Financial education: Learning from other countries

The experiences of other countries offer important lessons for the United States. While the increase in individual responsibility that is required in the pension system we’re transitioning to (moving from Defined Benefit to Defined Contribution pensions) provides incentives for individuals to become knowledgeable and informed, one has to be cautious about relying simply on individual initiative. For example, lack of understanding of critical components of pensions is a persistent feature, even in economies where personal retirement accounts have been in place for many years.

In Chile, which adopted personal retirement accounts more than 25 years ago, there is a remarkably low level of knowledge about pensions. Only 69 percent of participants in the Chilean system indicate that they receive an annual statement summarizing past contributions and projecting future benefit amounts while, in fact, every participant is sent a statement. Less than half of the participants know how much they contribute to the system, even though the contribution rate has been set at 10 percent of pay since the system’s inception. Understanding of what workers have accumulated and how their assets are invested is also scanty. For example, just one-third of respondents stated knowing how their own money is invested, and only 16 percent can correctly identify which funds they hold (compared to administrative records).

In Sweden, which implemented comprehensive pension reform during the 1990s, transforming the old public defined benefit plan into a defined contribution plan and implementing a broad public information campaign, the level of knowledge is also not high. The cornerstone of communication of information to plan participants in Sweden is the Orange Envelope. The envelope is sent out annually and contains account information as well as a projection of benefits. Overall, three-fourths of all participants say they have opened the envelope, though only half report reading at least some of its content. Relying on self-reports of participants, chapter twelve documents that half of participants rate their knowledge of pensions as poor. Moreover, the share of respondents who report having a good understanding of the pension system has decreased over time. Measuring actual knowledge of the pension system from surveys that ask respondents about components of the system confirms the evidence provided by self-reports. Many participants are still unaware of the key principles regarding how benefits are determined and many overstate the importance of individual accounts.

Another problematic area for U.S. investors, which is validated in looking at the experiences of other countries, is knowledge of commissions and fees. High fees can prevent investors from accumulating adequately for retirement. However, fees can be easily overlooked. The experience of Chile provides compelling evidence that this is the case; only a minuscule fraction of pension participants (around 2 percent) seem to know the fees that are charged on their accounts.

The experience of Sweden further shows that when individuals are confronted with a very broad range of funds in which to invest—as many as 800—there can be a substantial increase in information and search costs. In fact, fewer than 10 percent of new participants in Sweden make an “active choice” and choose their portfolios. The large majority invest in a default fund. Thus, it is critically important to design defaults in a way that promotes wise portfolio allocation.

Moreover, widespread evidence of illiteracy is not unique to the United States, but is present throughout OECD (Organisation for Economic Co-operation and Development) countries. Importantly, illiteracy in all countries is particularly severe among certain groups, such as women, those with low income and education, and the elderly. This suggests that these groups are particularly vulnerable to many of the changes that are occurring in modern economies. It also suggests that it is possible to share programs across countries and develop international cooperation in efforts to develop effective financial education programs.

These topics are covered in more detail in my forthcoming book: Overcoming the saving slump: How to increase the effectiveness of financial education and saving programs, to be published by the University of Chicago Press.