The financial decisions people have to make today are quite complicated, and the financial markets we interact with have made finances even more complicated. So, in such a complex world, where do people turn to for advice when making financial decisions? Survey after survey show that one of the primary sources of information are family members. Colleagues and friends are another common source. This is an important finding. A lot of financial transactions happen within the family and family members naturally exchange information and advice. Moreover, we spend a lot of time at work and the workplace is a natural environment in which to get information and exchange ideas. However, is it a good idea to rely mainly on family and friends for financial advice? Because there is inherently asymmetric information in this type of exchange (those who ask know less than those who provide information), it may be hard to know whether the advice one is receiving is sound. We trust family members to do right by each other, and it might be possible to know whether someone has made good decisions and trust that it is safe to follow in their footsteps. I have an older sibling and I have learned a lot by simply following some of the decisions she has made. But financial acumen is not always verifiable. We cannot always know whether our friends have chosen the best mortgage, how they invest their retirement wealth, and what they do with their credit cards. People do not go around with financial statements around their necks and the fact that someone has a nice house and a nice car might be an indication of a lot of debt rather than a lot of savings. Trust is important when it comes to financial information, but should trust trump expertise? If people around us are not really more knowledgeable in finance than we are, do we improve our knowledge by seeking advice from them? Ask yourself: would you trust a family member who is not a health care professional for medical advice? Finance is no less complicated than health, and the consequences of bad financial decisions can be as dire as taking the wrong medicine or leaving an illness untreated.
I am always intrigued by how much people like to dispense financial information and financial advice. Because I have been traveling a lot in the past few months, I have gotten a good deal of financial information and financial advice from taxi drivers, strangers at the airport, and hairdressers. One participant at a conference told me that in his town, everybody gets financial advice from the butcher. I will keep this in mind when I buy my steaks. I like that people are paying so much attention to finance and financial matters these days, and it’s interesting to hear what people are talking about. Some of the suggestions and theories I have heard are brilliant, some are odd, but others are just plain wrong. Finance and financial principles are grounded in theory: they follow laws that do not change based on who is in power or which state you live in; the power of interest compounding is no different in Florida than in California, and it does not change depending on whether the president is a Republican or a Democrat.
If we are so eager for financial information, there is a clear role for a provider of information—a reputable, independent, and expert source. For example, Social Security started to send around statements about Social Security benefits in 1995. This is a laudable initiative and studies have shown that these statements have changed people’s behavior. The Department of Labor is hard at work to find ways to improve and streamline the information provided by pension plan providers. The Securities and Exchange Commission is looking for ways to better inform investors.
I have my own recommendation to offer. If you need financial information, use www.mymoney.gov. It was built by experts to provide financial advice for citizens. It is from a reputable institution that cares about people making good decisions.
Let’s not mix roles. There is a joke in Italian that goes approximately like this: In heaven, the Italians are the cooks, the Germans build cars, and the Swiss are in charge of running the trains. In hell, the Germans are the cooks, the Swiss build cars, and the Italians are in charge of running the trains. As you can see, we Italians like to poke fun at ourselves. But the same principle applies here: ask taxi drivers for directions, hairdressers for a good shampoo, butchers for a good sausage, and your government for good financial advice! You would not ask a taxi driver for a haircut or send to the Treasury for sausage, would you?
About Business & Finance empowers people to make the most of their financial lives. Whether you want to plan a family budget, make the most of your savings.
How to Build a Successful Website for Financial Literacy
At an international conference in Washington, D.C., on financial literacy last year, the Retirement Commissioner from New Zealand stood up and stated that New Zealand has the best website in the world to promote financial literacy and financial education. I liked her instantly; you need to have a lot of guts to make that statement in front of an international audience of academics and policymakers, and possibly a good website. I checked out that website and good it is! It is called “Sorted,” a term that New Zealanders use to mean figuring things out and getting ready (http://www.sorted.org.nz/). The website is very well organized and provides information for financial decisions at every stage of life. One can find information about managing debt, mortgages, investment, and planning for retirement. And there is a variety of calculators as well to help people figure out the interest payments on their credit cards, how wealth can grow with the power of interest compounding, how much to save for retirement, and much more. On the website one can also take a money personality test “to help you work out your financial strengths and possible blind-spots.” I went through the questions and was told (among several other things) that when it comes to money matters, I am cool and dispassionate! I like that, too.
