Sunday, September 11, 2011

Advice to rookies

If you’re a regular reader of my blog, you’ll know that I have become a football fan. People change over the course of their life and pick up new hobbies and interests. For me, it’s football. So this Sunday, I watched the Ravens score a crushing victory against the Steelers. It was a beautiful game! I also watched the kickoff last Thursday. Two games in a week; that is pretty good for a rookie fan, no?

In this new season, with rookie players on their field for their first games, there is an abundance of discussions and articles about these newcomers. In the New York Times yesterday, there was an article about finance and financial advice to the rookies. The link to the article “Financial Lessons from Sports Stars’ Mistakes” is at the end of this post.

As I have mentioned in previous posts, the statistics about football players mismanaging their money are pretty staggering. The article mentioned several star athletes who have had brushes with bankruptcy: Michael Vick (recently acquired by the Philadelphia Eagles); Bernie Kosar, formerly of the Cleveland Browns; and Mark Brunell of the New York Jets.

Some have argued that the behavior of football players is similar to those who win the lottery. Flushed with large sums of money that come to them suddenly, players squander it and are left with little or nothing a few years out. I do not think that this is a good analogy. One difference between football players and lottery players is that we know the former are very talented people: Who else could do the things they do when they are out in the field? Moreover, these people know discipline; they show up to practice every day. They also know the correlation between efforts and outcome; if one works steadily at something, he will get better. These are great skills that can be applied not only to playing football but also to managing money.

So, why do we see players going bankrupt? One of the reasons why people (including football players) make mistakes is because they lack financial knowledge. This problem can be particularly acute for young, inexperienced people whose highest earnings are concentrated at the beginning of their career. But this is not an impossible problem to fix, and the New York Times article outlined a set of lessons that could be learned from some players’ mistakes.

I have three pieces of advice for rookies. (There is more advice to give, but let me start with this simple list; I will follow up in future posts.)

1) Do not spend it all. The career of football players is short and risky; you want and need to have provisions for the future and for uncertain events. An example? The recent lockout. What would have happened if the lockout had continued? Another example? Even superstars have injuries and/or cannot play for health reasons. Peyton Manning, for example, just had neck surgery.

2) Take it in your hands. Money management is too important and too personal to be delegated entirely to someone else. You are the one who knows your needs, your aversion to or love of risk, your objectives for the future. If you leave it to others to manage your money, chances are they will not make the decisions you had wished for. Even if you seek financial advice, rely on reputable experts and stay involved in the process. After all, it is your future that is at stake here.

3) Be humble about finance. My research repeatedly shows that the majority of people are overconfident about what they know of finance. Four out of five Americans gave themselves high financial knowledge ratings but, when asked questions about basic concepts, they answered incorrectly. And ignorance hurts. Study after study documents that it is those with low financial knowledge who pay more for financial services and who are more likely to end up in financial distress. Do not be afraid to speak up about what you do not know; it is not a weakness, it is a strength, and you will intimidate anyone around you when you admit it. Most people do not have that kind of courage. Do not jump into projects or investments you do not understand well. Tell people around you, “I want to be smart about my money.” Over time, you will be.

When I got my first job as an assistant professor at Dartmouth College about twenty years ago, I showed up in the Human Resources office and was given all of these forms to fill out, requiring me to indicate which of the three pension providers I wanted and how I would allocate my pension money. I remember feeling puzzled that such an important decision would be asked of me without inquiring about my knowledge and whether I needed any help. Throughout the years, I have worked to change that process and, with the collaboration of some great people at Dartmouth’s HR office, there are now programs in place to help new hires. I take a little pride in that.

The NYT article is posted here:

Tuesday, September 6, 2011

Think big, in a practical way

I left for Italy in mid-August feeling pretty discouraged. Most of the recent discussions I had heard about financial literacy were focused on cost. This is clearly an important concern, but, in practice, when people talk mostly about costs, it often means they are not interested in “buying” it. And while the cost of improving financial literacy is a very legitimate concern, how about the cost of this financial mess we’re in. How about that?

The discussion around some financial education programs was also not a mood booster. Some of the papers I saw presented this summer covered programs in which individuals—often impoverished and with little education—were brought to a classroom and given a few hours of “financial education.” The expectation was that those few hours would transform people into savvy entrepreneurs or investors. And what was the main discussion around this? How much these programs cost!

This dominant concern about cost obscures the fact that we face a very important and challenging problem in need of a solution. But we need to think big; we need creative ideas that can help overcome big barriers. Lack of financial knowledge is not something that can be tackled by bringing the adult population back to a classroom for a lecture or two on financial education. We need to be practical, too, regarding what can be implemented. As my college friend—a successful entrepreneur I get together with every time I return to Italy—put it: "think big, in a practical way."

Being in Italy, with a break from my daily routine, allowed me to focus on big ideas, and I have some recommendations, that are also practical, to at least start the discussion, and I would like to hear from others.

Big Idea #1: TEACH THE YOUNG. Financial literacy needs to be implemented in schools. It is too difficult to reach the adult population and it is hard to do any teaching if there is little or no base to start from. Also, we need people to be financially literate before rather than after they engage in financial transactions. There will and should be costs of educating the young. It is meaningless to mandate financial education without, for example, training the teachers to teach those courses. Mandates do not make people any smarter, but having a well-developed curriculum that is followed by trained teachers might.

Big Idea #2: FOCUS ON WOMEN. Women have low levels of financial literacy (lower than men), but they also know that they lack knowledge. Moreover, they want to be “treated”; in most financial programs I have been involved with or read about, the majority of participants have been women. It is going to be much easier to reach and deliver to a population who is interested in financial literacy. This is a simple truth that has been mostly ignored. There are costs of only thinking about costs!

Big Idea #3: MAKE IT SIMPLE. Some financial decisions are truly complex, but there are universal concepts that are at the basis of most financial decisions and that can and should be explained in very simple ways. I am talking about the power of interest compounding, the effects of inflation, and the benefits of risk diversification. In fact, even this is economic jargon we can get away from. Let’s use plain English and explain these ideas in very simple ways. We can even come up with ways to tell stories to teach the concepts so that even a five-year-old could learn them.

Speaking of five-year-olds and of being practical, I was given the following test to see whether one can think practically. Here it is: How do you put a giraffe into a refrigerator? The answer is at the end of the post, but please do not look before you come up with your own solution. I thought about it for five minutes and came up with a method about as simple as putting a man on the moon. That evening, I saw my little niece Giorgia drawing a picture of the family dog, depicting him with 9 legs and 2 enormous eyes. I thought she would be an ideal person for the giraffe test, so I asked her very innocently: “Giorgia, how do you put a giraffe into a fridge?” She looked up, gave me a big smile, jumped from her chair, and ran to the fridge. Moral: you can never beat the creativity of a five-year old!

Question: How do you put a giraffe into a refrigerator? Answer: You open the door and put the giraffe in.