Sunday, March 8, 2009

Overcoming the Saving Slump: How to Increase the Effectiveness of Financial Education and Saving Programs

In the previous blog, I have described a specific program about how to help people save. I would like to describe now a set of ideas I have pursued in my newly published book: “Overcoming the saving slump: How to increase the effectiveness of financial education and saving programs.”

This book explores the many challenges that have arisen in the transition to a pension system that requires more individual responsibility, focusing on micro behavior as it relates to saving and pensions and illustrating the impediments and barriers to saving. The issues at hand have not gone unnoticed. The financial industry, employers, and the government have taken initiatives to promote saving and financial education programs. The financial industry has developed and provided products that can better suit the needs of investors. In addition, financial education programs have been offered in different forms and from different institutions. This book tries to evaluate whether and how these developments are helping to effectively bridge the way to a new system. The authors who have contributed to this book have analyzed programs that are in place, examined available investment products, and taken a close look at the experiences of countries that have privatized their pension systems or experienced changes in their Social Security systems. From these contributions emerge what is perhaps the most important objective of this book: to provide suggestions on how to improve the effectiveness of these programs and products, thereby enabling the United States to make the transition to this new system more smoothly.

The economic changes that are occurring in the pension landscape in the United States are well documented in the first chapter of this book, which traces the increase of individual retirement accounts that has occurred in recent decades. Workers retiring before the 1980s relied mostly on Social Security and employer-sponsored defined benefit pension plans for their retirement income. The situation is very different for current workers, who will reach retirement with a different mix of funds—not only Social Security and defined benefit plans, but also personal retirement accounts, including IRAs and defined contribution pension plans. One characteristic of these accounts is that individuals are in charge of deciding how much to contribute and how to allocate their retirement savings. Moreover, individuals must decide how to decumulate their wealth when they reach retirement. A comprehensive retirement planning strategy requires consideration not only of how to save but also how to spend down wealth. Individuals have to make sure that retirement wealth lasts a lifetime (chapter six). The risk of individuals making costly mistakes in their saving and retirement planning are real. Throughout the book, evidence is shown of widespread financial illiteracy in the United States (chapters nine and thirteen). In addition, workers are found to be sorely lacking knowledge about their pensions. Chapter two documents that only about half of older workers know about their pension plans.

Lack of information and lack of financial literacy provide fertile ground for financial errors. Left to their own devices, employees may choose to invest their pension wealth in either too-conservative or too-aggressive assets. An analysis of portfolio allocation from a large sample of Vanguard investors (2,000 defined contribution plans and nearly 2.9 million 401(k) participants) in chapter four offers compelling evidence that portfolio allocation can be improved upon. Economic theory also suggests that life annuities can substantially increase welfare by eliminating the risk associated with uncertain life expectancies and providing consumers with a higher level of lifetime consumption. Yet, as described in chapter six, most individuals do not annuitize as often as the theory predicts, if they annuitize at all. And there are problems in relying on financial advice, as explained in chapter three, as the incentives of financial intermediaries do not always line up with the incentives of investors.

One of the key objectives of this book is to provide suggestions on how to increase the effectiveness of financial education programs. Effectively designing education and saving programs needs to take into account a number of factors: identification of barriers to effective saving, differences among demographic groups, and flexible program design. A variety of barriers are described throughout the book, from lack of literacy to lack of information to behavioral biases. However, this hardly exhausts the list of things that can affect individual behavior. The research that deals with increasing the effectiveness of financial education and saving programs, discussed in chapters seven, eight, ten, and thirteen, points to a variety of factors that need to be considered. Because individuals differ widely in their barriers to saving, it is important to develop methods to uncover those barriers. In designing effective programs, approaches such as in-depth interviews, focus groups, and ethnographic studies may need to be employed. The many differences among individuals must also be taken into account for successful implementation of financial education programs. Targeted education programs may better serve the needs of specific groups of the population, such as women, younger and older individuals, and those with low income. Chapters throughout the book document the many differences that exist among these groups. Furthermore, chapter seven shows that, to both understand and exploit differences in individual behavior, it is important to incorporate concepts of marketing and psychology into economics.

Fundamentally, to overcome the saving slump, as is discussed in chapter ten, it is important to create an infrastructure that promotes saving and asset accumulation. Such infrastructure would include not only effectively designed financial education and saving programs but also a variety of policies and initiatives to stimulate saving. For example, access to saving opportunities can be fundamental. About half of private-sector workers have jobs that do not offer pensions, making it particularly difficult for those workers to accumulate retirement wealth, and it is important to find ways to facilitate saving among those individuals. Low income households also display little or no savings. However, specific programs targeted to the poor have been proven to be effective in stimulating saving among this group of the population. Another important policy demand, given the findings of widespread financial illiteracy among high school students reported in chapter nine, is to prepare young people for financial life. This is a challenging task and a lot more has to be done to find effective ways to teach financial education in schools. As discussed in more detail in chapter ten, such infrastructure should pay attention to program design. For example, centralized and efficient accounting, low-cost investment options, and outreach can play important roles in stimulating saving. Moreover, the experiences of other countries offer important lessons for the United States. While the increase in individual responsibility that is required in the system we’re transitioning to provides incentives for individuals to become knowledgeable and informed, one has to be cautious about relying simply on individual initiative as the experiences of Chile, Sweden, and OECD countries described in chapters eleven, twelve and thirteen can teach us.

My aim in editing this book is to illuminate the issues facing so many Americans in regards to saving and retirement planning and to evaluate the existing programs and products that have been designed to facilitate saving. My hope is that such a close look at the situation faced today by individuals, businesses, and policymakers will help to provide a foundation to continue to devise effective financial education and saving programs, which can contribute to overcoming America’s saving slump.

More information about the book is available at: