Wealth, money, knowledge: how much do people know? Where are the gaps? What s working? What s next? Presentation to Financial Literacy 09 Retirement Commission, New Zealand June 26, 2009 Annamaria Lusardi Dartmouth College and NBER
Significance This presentation summarizes a multi-year project on financial literacy and saving Individuals are increasingly in charge of making saving and investment decisions Changes in the pension landscape Financial markets are more complex Financial mistakes can have devastating consequences
The great risk shift How well equipped are people to make saving and investment decisions?
Scheme of the presentation How much do people know? Evidence from different surveys Who knows the least? Does financial literacy matter? What to do in the presence of financial illiteracy?
Collecting data on literacy Olivia Mitchell (Wharton School) and I devised a module on Financial Literacy & Planning for the 2004 Health and Retirement Study (HRS) Financial Literacy Do people know basic economics/finance? Planning Do people calculate how much they need to save for retirement? How well do they plan?
Measuring Financial Literacy (I) To test numeracy and understanding of interest rates, we asked: Suppose you had $100 in a savings account and the interest rate was 2% per year. After 5 years, how much do you think you would have in the account if you left the money to grow? i) more than $102; ii) exactly $102; iii) less than $102; iv) don t know (DK); v) refuse to answer.
Measuring Financial Literacy (II) To test understanding of inflation, we asked: Imagine that the interest rate on your savings account was 1% per year and inflation was 2% per year. After 1 year, would you be able to buy: i) more than today with the money in this account; ii) exactly the same as; iii) less than today iv) DK; v) refuse.
Measuring Financial Literacy (III) Finally, to test understanding of risk diversification, we asked: Do you think the following statement is true or false? Buying a single company stock usually provides a safer return than a stock mutual fund. i) true; ii) false; iii) DK; iv) Refuse.
How much do older people know? We analyzed the knowledge of people aged 50+: NB: Only ONE THIRD (34%) correctly answer all 3 questions; only around HALF (56%) correctly answer Inflation & Compound Interest.
Scheme of presentation How much do people know? Evidence from different surveys Who knows the least? Does financial literacy matter? What to do in the presence of financial illiteracy?
Financial Literacy and Age 90.00% 80.00% 70.00% 60.00% 50.00% 40.00% 30.00% 20.00% 10.00% 0.00% Compound Interest Inflation Stock Risk 60 75.88% 80.79% 59.95% 61-70 67.22% 79.72% 54.01% > 70 57.63% 64.89% 42.61%
Correct responses: By Gender 90.00% 80.00% 70.00% 60.00% 50.00% 40.00% 30.00% 20.00% 10.00% 0.00% Compound Interest Inflation Stock risk Male 74.70% 82.20% 59.30% Female 61.90% 70.50% 47.50%
Financial Literacy in other surveys These questions have now been added to many other surveys in the US NLSY (23-27 years old) Rand American Life Panel (all age groups) These questions have been added to many surveys abroad The Netherlands Italy and Germany Russia New Zealand
How much do young people know? We analyzed the knowledge of people between the ages of 23 and 27: Distribution of Responses to Financial Literacy Questions (%) Responses Correct Incorrect DK Refuse Interest rate 79.24 14.76 5.87 0.12 Inflation 53.88 30.53 15.41 0.18 Risk diversif. 46.57 15.86 37.5 0.07 NB: Only LESS THAN HALF (45%) correctly answer all 3 questions.
Correct responses: By Gender 90.00% 80.00% 70.00% 60.00% 50.00% 40.00% 30.00% 20.00% 10.00% 0.00% interest rate Inflation Stock risk Male 81.79% 59.98% 53.29% Female 76.61% 47.57% 39.62%
Debt Literacy Together with Peter Tufano (HBS), I designed questions about debt literacy Relevant given sharp increase in debt We engaged a market research firm (TNS) to provide timely data TNS is leader firm in opinion polling Representative sample of the US population
TNS Survey: Compound interest We tested understanding of compound interest: Suppose you owe $1,000 on your credit card and the interest rate you are charged is 20% per year compounded annually. If you didn t pay anything off, at this interest rate, how many years would it take for the amount you owe to double? - 2 years - Under 5 years - 5 to 10 years - More than 10 years - Do not know - Prefer not to answer Interest compounding Percent 2 years 9.6 Less than 5 years (correct) 35.9 5 to 10 years 18.8 More than 10 years 13.1 Do not know 18.2 No answer 4.3
TNS Survey: Paying off credit cards We tested participants understanding of the impact of paying of credit cards: Suppose you owe $3,000 on your credit card. You pay a minimum payment of $30 each month. At an Annual Percentage Rate of 12% (or 1% per month), how many years would it take to eliminate your credit card debt if you made no additional new charges? - Less than 5 years - Between 5 and 10 years - Between 10 and 15 years - Never, - Do not know - Prefer not to answer Credit card payment Percent Less than 5 years 3.8 Between 5 & 10 years 12.4 Between 10 & 15 years 21.6 Never (correct) 35.4 Do not know 21.7 No answer 5.1
Self-reported financial knowledge 35% 30% 25% 20% 15% 10% 5% 0% 1 (low) 2 3 4 5 6 7 (high) Do not know Refuse
Who know the least? TNS survey results from among the elderly showed several important findings Question about interest compounding Only 28.6% answer correctly 28.3% answer they do not know Question about credit cards Only 32.3 answer correctly 30.7% answer they do not know However, the elderly rate themselves highest in term of self-reported literacy Average score is 5.3!
