Friday, April 1, 2016

Happy Financial Literacy Month!

This is a slighly modified blog that was published in Forbes. The link is here:
April is Financial Literacy Month. You might suspect there is a problem with financial literacy in America, if an entire month is dedicated to it! And you would be right.

The S&P Global Financial Literacy Survey released last fall showed that only 57 percent of adult Americans know basic financial literacy concepts such as interest compounding, inflation, and risk diversification. And high school students do no better: the Programme for International Student Assessment (PISA) reported that 18 percent of US students do not reach the baseline level of proficiency in financial literacy. Moreover, Millennials don’t learn much about financial literacy after they leave high school, according to the National Financial Capability Study.

For this reason, April is an opportune time to look at three efforts that may have a chance to combat financial illiteracy. These are chosen because of their scalability and capacity to make a real difference for financial literacy in America.

Financial literacy in school: According to the Council for Economic Education, only 19 states require schools to offer a personal finance course. This does not bode well, considering that the student loan market has now surpassed $1 trillion, and student loans are a deep worry for many young adults.

Teaching kids about financial matters in school can help. For instance, students exposed to a rigorous financial literacy program are much less likely to get into trouble with debt after they graduate, according to recent research. We don’t need a federal or state mandate to add financial literacy in schools: parents can simply ask their school districts for such courses. After all, nations around the world have now agreed: financial literacy is essential to participate in society in the 21st century.

Financial literacy in the workplace: Many companies today offer defined contribution pensions, which put workers in charge of deciding both how much to save and how to invest their pension assets. And health plans also require participants to be more financially savvy, to manage high deductibles, copays, and Health Saving Accounts, and to compare prices for medical care.

For this reason, workplace financial education programs are often provided to educate employees on how to manage these decisions. Yet employers can benefit as well, since the stress generated by money problems can translate into lower worker productivity, higher absenteeism, and more turnover. In our tightening labor market, an employer who offers help with money management or debt can readily attract and retain workers. Some firms have even stepped up to help relieve employees of student loan obligations, which can improve worker loyalty.

Financial literacy in the community. One particularly noteworthy program, both for its potential impact and scalability, comes from the American Library Association. Every community, big or small, has a library—a place where anyone, young or old, can go to learn, including via easy access to the Internet. As hubs for knowledge and information, libraries are ideal venues in which to provide financial education. Through the Association, programs that prove especially effective in one place can be extended nationwide. Libraries can also complement school or workplace financial literacy programs.

Financial literacy won’t change overnight, nor in a month or even a year. Yet initiatives taken in schools, workplaces, and in communities add up. My hope is that someday, in the future, the month of April can be re-dedicated to another topic!

Sunday, February 7, 2016

Looking for a Super Bowl cheer that lasts a lifetime

This a slighly modified version of the blog I wrote for the Wall Street Journal in collaboration with Colin Camerer. The WSJ blog is posted here :

