New insight into Americans' financial capability

This blog was originally published in the May 15, 2017 print issue of Pensions & Investments. The online version can be found here.

When the National Financial Capability Study launched in 2009, it promised valuable new information about the financial situations of U.S. households following the Great Recession. The ongoing national surveys — every three years — have lived up to that expectation, revealing not only how people manage their finances but also whether they are capable of handling those responsibilities.

But the FINRA Investor Education Foundation sought an even deeper dive into what we know about consumer finances. In 2012, it provided funding to add the NFCS' questions to a representative sample of 2,000 individuals selected from the RAND American Life Panel, which includes more in-depth information about Americans' finances. That new data is examined in “Financial Capability of the American Adults: Insights from the American Life Panel,” a report I wrote in collaboration with Marco Angrisani and Arie Kapteyn from the Center for Economic and Social Research at the University of Southern California. It includes a number of findings of interest for the pension and financial industry.

Out-of-pocket medical expenses are a significant source of financial strain.

The likelihood of incurring large out-of-pocket expenses — for preventive care or treatment after a medical crisis — is, perhaps not surprisingly, linked to how healthy an individual is and whether they have insurance. But the weight of those factors is impressive when looking at short-term shocks and their affect on families' security. At the same time, since low education and low income often go hand-in-hand with poor health and lack of insurance, households with low socioeconomic status are both more likely to face economic shocks and less prepared to deal with them.

Using respondents' self-assessment, our study divides individuals into those with good health and those with poor health. As expected, we find the risk of health shocks to be high for individuals who smoke, have a body mass index greater than 30 or have been diagnosed with high blood pressure. We also break respondents into groups depending on whether they have health insurance. Respondents with poor health, a higher risk of health shocks and no health insurance — those who are most likely to face a health shock — are 15 to 30 percentage points less likely to have money to cover an emergency than respondents on the opposite end of the scale.

When it comes to planning for the long term, most Americans fall short.

An important aspect of planning is to set medium- and long-term financial goals, taking into consideration future events such as retirement. But the NFCS-ALP reveals a widespread lack of planning. Only 40% of respondents have ever thought about their retirement savings. Looking more closely, only 47% of workers aged 40 to 59 have planned at all. Among younger (workers aged 18 to 39) the figure is much lower: it is only 31%.

People nearing retirement age are not thinking ahead.

Even when it comes to individuals aged 60 and older, less than 50% have thought about planning for their post-work years. To look at this unsettling finding in more detail, we take working individuals in the NFCS-ALP who are at least 60 years old and separate them into two groups, according to whether their expected likelihood of working past age 65 is below or above 50%. We would assume that workers more likely to leave the labor force by 65 will have put more thought into their retirement savings. Indeed, 66% of them have (as have 56% of those more likely to work past 65). Still, it is striking that more than half of older workers on the verge of retirement have not done any retirement planning.

Financial planning is critical for economic well-being, but a large proportion of Americans live from paycheck to paycheck.

The NFCS-ALP questionnaire asks respondents whether they have set aside a “rainy day” fund to cover expenses for three months in the event of sickness, job loss or other adverse circumstances. Only 41% of respondents answer affirmatively. As further evidence of the financial fragility of American families, only 44% are certain they could come up with $2,000 if an unexpected need arose within the next month.

Planning for retirement pays off in powerful ways.

There are striking differences between non-planners and planners when it comes to the wealth they have available beyond employer-sponsored pension plans. Among workers over the age of 60, the median financial wealth is only $1,500 for those who have not planned. At $160,000, it is many times that amount for planners. Viewed another way, the mean financial wealth for non-planners is $65,000 while that of those who plan is $310,000 — still a dramatic difference.

Financial literacy levels are an obstacle.

Research has found that higher financial literacy correlates strongly with whether individuals plan for retirement and have rainy day funds. The NFCS measures financial literacy through questions addressing key concepts of economics and finance, notably compounding interest, inflation and risk diversification. Two additional questions test individuals' understanding of the effect of the length of a mortgage and the relationship between interest rates and bond prices. These questions have been asked in the broader ALP panel as well. Only 18% of the respondents in the NFCS-ALP sample answer all five questions correctly. Less than a third — 31% — answer four questions correctly. Consistent with previous research, data from the NFCS-ALP show those who are more financially literate are more likely to plan for retirement and more likely to hold precautionary savings.

What do all these findings mean? By exposing the behaviors and barriers that contribute to financial vulnerability, the new data open a pathway for exploring policies and programs that will make American families more secure. It will be important to fortify financial health not only in the long term but also in the short term. And it will be critical to ensure Americans have the basic knowledge needed for sound financial decisions, including to plan for retirement and to save for unexpected shocks.