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Behavior

Our Stubborn State of Financial Illiteracy

The U.S. retirement system is built on people having a working knowledge of finance.  Yet financial literacy among a big chunk of Americans ranges from unimpressive to abysmal.

This revelation was again confirmed in a survey that recently debuted by financial literacy guru Annamaria Lusardi, head of the Global Financial Literacy Excellence Center at George Washington University. In a 2011 survey, Lusardi had found that too many Americans were unable to answer three very simple financial questions.

This new survey is more ambitious, though the results are no more promising. It asks 28 questions in eight areas: earning money, budgeting, saving, investing, borrowing, insuring, understanding risk, and information sources.  In the nationally representative survey, about one in four people got no more than seven answers (25%) correct.

One telling finding is that the highest scores were for knowledge about borrowing, with nearly two out of three answering these questions correctly. I suspect this knowledge has been gained from experience – experience with high-interest credit card bills and onerous student loan payments, as well as mortgages.

Understanding risk questionIn every other financial topic surveyed, about half or less answered the questions correctly.  Questions about risk, which is at the heart of many financial decisions, fared worst – only 39 percent answered these correctly.

An important connection is made in the report regarding 18- to 44-year olds, who answered only 41 percent of the questions correctly (versus 55 percent for people over 45). Younger adults also answered “I do not know” most often. 

When it comes to retirement, those who would gain more from financial knowledge are the least knowledgeable.  Saving that starts in early adulthood can go a long way toward achieving retirement security, thanks to compound investment returns over the many years remaining prior to leaving the work force. It’s unfortunate that those who could benefit from compounding often don’t comprehend its effect. …Learn More

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Research

Nearly Retired, Lugging a Mortgage

Traditionally, the picture-perfect retirement included a paid-off house. But the Me Generation isn’t sticking to the script.

Snapshots of three generations of U.S. households on the cusp of retirement – people born in the Depression, at the beginning of World War II, and after the war – show that more of the most recent generation, the baby boomers, are still carrying mortgages as they head into their retirement years.

About 40 percent of households who were between the ages of 56 and 61 in 1992 – the Depression-era parents of baby boomers – held mortgages at that age. This share had increased to 48 percent by 2008, as the front wave of baby boomers were reaching their late 50s and early 60s

“The current generation has bought larger, more expensive homes, and they arrive at retirement with more mortgage debt,” concluded George Washington University business professor Annamaria Lusardi, who presented the findings of her study with Olivia Mitchell of the Wharton School during an August meeting of the Retirement Research Consortium. …Learn More

Field Work

What’s Up With Women?

The share of women enrolled in college is increasing, and more women are breaking into the top tier of business, government and non-profits.

But at the same time that women are achieving more status than at in any time in history, we still know much less than men about money and finance. What’s up with that?

Financial literacy is important to women, because they live longer and need more retirement savings. Another reason this matters is that women are, according to a recent federal report, more financially vulnerable than men, particularly when they become divorced, widowed, or retired.

Anyone who is not savvy “will have a much tougher time preparing themselves for retirement,” Roger Ferguson, the president of the TIAA-CREF retirement system, said at the retirement research conference in Washington.

In a now-famous survey designed by Annamaria Lusardi, a professor at the George Washington University School of Business, and Olivia Mitchell at The Wharton School, only one in five American women who were asked three simple financial questions got them all right.

And the problem of financially illiterate women is universal. Lusardi recently fielded her survey on a global scale and found the same abysmal results. “Whether you look at the Netherlands or Sweden or Italy or the U.S. – these are very different countries – women know less than men,” she said.

She is, nevertheless, optimistic, because women are also more likely to admit what they do not know. Half of women in a separate U.S. study said they didn’t know the survey answers, while only one-third of men did. This admission can be viewed as “a good thing for women,” Lusardi said.Learn More

Field Work

Fourth of July Quiz

Just over two-thirds of Americans were able to answer the questions below correctly. Given their “simplicity,” Annamaria Lusardi and Olivia Mitchell called the results “discouragingly low” in their 2011 research published by the National Bureau of Economic research.

Women did worse than men: 59 percent of women got it right, compared with 71 percent of men.

Take the test to see how you do.