The winners of this Sunday’s Super Bowl will have much to celebrate. In addition to their team victory, the players will see substantial financial bonuses, including potentially richer contracts and future sponsorships. Even the players who lose at football will be financial winners. After all, they, too, made it to the Super Bowl, one of the world’s most-watched sporting events.
The 2016 championship game may mark the career finale for some of these extraordinary players. Will Peyton Manning retire after this year? Will anyone else leave football? If they do, sad to say, they may be in for some bad news. Our research shows that a surprising number of NFL players declare bankruptcy not long after they retire.
For our research published last year in the American Economic Review, we collected data on more than 2,000 players—all of those who were drafted by the NFL from 1996 to 2003—and followed them until 2013. We were interested in seeing how well football players do, financially, after they leave the game. Because it is very hard to find out how much they earned and spent after they retire, we looked at a simple measure of financial distress which is publicly available: bankruptcy filings. And we found that things did not go well at all.
Football players, even those with short careers, usually earn more than what most college-educated workers earn during a lifetime. Because NFL careers are so short, the players’ post-NFL retirements can be long. Many get other jobs, but only a tiny percentage end up with coveted high-salary jobs such as sportscasting. Following all the players together as a group, as they retire, players start going bankrupt.  After 12 years in post-NFL retirement, more than 15 percent of the players we followed had declared bankruptcy. We also found that bankruptcy does not depend on how much an NFL player earned in their career or how long he plays. Amazingly, higher income or longer careers seem to offer little protection against bankruptcy.
These findings have been documented, with some variation, by other sources. There are numerous news stories and interviews describing instances where players have lost all the money they earned. Unfortunately, we continue to witness this phenomenon each year.
We offer three recommendations that could help keep these professional athletes celebrating financial success long after the Super Bowl. These guidelines apply to anyone who finds himself/herself with a lot of money earned in a very lucrative short-lived career.
First, become financially literate. Exposure to basic financial knowledge helps young people understand not just the workings of interest rates and financial markets, but it also builds healthy habits around money and money management. The opportunity to become financially literate before contracts are signed and large sums of money are earned is probably the best medicine for the financial health of these high-earning young professionals.
Second, learn to manage money. Money-management training could be a key part of contract signings or receipt of bonuses. Athletes are used to the kind of training that requires enormous discipline, and they are very good at it. Comprehensive money-management training could offer information that goes beyond simple recommendations for investments or rookie camps. Players could get training that helps them to figure out how far into the future their money can last, how to build a budget that allows them to achieve their objectives, and how to help their families and friends without putting themselves at financial risk. An extra benefit is that managing their own money well makes them into financial role models in addition to athletic role models. The same traits that make players successful on the field—practice, persistence, and the ability to overcome setbacks—can make them successful in managing their finances.
Third, choose a pay structure wisely. Financial advisors often tell big lottery winners to arrange their winnings to be paid over decades, rather than in one tempting lump sum.  How about a system that offers remuneration as a series of payments over a long period of time? This option could generate a stable standard of living for those players who prefer not to engage in complex money management decisions. It also has the benefit of showing how far the money that athletes receive in a single contract can, indeed, go.  After all, the income earned by college-educated people who are not professional athletes is distributed over a lifetime. And it is a way to tie ones’ hand and resist the temptation to spend it all. A lot of research has shown that these types of commitment devices work like wonder.
Wouldn’t it be something if the winners in this year’s Super Bowl could wear their Super Bowl ring proudly for the rest of their lives, rather than having to sell it some day to stay afloat?
Colin Camerer is a neuroeconomist and the Robert Kirby Professor of Behavioral Economics at the California Institute of Technology. In 2013, he was awarded the MacArthur Fellowship

Friday, January 22, 2016

Understanding the Implications of an Interest Rate Hike

This is a slightly modified version of the blog I wrote for Forbes.

Pundits keep a close watch on the U.S. Federal Reserve as it meets to raise interest rates after seven years of effectively zero rates. Yet the reality is that many Americans know little about interest rates, and much less about the implications of a rate hike for their finances!  This was one key finding from the recently released S&P Global FinLit Survey, gathered with the support of McGraw Hill Financial.

The goal of the international study was to compare adult financial literacy levels across more than 140 nations. Financial literacy was measured using questions assessing basic knowledge of four fundamental concepts: numeracy or capacity to do simple calculations in the context of interest rates, interest compounding, inflation, and risk diversification. Respondents were deemed “financially literate” if they could correctly answer three of the four questions. The Global Financial Literacy Excellence Center helped design the survey and analyze the results.

Staggeringly, we found that only one in three adults is financially literate around the world. While Americans far a bit better, only a little more than half of US adults scores this well, a finding that bodes ill for one of the world’s most advanced financial markets.

More importantly, our research has also identified what people don’t know about their finances. One giant void has to do with compound interest, despite the fact that many are quite vulnerable to interest rate changes. For example, when combining information with the Global Findex data, we find only 66% of Americans who hold credit cards understand interest compounding. In Brazil, Latin America’s largest economy, only about half of credit-card holders can accurately answer our interest-compounding question. Similar results apply to borrowers elsewhere. The logical implication is that, whatever the Federal Reserve decides, most people will snooze through the news. This, of course, can be dangerous to debtors everywhere.

There are a few financial concepts that people do tend to understand, particularly inflation. Naturally, this topic is one where experience matters: having struggled mightily with hyperinflation in the late1980s and early 1990s, two-thirds of Argentinians can answer an inflation question accurately. Similar patterns are observed in Georgia, Bosnia and Herzegovina, and Peru, all of which also suffered under hyperinflation in the past. By contrast, only half of Japanese adults understand the corrosive power of inflation, having suffered deflation over the past few decades. In the U.S., the figure is just shy of two thirds (63%).

Monetary policy affects households and household finances, yet what people know about some of its levers is limited. As interest rates start rising, some people will learn about interest compounding. But this begs the question: should experience alone be our teacher?