint a troubling picture of the U.S. population both in terms of financial knowledge and financial behavior. As has been documented in other surveys, knowledge of basic concepts of finance and economics is lacking in the population. The majority of people do not understand the workings of inflation, risk diversification, and basic asset pricing. Nevertheless, individuals have to decide how much to save to afford a comfortable retirement and how to allocate their pension wealth. Moreover, and disturbingly, half of the population does not have a buffer stock of savings to shield against unexpected events like job loss or emergencies. This makes both individuals and the economy as a whole more vulnerable to shocks. There are many other findings that I will discuss in more detail in future blogs. (The executive report is available at http://www.finrafoundation.org/resources/research/p120478).
My first wish for the New Year is that these findings will provide the stimulus for implementing policies to improve financial literacy and help American families in their financial decision-making.
My second wish for the year is that attention will turn to the groups that need financial literacy the most. One of these groups is women. The Survey on Financial Capability (as well as other surveys) documents that women are lagging behind men in terms of financial knowledge. This is not only the case for older women; it is also true for young women entering the labor market and for high school students. In all of these demographic groups, women are found to be less financially knowledgeable than men. Women are a large and important group. With one in two marriages ending in divorce or separation, women increasingly have to rely on both their earning capacity and their ability to manage resources well to take care of themselves and others. However, very few financial education programs are targeted to women and much more can and should be done to empower women with financial knowledge and financial capability.
My third wish is for financial literacy to be taught in schools. As I have mentioned in previous blogs, financial literacy is an essential piece of knowledge that every student should have. Just as reading and writing became skills that enabled people to succeed in modern economies, today it is impossible to succeed without being able to "read and write" financially—in other words, without financial literacy. Students face formidable financial challenges both during their school years (when they are bombarded with credit card offers) and in the years of young adulthood when they have to make important decisions, including how to finance a college education. My hope is that knowledge and understanding of financial concepts will impact their lives in one particularly important way: the understanding that one of the most important assets they can invest in is their own education.
On a personal level, I will try to stay away from New Year’s resolutions I know I cannot keep, such as shedding these extra pounds (I like eating!), traveling less (the weather and the new security measures are taking care of it), and writing a novel (I am too nerdy for it). But I will continue doing my research and writing my blog. This continues year after year and does not notice the passage of time. It does not even require a special resolution. Happy New Year to all of you!
In December, the findings from the new Survey on Financial Capability were released. They paint a troubling picture of the U.S. population both in terms of financial knowledge and financial behavior. As has been documented in other surveys, knowledge of basic concepts of finance and economics is lacking in the population. The majority of people do not understand the workings of inflation, risk diversification, and basic asset pricing. Nevertheless, individuals have to decide how much to save to afford a comfortable retirement and how to allocate their pension wealth. Moreover, and disturbingly, half of the population does not have a buffer stock of savings to shield against unexpected events like job loss or emergencies. This makes both individuals and the economy as a whole more vulnerable to shocks. There are many other findings that I will discuss in more detail in future blogs. (The executive report is available at http://www.finrafoundation.org/resources/research/p120478).
My first wish for the New Year is that these findings will provide the stimulus for implementing policies to improve financial literacy and help American families in their financial decision-making.
My second wish for the year is that attention will turn to the groups that need financial literacy the most. One of these groups is women. The Survey on Financial Capability (as well as other surveys) documents that women are lagging behind men in terms of financial knowledge. This is not only the case for older women; it is also true for young women entering the labor market and for high school students. In all of these demographic groups, women are found to be less financially knowledgeable than men. Women are a large and important group. With one in two marriages ending in divorce or separation, women increasingly have to rely on both their earning capacity and their ability to manage resources well to take care of themselves and others. However, very few financial education programs are targeted to women and much more can and should be done to empower women with financial knowledge and financial capability.
My third wish is for financial literacy to be taught in schools. As I have mentioned in previous blogs, financial literacy is an essential piece of knowledge that every student should have. Just as reading and writing became skills that enabled people to succeed in modern economies, today it is impossible to succeed without being able to "read and write" financially—in other words, without financial literacy. Students face formidable financial challenges both during their school years (when they are bombarded with credit card offers) and in the years of young adulthood when they have to make important decisions, including how to finance a college education. My hope is that knowledge and understanding of financial concepts will impact their lives in one particularly important way: the understanding that one of the most important assets they can invest in is their own education.
On a personal level, I will try to stay away from New Year’s resolutions I know I cannot keep, such as shedding these extra pounds (I like eating!), traveling less (the weather and the new security measures are taking care of it), and writing a novel (I am too nerdy for it). But I will continue doing my research and writing my blog. This continues year after year and does not notice the passage of time. It does not even require a special resolution. Happy New Year to all of you!
Tuesday, November 24, 2009
The Silent Course of Financial Mistakes
One of the problems with financial mistakes is that they can go unnoticed for a long time before a crisis erupts. For example, one could spend many years undersaving for retirement only to discover at age sixty or sixty-five that one has not accumulated enough to afford a comfortable retirement. But prior to such a discovery there are no signals, no warnings: no bells go off to warn about lack of savings, no statements caution “careful, this amount of savings seems low for your age.” In some of my work I have found that people start planning for retirement or make changes to their retirement savings accounts when they witness negative shocks to those around them (older siblings or parents) but, clearly, relying on such signals is insufficient.
