Financial Literacy: Implications for Retirement Security and the Financial Marketplace

Olivia Mitchell and I organized a conference at Wharton last Thursday and Friday, April 29–30, titled “Financial Literacy: Implications for Retirement Security and the Financial Marketplace.” This seems a good way to end Financial Literacy Month and reflect on the importance and role of financial literacy.

There are 3 ingredients to a successful conference: (1) good people, (2) good papers, and (3) good food. We provided a good lunch and we had dinner, surrounded by Chinese art, in a large hall in the University of Pennsylvania museum. But the people and papers were more than good, and I left Philadelphia with a lot of ideas and projects I want to pursue.

Our keynote speaker, who opened the conference, was Michelle Greene, the Deputy Assistant Secretary for Financial Education and Financial Access at the U.S. Treasury. She told the audience about the initiatives and the approach of the office she heads at the U.S. Treasury. Several things resonated with me. She stressed the importance of evidence-based policies and cited several studies, from the FINRA Financial Capability Survey to the FDIC Survey of Unbanked and Underbanked Households. She also stressed that the U.S. Treasury wants to put financial education where it works and where it is most needed. In my view, these criteria are not only critically important but also offer a way for research to make a real difference and to impact policy. She discussed the work that the Treasury is doing with state and local governments and with the private and nonprofit sectors. This is a reminder that while we need a national financial literacy policy, a lot of work is done at the local level, thus a grassroots approach when dealing with financial literacy is important. The U.S. Treasury is also coordinating the many federal agencies that are doing financial education programs. I was particularly pleased to know that the White House has joined the Financial Literacy and Education Commission and, in particular, that the White House Council on Women and Girls has become involved in financial literacy. As I have mentioned in many of my blogs, there is a real need to focus attention on women and girls and to address the existing gender gap in financial literacy. Michelle also mentioned that the website www.mymoney.gov has been revamped. This is the website to go to obtain financial information, and, again, I cannot stress enough the importance of having a trusted and independent source of information to rely on.

The papers that were presented at the conference spanned many topics. Some documented individuals’ financial mistakes. While the experience with subprime mortgages has made us acutely aware of the problem of financial errors, evidence about the use of credit cards and payday loans adds reasons to worry about the behavior of households who use high-cost methods of borrowing. Families have also started to borrow from their 401(k) plans, i.e., they are now borrowing from themselves and the money they have put away for retirement. And financial literacy seems to be a contributing factor: those with low levels of financial literacy are found to be more likely to borrow from themselves. Low literacy is also found to keep people from investing in the stock market. While one has to understand and be aware of the risks of investing in stocks, it is problematic to shy away from the stock market, particularly when investing for the long run. Moreover, when selecting a pension fund from a menu of possible offerings, those with low financial literacy are shown to rely more on the advice of employers, friends, and coworkers than on cost fundamentals. Those with low financial literacy are also more sensitive to how information is framed when interpreting the relative benefits of different investment choices. Given the choices that people have to make on their DC (defined contribution) pensions, these are worrisome findings.

Other papers documented other aspects of financial literacy. For example, when surveyed individuals are asked to rank their own financial knowledge, many give themselves high rankings, yet responses to a set of financial literacy quiz questions result in relatively low scores for many individuals. This type of overconfidence can negatively influence financial behavior.

Still other papers looked at the effectiveness of financial education initiatives provided by employers or by counseling agencies. Paraphrasing Michelle Greene’s message, we need these studies and rigorous evaluations of financial education programs to be able to allocate our resources to where they are needed, to where programs are proven to work!

The conference did not focus on the U.S. experience only. The retirement commissioner from New Zealand described some of the successful strategies that have been used to promote financial literacy among Kiwis (I mean the citizens of New Zealand, not those delicious fruits). The OECD has been a pioneer in promoting financial literacy and financial education programs and has worked on this topic since 2003. They have been not only a major force behind many important initiatives but are also working on promoting financial literacy in many emerging nations, from India to China to Latin America. Most importantly, they are serving as the coordinator of the activities that many countries are engaging in and serve as a clearinghouse for data and information. The World Bank has recently joined that effort and is devoting resources and expertise to promoting financial literacy among developing countries; in my view, an important and necessary effort.

In the closing panel, one representative of the Social Security Administration remarked that “he had not heard yet that financial literacy hurts.” I would very much agree that there are no obvious downsides to financial literacy.

We ended the conference with a quote that Michelle Greene had included in her presentation slides. She cited President Obama, who said, “If you work hard your whole life, you ought to have every opportunity to retire with dignity and financial security.” We hope that the government, academics, the financial community, and not-for-profit institutions will all work to make that opportunity possible.