As I have argued before, citizens in every country could use one reliable, accurate source of information for managing their financial decisions. However, what really puts New Zealand's website over the top is the fact that it is so engaging. The information is not provided in those sterile graphs and statistics that even people with advanced degrees understand only after a bit of head scratching. One can watch a movie about investment, saving, and retirement. The soundtrack is so good that it made me play the movies a couple of times to listen to it again. One can also listen to stories and follow the journeys of Liz, Carl and Jess, Rochelle and Junior, and Raeanna and learn how they used the tools available on the website to help organize their finances. It is not just about information and simplifying decisions, but also about implementation. The website describes the steps that one has to take, for example, to set goals and to do a budget. And there are tips on a variety of topics, including how to cope with today’s financial climate. The information provided online is also available in booklets that can be downloaded or ordered for free.
According to a survey that was just released in June 2009, one-third of New Zealanders had either visited the website of the Retirement Commission or read one of the booklets, and a quarter had done so within the past twelve months (http://www.financialliteracy.org.nz/.) This is an extraordinary result. In my view, there are several reasons for this success. First, the Retirement Commission is an autonomous entity with the mission to “educate and inform New Zealanders from age 5 to 105 about managing their personal finances to ensure adequate provision for retirement.” Thus, the citizens of New Zealand know where to go to get a reliable source of information. We do not need many web sites, we only need one! And both the website and the work of the Retirement Commission are well advertised in the media and New Zealanders know about it. Most importantly, as the Retirement Commissioner remarked, it is a good website!
I visited the Retirement Commission last week to speak at their Financial Literacy Summit. I discovered that they designed a survey of financial knowledge in 2005, well before other countries. The development of a national strategy to lift New Zealanders’ financial literacy was announced at the inaugural Financial Literacy Symposium in Wellington in December 2006 and launched in 2008. And if the new survey in 2009 is any indication, 43 percent of New Zealanders are now scoring high on financial knowledge, and women and low income households are among the groups with the biggest improvements since 2006, when data from the first survey was collected. At the conference last week, the Secretary for Education announced that financial education will become part of the curriculum in schools throughout New Zealand. Moreover, the advisory committee for the National Strategy for Financial Literacy (composed of the Governor of the Reserve Bank of New Zealand, the Chair of the Securities Commission, the Chair of the Investment, Savings and Insurance Association, the Secretary for Education, the Associate Dean for Mâori and Pacific Development at the University of Auckland Business School, and the Retirement Commissioner) will now report to the Minister of Finance twice a year on progress in implementing the strategy.
As you may know, New Zealanders are also called “Kiwis.” The Kiwi is a flightless bird. As the story goes, Tane Mahuta, the lord of the forest, was surveying his ferny domain and became concerned that his children, the trees, were ill from being eaten by bugs. He called the birds together to ask if any might be prepared to eat the bugs, which would entail living on the dark, damp forest floor. The Kiwi put himself forward. As a reward it became the best-known and most-loved bird of all.
It is good to have such a symbol in a country so hard at work to improve financial literacy. Can they improve financial literacy? The answer I heard at the conference was: Yes, we can!
As I have argued before, citizens in every country could use one reliable, accurate source of information for managing their financial decisions. However, what really puts New Zealand's website over the top is the fact that it is so engaging. The information is not provided in those sterile graphs and statistics that even people with advanced degrees understand only after a bit of head scratching. One can watch a movie about investment, saving, and retirement. The soundtrack is so good that it made me play the movies a couple of times to listen to it again. One can also listen to stories and follow the journeys of Liz, Carl and Jess, Rochelle and Junior, and Raeanna and learn how they used the tools available on the website to help organize their finances. It is not just about information and simplifying decisions, but also about implementation. The website describes the steps that one has to take, for example, to set goals and to do a budget. And there are tips on a variety of topics, including how to cope with today’s financial climate. The information provided online is also available in booklets that can be downloaded or ordered for free.
