Tuesday, January 29, 2008

The Newly Created Advisory Council on Financial Literacy

President Bush announced last week the creation of the Advisory Council on Financial Literacy

More information is available on the White House web page:

Operating under the guidance of the U.S. Treasury Department with the specific charge of keeping America competitive and assisting citizens in understanding and addressing financial matters, the 19-member council will focus exclusively on economic empowerment issues. Their duties will include advising the president and Treasury Secretary on such goals as improving financial education efforts for students and adults in the workplace, and establishing effective measures of
national financial literacy, and promoting effective access to financial
services, especially for those without access to such services.

This is a very important step. Financial literacy is sorely lacking in this country and it is urgent to address this issue. The hope is that the council will get to work right away!

Saturday, January 19, 2008

Finance Literacy and Women

The decision of how much to save for retirement is a complex one, as it requires collecting and processing information on a large set of variables including Social Security and pensions, inflation, and interest rates, to name a few, and also making predictions about future values of these variables. It is also necessary for the consumer to understand compound interest, inflation, financial markets, mortality tables, and more. Nevertheless, little research has asked exactly how households make saving decisions, how they overcome the difficulty of making those decisions, and whether they are financially literate enough to make well-informed choices. These topics are of paramount importance, particularly when older households are increasingly required to take responsibility for investing and allocating their pension wealth. This is a particular concern for women, who tend to live longer than men and have shorter work experiences and lower earnings.

To gain insight into how households make saving decisions, Olivia Mitchell and I devised a module on planning and financial literacy for the 2004 Health and Retirement Study. The module includes three questions on financial literacy, as follows:

1. Suppose you had $100 in a savings account and the interest rate was 2% per year. After 5 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?
2. Imagine that the interest rate on your savings account was 1% per year and inflation was 2% per year. After 1 year, would you be able to buy more than, exactly the same as, or less than today with the money in this account?
3. Do you think that the following statement is true or false? Buying a single company stock usually provides a safer return than a stock mutual fund.

The first two questions, which we refer to as “Interest Rate” and “Inflation,” help evaluate whether respondents display knowledge of fundamental economic concepts and basic numeracy. The third question, which we refer to as “Risk Diversification,” evaluates respondents’ knowledge of risk diversification, a crucial element of an informed investment decision

The responses to these three questions among a sample of 785 women age 50+ in the 2004 HRS module on planning and literacy indicate widespread illiteracy. Only 61.9 percent of women correctly answered the interest rate calculation question. This is a relatively easy question, so it is surprising that so many were unable to respond correctly, particularly because these older women have most likely made numerous decisions involving interest rates over their lifetimes (e.g. credit card rates, mortgage financing rates, etc). Respondents were more accurate about the inflation question, with 70.6 percent answering correctly. By contrast, only 47.6 percent of the women respondents knew that holding a single company stock implies a riskier investment than a stock mutual fund.

Note also that only less than half of all respondents could answer correctly both the interest rate and inflation questions. This is a remarkably low ratio, taking into account the complex financial calculations that households on the verge of retirement have almost surely engaged in over their lifetimes. Also disturbing is the fact that only 29 percent of respondents could answer all three questions correctly.

These findings raise concerns about the ability of women to make sound saving and investment decisions over a long retirement period. In an environment where individuals rather than employers and governments are charged with handing retirement finances, it is essential that consumers become more financially literate in order to be more successful at retirement.

Tuesday, January 8, 2008

Where do presidential candidates stand in terms of policies for financial literacy?

As people in New Hampshire cast their votes today, it is important to know where presidential candidates stand in terms of financial literacy policies. To that aim, together with the Networks Financial Institute we have sent the following letter to all presidential candidates:

Dear Presidential Candidate:

In recent days, the state of the economy has surpassed the war in the Iraq as the number-one concern of American voters. Networks Financial Institute at Indiana State University, in collaboration with Dartmouth College professor Annamaria Lusardi, is writing to ask how you, as President, would take steps to help more Americans make sound financial decisions.

The need to improve our citizens' financial literacy has gained recognition as Americans save less, spend the majority of their disposable income, and incur rising levels of debt. Data at both the national and state levels indicate that consumer financial knowledge is at an all-time low, which suggests our nation is now facing a financial literacy crisis. Consider the following:

i) the U.S. savings rate has been extremely low for several years;
ii) home foreclosures nationwide are rising very rapidly and are expected to continue to do so for the next year;
iii) the average American with at least one credit card owes nearly $9,000.

Aggravating the situation are a host of business and social factors including vigorous growth in the sub-prime lending industry, a proliferation of “pay day lending” companies and even an increasing array of credit products marketed to the “tween” demographic market. Our educational system has assumed that students will learn the necessary financial skills from their parents, while statistics show that the majority of our nation's adults lack sound financial skills themselves. Given these circumstances we would like to pose the following questions for your response.

First, the economic well-being of Americans increasingly depends upon making good decisions about complex subjects such as student loans, retirement saving, home ownership, and many others. Do you believe that the federal government has a role in improving the financial literacy of our citizens?

Second, educational research has shown that the foundation for learning core subjects like reading and math occurs during the early grades. Our research revealed that only 38% of elementary school teachers and only 52% of teachers in all grades across the nation address financial literacy in their classrooms, citing a lack of time and educational standards as their main obstacles. Do you support the development of national financial literacy standards to help educators prepare the next generation of consumers?

Thank you for addressing these questions.


Elizabeth Coit
Networks Financial Institute

Annamaria Lusardi
Dartmouth College

I will post the replies as soon as we receive them.