Fixes for the Financial System

Today's New York Times described the proposal of six academics for changing the financial system. Mine is one of them.

http://www.nytimes.com/2010/04/25/weekinreview/25chan.html?pagewanted=1&sq=They%20have%20got%20it:%20fixes%20for%20the%20financial%20system&st=cse&scp=1

Compound Interest 101
ANNAMARIA LUSARDI

A person borrows $100 at an annual interest rate of 20 percent. How long does it take that debt to double? About four years. What share of American adults can figure that out? About one in three, says Annamaria Lusardi, an economist at Dartmouth College.

Ms. Lusardi wants to add financial literacy to high school curriculums. A crisis sparked in part by the decisions of millions of Americans to take mortgage loans they could not afford has underscored her conviction that “lack of financial knowledge is alarmingly widespread.”

Only three states — Missouri, Tennessee and Utah — now require a course devoted to personal finance, according to the JumpStart Coalition for Personal Financial Literacy, a nonprofit group. Another 18 states incorporate some lessons into other courses.

“Financial literacy is an essential piece of knowledge that every student should have,” Ms. Lusardi wrote recently on her blog. “Just as reading and writing became skills that enabled people to succeed in modern economies, today it is impossible to succeed without being able to ‘read and write’ financially.”

Let's hope that in this time of reforms some attention will be given to consumers and to financial literacy.

April showers bring future flowers

I like very much the fact that April has been declared Financial Literacy Month. As a result there has been a flurry of events and activities devoted to discussing, promoting, and improving financial literacy. I cannot stress enough how important it is to have financial literacy at the center of attention, including the extensive coverage it’s been receiving in the media.

It is also at this time that one realizes the need for information. How many institutions are doing financial education programs and how do they do them? I do not know the answer to this question nor would I know where to find this information. I also fear that anybody who is entering this field could end up reinventing the wheel: devising yet another set of curricula, materials, and programs rather than making use of what already exists or backing their program with proven best practices.

Via the creation of the Financial Literacy and Education Commission (FLEC) under the coordination of the Office of Financial Education at the U.S. Treasury, the federal government had admirably coordinated the efforts of its agencies and bureaus that are doing financial education programs. But what about the not-for-profits and other organizations that have become engaged in financial literacy?

In my view, there are many advantages to sharing information and in some degree of coordination among agencies, organizations, and businesses. First, it is very important to know what others are doing so as to minimize wasteful overlap. These days everybody seems eager to set up yet another Web page adding to the ten-thousand existing Web pages! While I appreciate the differences that may distinguish these offerings, I am afraid that their proliferation may simply add to the search costs of individuals who have to navigate an ocean of information on the Web. For those developing financial literacy programs, coordination with others who are doing the same thing can save valuable time and resources. For multiple organizations to spend weeks and months in designing programs that others have already thought about and perhaps even implemented and tested is certainly a waste of time and brain power.

Understanding what is effective in improving and promoting financial literacy is another critical piece of information. It would be very valuable to have this information reported somewhere. We need to devote resources to that which is effective and which has an impact. Funders should be able to determine which programs are effective and worthy of support and institutions interested in promoting financial literacy should be able to look for success cases and use them as models for their own programs.

Because I direct a center that is devoted to promoting financial literacy, I have to subject myself and the center’s research teams to these criteria: evaluate what we do, share information, coordinate activities, and not waste a cent of our valuable resources.

Tax day

Today is April 15: the deadline for filing income taxes. Money is on everyone’s minds these days. Even before the recession, Americans were confronted with an increasingly complex financial landscape that requires difficult financial decisions. Yet, studies show that most are not well-prepared to handle their personal finances. I discussed this topic on Vermont Public Radio last Tuesday, and how we can improve our financial literacy. If you would like to listen to the interview, the link is below:

http://www.vpr.net/episode/48366/

April 2010: Financial Literacy Month!

April is Financial Literacy Month. You know financial literacy is in troubles when they dedicate a month to it! Because today is April 1, I thought we could start off with a list of the reasons to be financially literate, following the example of other famous top ten lists.

Top ten reasons to be financially literate:

1. Because being financially literate is smart and sexy!
2. Because it is useful to know that ARM has to do with mortgages and is not a rock band;
3. Because 401(k) is the worse name that could be given to pensions and you still cannot figure out how anyone came up with it;
4. Because you are tired of having to get endless stock market tips from your brother-in-law;
5. Because you would love to criticize banks but do not know what to say;
6. Because you need topics to share with your barber/hair-dresser, taxi drivers, and bar tenders that make you look rich and cool;
7. Because everybody talks about the financial crisis and you have no clues what is going on and whom to blame other than banks;
8. Because you have time to spare now that unemployment is really high and nobody seems to be able to find a job;
9. Because you want to protect granny from scams;
10. Because you want to mathematically prove that the Lexus your neighbor drives with such pride was a bad financial decision.