Who has lower debt literacy? The debt literacy question showed marked differences between men and women: Percent answering credit card question correctly or do not know by gender 50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% Correct answer Do not know Male Female
Two Takeaway Points Financial literacy should not be taken for granted Illiteracy is widespread Financial literacy varies widely among demographic groups.
Scheme of presentation How much do people know? Evidence from different surveys Who knows the least? Does financial literacy matter? What to do in the presence of financial illiteracy?
Does Financial Literacy Matter? Consumers may not need financial knowledge because they can consult experts or get help when making financial decisions Even without being mechanics, we all drive cars Consumers may make good decisions even without knowledge or advanced knowledge We can be good at playing pool even without knowing physics
Financial Literacy and Advice Where do people turn for financial advice? Levels of Financial literacy 1 st (low) 2nd 3rd 4 th (high) Parents, friends, acquaintances 40.7 37.4 19.9 17.9 Information from newspapers 1.1 6.0 10.6 13.7 Financial magazines, books 2.1 7.6 9.7 17.0 Brochures from my bank 6.6 6.7 11.3 6.2 Advertisement on TV 4.0 3.6 5.0 1.4 Professional advisers 19.4 23.6 27.5 24.1 Fin. Computer programs 0.2 0.3 1.1 0.5 Fin. Information on Internet 6.3 6.6 7.6 12.4 Other 19.7 8.2 7.3 6.9
Retirement planning and net worth in 1992 ($2004) Age : 51-56 in 1992 Total net worth distribut. % of sample 25 th Percentile Median 75 th Percentile Mean Planning (1992 HRS): How much have you thought about retirement? Hardly at All 32.0 10,098 76,906 200,613 224,310 A Little 14.3 37,699 126,562 290,149 343,145 Somewhat 24.8 72,032 173,753 367,298 340,681 A Lot 28.9 71,393 173,686 356,796 353,523
Retirement planning and net worth in 2004 ($2004) age 51-56 Total net worth distribut. % of sample 25 th Percentile Median 75 th Percentile Mean Planning (2004 HRS): How much have you thought about retirement? Hardly at All 27.7 10,300 84,100 289,900 350,770 A Little 16.7 59,700 172,000 390,500 357,215 Somewhat 27.9 56,000 189,000 450,000 367,832 A Lot 27.7 55,000 199,000 467,600 508,269
HRS Module: Retirement Planning We asked participants about their current retirement planning: Trying to plan Have you ever tried to figure out how much your household would need to save for retirement? Developing a plan Have you developed a plan for retirement saving? Sticking to the plan How often have you been able to stick to this plan? Would you say: i) always; ii) mostly; iii) rarely; or iv) never?
HRS Module: Findings Depending on whether participants had tried to plan, results varied: Tried: Have you ever tried to figure out how much your household would need to save for retirement? Yes (31.1%) No (67.8%) Developed a plan Have you developed a plan for retirement saving? Yes (58.4%) More or Less (9.0%) No (32.0%) Stuck to the plan How often have you been able to stick to the plan? Always (37.7%) Mostly (50.0%) Rarely 8% Never 2.6%
HRS Module: Prevalence of planners
The Importance of Planning Median Net Worth $350,000 $300,000 $250,000 $200,000 $150,000 $100,000 $50,000 $0 Planners $308,000 Non Planners $122,000
HRS Module: Analysis of Planners We classified participants as Simple, Serious, or Successful Planners and analyzed their test results:
The building blocks Wealth Planning Information & calculations
The cost of ignorance High cost debt No stocks Lack of saving
Takeaway Points Financial literacy influences behavior. Those with low literacy: are more likely to use family and friends as sources of advice are less likely to plan for retirement and consequently accumulate less wealth In other work using Dutch data I show that those with lower literacy are less likely to invest in stocks This finding is now confirmed in US data
Table of contents How much do people know? Evidence from different surveys Who knows the least? Does financial literacy matter? What to do in the presence of financial illiteracy?
What to do given widespread illiteracy? The Dartmouth Project Simplify financial decisions Provide information and advice Target specific groups Use communication that does not rely on figures and numeracy
The Dartmouth Project: Planning Aid Together with a Tuck School of Business Marketing professor, I designed a planning aid intended to help college staff enroll in the college supplementary retirement account (SRA)
The Dartmouth Project: Planning Aid Don t give up! Contact the Benefits Office (6-3588) if for any reason you could not complete the online application. It takes no time to prepare for your lifetime! Most people plan on electing a supplemental retirement account, but feel they don t have the time or information right now. We have outlined 7 simple steps to help you complete the election process. It will take between 15 30 minutes, from start to finish. It will take less time for you to start to insure your future than it takes you to unload your dishwasher!
Program Effectiveness There was a sharp increase in savings enrollment within 30 days of hiring among participants who received the brochure, and the number who enrolled within 60 nearly doubled: 30 days After Hire 60 days After Hire Number of Observations Control Group 7.3% 28.9% 210 7-Step 21.7% 44.7% 166 Planning aid
Other Ideas Additional programs to increase financial literacy and saving rates: Provide incentives to become literate (the UK Child Trust Fund) Have financial education in school Provide information from experts and make it widely available
Recommendations Simplify decision-making Step-by-step approach Use effective communication: Stories, testimonials As simple as a traffic light!
The Financial Literacy Initiative I have several financial literacy projects underway, in addition to continued research on the topic: A survey on financial capability for the U.S. Treasury A new survey on risk literacy I have a blog dedicated exclusively to financial literacy
My new book My new book has recommendations on how to address the retirement savings crisis
Do you want to read more? For more information: Other papers I have written on this topic are available on my webpage: http://www.dartmouth.edu/~alusardi Initiatives in progress dedicated to women