According to a survey that was just released in June 2009, one-third of New Zealanders had either visited the website of the Retirement Commission or read one of the booklets, and a quarter had done so within the past twelve months (http://www.financialliteracy.org.nz/.) This is an extraordinary result. In my view, there are several reasons for this success. First, the Retirement Commission is an autonomous entity with the mission to “educate and inform New Zealanders from age 5 to 105 about managing their personal finances to ensure adequate provision for retirement.” Thus, the citizens of New Zealand know where to go to get a reliable source of information. We do not need many web sites, we only need one! And both the website and the work of the Retirement Commission are well advertised in the media and New Zealanders know about it. Most importantly, as the Retirement Commissioner remarked, it is a good website!
I visited the Retirement Commission last week to speak at their Financial Literacy Summit. I discovered that they designed a survey of financial knowledge in 2005, well before other countries. The development of a national strategy to lift New Zealanders’ financial literacy was announced at the inaugural Financial Literacy Symposium in Wellington in December 2006 and launched in 2008. And if the new survey in 2009 is any indication, 43 percent of New Zealanders are now scoring high on financial knowledge, and women and low income households are among the groups with the biggest improvements since 2006, when data from the first survey was collected. At the conference last week, the Secretary for Education announced that financial education will become part of the curriculum in schools throughout New Zealand. Moreover, the advisory committee for the National Strategy for Financial Literacy (composed of the Governor of the Reserve Bank of New Zealand, the Chair of the Securities Commission, the Chair of the Investment, Savings and Insurance Association, the Secretary for Education, the Associate Dean for Mâori and Pacific Development at the University of Auckland Business School, and the Retirement Commissioner) will now report to the Minister of Finance twice a year on progress in implementing the strategy.
As you may know, New Zealanders are also called “Kiwis.” The Kiwi is a flightless bird. As the story goes, Tane Mahuta, the lord of the forest, was surveying his ferny domain and became concerned that his children, the trees, were ill from being eaten by bugs. He called the birds together to ask if any might be prepared to eat the bugs, which would entail living on the dark, damp forest floor. The Kiwi put himself forward. As a reward it became the best-known and most-loved bird of all.
It is good to have such a symbol in a country so hard at work to improve financial literacy. Can they improve financial literacy? The answer I heard at the conference was: Yes, we can!
Protecting Consumers: Regulation is not Enough
This week, the Obama administration laid out a financial reform plan that included the creation of a Consumer Financial Protection Agency. This and the Credit CARD Act of 2009, which was passed in Congress last month, are important steps toward improving consumer protection in the marketplace—but without a renewed focus on promoting financial literacy and financial education programs, these initiatives will fall flat.
Financial literacy is an essential tool for consumers trying to navigate today’s world, where they engage in a myriad of financial transactions in an increasingly complex financial marketplace. Consumers require financial literacy to make decisions related to saving, retirement planning, managing credit card debt, and acquiring mortgage loans. The transition in recent decades from defined-benefit to defined-contribution pension plans has meant that the responsibility for securing late-life financial well-being is now placed on the shoulders of consumers. Just like the fundamental skills of reading and writing, financial literacy is a key ingredient for economic success.
Promoting “transparency, simplicity, fairness, accountability, and access,” as the White House report touts, is certainly an essential goal for any effective consumer regulatory regime. However, the mere provision of accurate and clear information is often inadequate to achieve good consumer decision-making. For instance, the Truth in Lending Act of 1968 was designed to protect borrowers by requiring the disclosure of critical loan terms, such as the annual percentage rate (APR); but in fact many consumers do not understand the workings of interest rates. Without knowledgeable consumers, transparency is not enough.