Regional Feds and Financial Literacy

I recently visited the Federal Bank of Richmond to give a presentation at their Community Development Advisory Council’s spring meeting. Under the leadership of President Jeffrey Lacker, the Community Affairs Office of the Bank is making the promotion of financial literacy one of their strategic goals.

Regional Feds are ideal vehicles for the promotion of financial literacy. They have an intimate knowledge of the local economy and of the problems and most pressing needs in the community. They are in contact not only with local banks but with business owners and employers, community development agencies and not-for-profits. Much of the conversation that took place during my short visit to Richmond—including during coffee breaks and on a shared cab ride to the airport—was about using business principles to help development in the local community. This is ideal grounding for financial literacy; we need to develop and implement effective programs and avoid feel-good initiatives that may go nowhere.

So, I welcomed the hard questions that I was asked during the presentation, the insistent focus on what works and what the evidence shows about the effects of financial literacy. I prepared a lot for this audience because I knew I would be facing researchers who understand the nuances of research work and also economists and businesspeople who are interested in the relevance of the subject to their work.

Regional Feds have active research departments and some of the best research originates from these banks. Not only do these researchers not have teaching commitments (which—believe it or not—take a lot of time!) but they often have access to great data. They are confronted all the time by tough and important questions and this directs them toward research that is of economic and policy relevance. Economists from the Richmond Fed’s research department have written about entrepreneurship and financial education, among other topics. They had produced a review of the effectiveness of financial education that I have used in my research and that I discussed with them at the meeting.

During the lunch discussion in an elegant room in the high floor of the building, we talked about financial literacy in schools. Two main ideas emerged that I want to credit to the economists from the research department.

First, the advancement of learning normally builds over the years: one first learns beginning Spanish, then masters intermediate Spanish, and then can take advanced Spanish courses in the later years of high school. Similarly, one starts by reading short chapter books, then simple essays, short stories, then novels . . . it takes a while to build up to War and Peace. But financial education is often a stand-alone course offered in the final year of high school without much, if any, preparation in previous years. It is hard to imagine, even from a simple pedagogical perspective, that this method could be effective either in teaching financial literacy or in making financial knowledge stick. (In my case, I remember little from my one Spanish course but I could challenge Schwarzenegger to a Hasta la vista, baby! contest.)

The second idea is that one of the objectives of financial literacy education should simply be to make people interested in learning more; laying the groundwork so that people will seek out information and education over the course of their life. In the same way that good English literature instruction makes us appreciate a good book and fosters a taste for reading, so good financial literacy instruction may give people a taste, early in life, for future learning: reading the business section of the newspaper and making an effort to incorporate good financial practices into everyday life.

President Lacker took me around the building that houses the Richmond Fed, with its stunning views of the James River. He pointed out the bridges from the Civil War era that are still standing across the river. He spoke of the history of Richmond, and how much he enjoys living there. And he spoke with pride about the work that the Bank is doing. I returned home content and very much convinced that, in the Richmond district, financial literacy is in good hands.

Take the National Financial Capability Challenge

In previous posts, I have described the importance of teaching financial literacy in school, the difficulties in teaching financial literacy, and the need for teachers’ training. In this post I would like to inform readers about the National Financial Capability Challenge and encourage students and teachers to participate in the challenge.

The National Financial Capability Challenge is an awards program designed to increase the financial knowledge and capability of high school students across the United States. It challenges high school teachers and other educators to teach the basics of personal finance to their students, and rewards students, educators, schools, and states for their participation and their success.

All high school teachers and other educators working with U.S. high-school aged students (ages 13-19) are encouraged to register for the Challenge, download the Educator Toolkit, prepare their students, and administer the online exam. Educators who have been teaching students about personal finance for years as well as those who never have before are urged to join this national initiative.

Please note that this is a free program and it works as follows:

Registration: Educators are encouraged to go to http://challenge.treas.gov, view the video message from Education Secretary Arne Duncan, and sign up as soon as possible. Registration is open through March 14, 2010.

Educator Toolkit: Once registered, educators will have access to a free Educator Toolkit that includes ready-to-use lesson plans that cover all the core concepts students need to learn to take the Challenge. Educators are encouraged to use whichever modules they like, use other existing resources, or create their own innovative approaches to teaching these concepts in an effort to help students increase their financial capability.

Challenge Exam: The Challenge online exam, which is designed to illustrate the relevance of financial topics to students, as well as to assess their learning, will be offered from March 15 - April 9, 2010. It will take the average student less than 40 minutes to complete, and each student should take the exam only once. Educators can decide which day to administer the exam and are expected to treat it just like an official exam.

Awards Program: The top two scorers at each school, plus all students scoring in the top 20%, will receive National Financial Capability Challenge Award Certificates. All participating educators will receive an official certificate, and educators from schools and states with the highest proportion of participating students will be recognized as well.

Please spread the word about this important program.