This is the case not only for assets but also for debt. One could pay the minimum amount due on credit cards and have the debt pile up until it is too large to be paid off. Of course, borrowing at rates of 18% or higher makes the debt balloon, but the law of compound interest can cause debt to accumulate rapidly if one does not understand that interest accumulates on interest. The consequences of this can be devastating. People who have accumulated a significant amount of debt may have to postpone retirement or work a second job or sharply decrease their standard of living after retirement. They may even end up in bankruptcy. Throughout the current financial crisis, we’ve witnessed people losing their jobs and having little savings to fall back on, with many ultimately losing their homes. As a result of this crisis, saving has increased to an unprecedented level, but it is unfortunate that it took a negative shock to lead to appreciation for having a buffer stock of savings. Wouldn’t it be better if good saving habits were instead the result of routine assessment and maintenance of one’s financial “health”?
If we consider how we take care of our finances in light of how we take care of our physical health, we might come to some interesting conclusions. Everyone knows that regular health screenings are important. Underlying health conditions are not always obvious: nothing hurts, no obvious symptoms are experienced, everything seems fine until one finds a lump while taking a shower. In matters of health, we know that it is best to catch a health condition before it is at an advanced stage. Doctors have long recommended regular physical checkups, and we subject ourselves to routine tests and visits to the doctor even when we feel healthy and in good shape. We also take the usual health precautions, getting flu shots in the winter, washing our hands carefully, taking vitamin and mineral supplements (at least for those of us over…ahem, 40). Recommendations like these abound in doctors’ offices, in the media, and in everyday personal interactions. Everyone knows what precautions they should be taking on a daily, monthly, and yearly basis to maintain their physical health.
But how about financial health? What are we doing to make sure we are doing well in our financial planning? What precautions are we taking to make sure our finances stay healthy? Are we setting aside a buffer stock of savings that can shield us against negative shocks such as loss of income or an unexpected expense? Are we managing our debt wisely and making good investments?
Health maintenance is not exactly fun. I do not particularly enjoy having needles stuck in my arms, spending time reading old magazines in doctors’ waiting rooms, or the fearful anticipation in opening a letter that contains test results. Yet, most of us do exactly this and we advise our friends and loved ones to do it too. Maintenance of financial health won’t be any more fun than getting regular checkups, but it can be just as important. Financial markets are more complicated today than they’ve ever been and we are more responsible for our own financial well-being than ever before. Regular financial checkups can help to prevent a poor investment decision from causing long-term damage to a retirement plan or keep an accumulation of debt from growing to a point that it’s impossible to recover from. Just as regular medical checkups can keep us healthy and provide a better quality of life, so regular financial checkups can keep our accounts in good shape and ensure financial well-being for years to come.
This is the case not only for assets but also for debt. One could pay the minimum amount due on credit cards and have the debt pile up until it is too large to be paid off. Of course, borrowing at rates of 18% or higher makes the debt balloon, but the law of compound interest can cause debt to accumulate rapidly if one does not understand that interest accumulates on interest. The consequences of this can be devastating. People who have accumulated a significant amount of debt may have to postpone retirement or work a second job or sharply decrease their standard of living after retirement. They may even end up in bankruptcy. Throughout the current financial crisis, we’ve witnessed people losing their jobs and having little savings to fall back on, with many ultimately losing their homes. As a result of this crisis, saving has increased to an unprecedented level, but it is unfortunate that it took a negative shock to lead to appreciation for having a buffer stock of savings. Wouldn’t it be better if good saving habits were instead the result of routine assessment and maintenance of one’s financial “health”?
If we consider how we take care of our finances in light of how we take care of our physical health, we might come to some interesting conclusions. Everyone knows that regular health screenings are important. Underlying health conditions are not always obvious: nothing hurts, no obvious symptoms are experienced, everything seems fine until one finds a lump while taking a shower. In matters of health, we know that it is best to catch a health condition before it is at an advanced stage. Doctors have long recommended regular physical checkups, and we subject ourselves to routine tests and visits to the doctor even when we feel healthy and in good shape. We also take the usual health precautions, getting flu shots in the winter, washing our hands carefully, taking vitamin and mineral supplements (at least for those of us over…ahem, 40). Recommendations like these abound in doctors’ offices, in the media, and in everyday personal interactions. Everyone knows what precautions they should be taking on a daily, monthly, and yearly basis to maintain their physical health.
But how about financial health? What are we doing to make sure we are doing well in our financial planning? What precautions are we taking to make sure our finances stay healthy? Are we setting aside a buffer stock of savings that can shield us against negative shocks such as loss of income or an unexpected expense? Are we managing our debt wisely and making good investments?
Health maintenance is not exactly fun. I do not particularly enjoy having needles stuck in my arms, spending time reading old magazines in doctors’ waiting rooms, or the fearful anticipation in opening a letter that contains test results. Yet, most of us do exactly this and we advise our friends and loved ones to do it too. Maintenance of financial health won’t be any more fun than getting regular checkups, but it can be just as important. Financial markets are more complicated today than they’ve ever been and we are more responsible for our own financial well-being than ever before. Regular financial checkups can help to prevent a poor investment decision from causing long-term damage to a retirement plan or keep an accumulation of debt from growing to a point that it’s impossible to recover from. Just as regular medical checkups can keep us healthy and provide a better quality of life, so regular financial checkups can keep our accounts in good shape and ensure financial well-being for years to come.
Saturday, October 17, 2009
Our new Financial Literacy Center
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.
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.
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
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