Monday, November 17, 2008

Friends, Family and Finances

In this post, I want to talk about how people become financially literate and from whom they learn about finances. In many of the surveys I have reviewed, including the ones I have designed, people report that they rely on family and friends for financial advice. In focus groups as well, people state that they learn from their family and friends. This is an important finding. I believe that people rely so much on friends and family because they want advice from people they trust and who have their best interests at heart. There are, however, limitations and drawbacks to relying solely on friends and family for financial advice.

One limitation of learning from our friends is that we tend to choose friends who are like us. So, if you are an artist, you are likely to be surrounded by people who know how to draw but do not necessarily know how to invest retirement savings. Furthermore, many financial matters are private. You may assume that your friend John is financially savvy, but you have probably not seen his 401(k) statement, and it is hard to tell from his house or car whether he is good at picking mutual funds. Nevertheless, he may be happy to offer you tons of financial advice.

Like friends, family members, parents in particular, are a popular source of financial advice, and many have argued that financial education does start at home. There are, nevertheless, drawbacks to advice from this source. First, not everybody has parents who are financially literate. Approximately half of the families in the United States do not invest in the stock market (at least when considering investment of private wealth). Thus, for many, it is not possible to learn about the stock market from parents. Second, parents—particularly older ones—lived in a very different economic environment than the one the current generation of working Americans are facing. Most parents of today’s young and middle aged adults had pensions that were defined benefit plans, experienced inflationary periods that decreased the burden of their debt, and hardly invested in the “global economy.” Financial markets have changed substantially from the time this generation of parents bought their homes, got their pensions, and invested their savings.

I do not mean to imply that we cannot learn from family and friends. One valuable lesson can be to avoid the mistakes that those around us have made, such as not preparing adequately for retirement, not having enough insurance, or having too much debt—mistakes that are proven to be all too common among many Americans today. But relying on such advice seems to me often too little and sometimes too late.

In my view, financial education belongs in schools. Finance and economics are sciences and should be taught as such. Moreover, people need to be financially literate before they engage in financial contracts and not after having learned how much financial mistakes can hurt. Finally, having financial education in schools offers a better chance that students whose parents do not work on Wall Street will be able to access financial knowledge.

There is an additional benefit: if everyone learns about finance in school, we can then talk to our friends about art, about history, about something other than our finances. One of the great benefits of obtaining financial savvy and know-how is that we are then able to devote ourselves to what really matters to us, without the distraction of financial worries.


Retiredebetfreehappy said...

There are clear benefits to approaching family or friends for a loan or investment rather than conventional sources.

Retirement Plans, Retirement Savings,Retirement Investments,Home based Business

Csaba said...

In general, I agree that financial education should be in some form a part of education. But I disagree in involving primary or secondary education beyond teaching basic interest-rate calculations or history lessons. I would encourage NGOs and governments to get involved in financial education and not schools. Primary and secondary schools should provide skills in mathematics, science and humanities so that school-leavers become thinking individuals who can recognise the salience of issues and decide whether acting as a "homo oeconomicus" is necessary.
Several authors have shown that higher education level makes financial and retirement planning more probable (e.g. Bottazzi, Jappelli and Padula (2005): Retirement expectations, pension reforms and their effect on private wealth accumulation, or Oehler and Werner (2008): Saving for retirement- A case for financial education in Germany and the UK? An economic perspective). Well educated and reflective people can judge the relevance of pension and financial planning. This is where regulation, governmental actions and NGOs can call the attention. Still, I need to emphasise that interest rate calculations should, of course, be taught at maths class and historical crises (e.g. 1873 or 1929) should be a part of history lessons.

Csaba Burger
DPhil Candidate
University of Oxford