1. Suppose you had $100 in a savings account and the interest rate was 2 percent per year. After five years, how much do you think you would have in the account if you left the money to grow?
a. More than $102
b. Exactly $102
c. Less than $102
d. Do not know
e. Refuse to answer

2. Imagine that the interest rate on your savings account was 1 percent per year and inflation was 2 percent per year. After one year, how much would you be able to buy with the money in this account?
a. More than today
b. Exactly the same
c. Less than today
d. Do not know
e. Refuse to answer

To see the answers, click “Learn more” below. And happy Fourth of July!Learn More

Five raised hands.

Research

Hubris Hampers Education Efforts

Most people think they’re above average when it comes to financial knowledge. And it’s not easy to educate people who think they know more than they actually do.

But hubris – or something like it – is what financial educators are up against, indicates research by professors Annamaria Lusardi at the George Washington School of Business and Olivia Mitchell at the University of Pennsylvania’s Wharton School. Their paper used data from 1,200 respondents to a survey they conducted for the Investor Education Foundation or FINRA, the self-regulatory agency for the securities industry. It may be the most comprehensive study on Americans’ financial literacy.

Seventy percent of the survey’s respondents believe they know more about basic financial concepts than most other people. But they scored poorly on the survey’s three rudimentary financial literacy questions. One-third to one-half of them answered the questions incorrectly or indicated they didn’t know the answers.

The results “paint a troubling picture of the current state of financial knowledge in the United States,” the authors said.

Further, this low level of knowledge, when combined with overconfidence about that knowledge, does not bode well for attempts to educate people about money and their personal finances.

Before I provide more detail about Lusardi and Mitchell’s findings, take the quiz yourself. Here are the questions1:
Learn More

Feature

Field Work

Financial Savvy Means More 401k Returns

Financial knowledge is critical to one’s retirement security, finds a new study showing that 401(k) plan participants who scored higher on a test of their financial knowledge earned an additional 1.3 percentage points of investment returns annually on their retirement accounts.

Over a 30-year working life, that higher rate of return would add 25 percent to total savings at retirement.

Readers can take the quiz by clicking here; answers appear at the end of this blog post. …Learn More

Field Work

Conference Will Guide Financial Advisors

At a dinner next Monday night, finance professor Zvi Bodie at Boston University and his co-hosts will kick off their third conference geared toward educating financial professionals about cutting-edge thinking in the field. “The Future of Life Cycle Saving and Investing” will focus on serving low-income individuals. However, Bodie said in this recent interview that the conference lessons apply to all financial consumers.

Zvi BodieSQUARED AWAY: Is this an annual conference?
BODIE: No. The first one was in 2006, the second in 2008. Truthfully, what inspired me to have these conferences, among other things, was the strong support of MIT economics professor Paul Samuelson. I decided I was sick of the baloney about personal investing that is served up on websites, brochures, etc. – all of which is designed for the benefit of the service providers rather than the customers. So much of it flatly contradicts what I teach. We’re dedicating the dinner to the memory of Paul Samuelson, who died last year.

SQUARED AWAY: What baloney?
BODIE: Say you’re a beginning investor. You go to any website – go to investor.gov. It’s a really nice looking website. This is the Securities and Exchange Commission, so you’d think, ‘Wow, I can trust this.’ But, actually, all this material was fed to the government by the investment industry. …
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Field Work

Women “Reactive,” Not Planning Finances

What motivates women to get to work on their personal finances? Change.

Emotions are also important motivators. But “the most compelling factor” spurring most of the women interviewed in a focus group to take action was a significant life change, Utah State University researchers write in the Journal of Financial Counseling and Planning.

Since April is financial literacy month, Squared Away is again making an appeal to women, who continue to make strides professionally, yet lag men in understanding how to manage their money.

“Major life changes like a premature death of a spouse or divorce are often the wake-up call to people to reassess their lives,” said Utah State researcher Jean Lown, who also teaches a workshop, Financial Planning for Women.

This tendency isn’t necessarily a good thing for women. Rather than being “reactive,” she said, women need to learn to plan ahead and prepare for the future.

For Megan Rowley, who conducted the focus group, the women’s stories hit home. While Rowley pursued her master’s and worked full-time at Utah State, her husband left a part-time job to complete his MBA. After they graduated, he found employment at a pipeline company in Salt Lake City, and she became a stay-at-home mother, said Rowley, who wants to become a financial counselor when her three young children are older. …Learn More