And lack of financial knowledge is alarmingly widespread. In a survey of Americans that Peter Tufano of Harvard Business School and I conducted with the market research firm TNS Global, we found strikingly low levels of financial knowledge across the U.S. population. Only one-third of respondents were able to apply concepts of interest compounding to everyday situations or understand the workings of credit cards. While many American families use credit cards and carry balances, only a minority of respondents knew that borrowing at an interest rate of 20 percent, compounded annually, will lead to a doubling of debt in fewer than five years. Lack of financial literacy is particularly severe in groups that are already financially vulnerable: women, the elderly, minorities, and those who are divorced or separated. And the less financially knowledgeable pay dearly for their ignorance: the credit card fees paid by a low-knowledge individual are 50 percent higher than those paid by an average cardholder.
The Credit CARD Act of 2009 makes important strides in that it requires credit card companies to include, in the billing statement, the number of months it will take a consumer to pay off the balance if he or she makes only the minimum monthly payment. Making it easier for consumers to process information is an effective way to aid in financial decision-making.
Simplification can be taken much further: an example is the auto-enrollment IRA, one of the initiatives that the White House pushes for in its report. Automatic enrollment in pensions has been a way to substantially increase workers’ participation in defined-contribution pensions. However, this can fall short of securing retirement needs. Workers who carry credit card balances should reduce their debt rather than enroll in a pension. And automatic enrollment in pensions and IRAs is not a substitute for retirement planning; workers need to ensure they are saving for a retirement that meets their needs and goals, an objective that a one-size-fits-all automatic enrollment program might not achieve.
Increasing regulation of consumer financial products and circumscribing the set of products available to consumers, either by requiring businesses to provide “plain vanilla” financial products or by outlawing products that are deemed manipulative or misleading, as the White House outlines in its report, can be effective in limiting the scope of financial mistakes that consumers can make. However, these measures are not enough to promote long-term financial well-being.
Consumers engage in such a varied and increasingly complex array of financial transactions that it is not feasible to circumscribe and regulate all possible actions in every possible financial area, nor is it desirable. Instead, policymakers need to equip consumers with enough financial knowledge to make them capable of effective financial decision-making.
To this end, the Obama administration’s plan deserves praise for recognizing the importance of promoting financial education: the White House report envisions the Consumer Financial Protection Agency taking a “leading role” in educating consumers about finance. Consumer protection is a two-way street: it requires not just regulation and oversight of businesses but also ensuring consumers are adequately equipped to confront the array of financial choices available to them. Navigating today’s financial markets is not unlike navigating busy roads: putting up more road signs, increasing patrolling, and restricting traffic can limit accidents but if people do not know how to drive, they are still going to crash. Promoting financial literacy needs to remain not just an afterthought, but a top priority.
Financial literacy is an essential tool for consumers trying to navigate today’s world, where they engage in a myriad of financial transactions in an increasingly complex financial marketplace. Consumers require financial literacy to make decisions related to saving, retirement planning, managing credit card debt, and acquiring mortgage loans. The transition in recent decades from defined-benefit to defined-contribution pension plans has meant that the responsibility for securing late-life financial well-being is now placed on the shoulders of consumers. Just like the fundamental skills of reading and writing, financial literacy is a key ingredient for economic success.
Promoting “transparency, simplicity, fairness, accountability, and access,” as the White House report touts, is certainly an essential goal for any effective consumer regulatory regime. However, the mere provision of accurate and clear information is often inadequate to achieve good consumer decision-making. For instance, the Truth in Lending Act of 1968 was designed to protect borrowers by requiring the disclosure of critical loan terms, such as the annual percentage rate (APR); but in fact many consumers do not understand the workings of interest rates. Without knowledgeable consumers, transparency is not enough.
And lack of financial knowledge is alarmingly widespread. In a survey of Americans that Peter Tufano of Harvard Business School and I conducted with the market research firm TNS Global, we found strikingly low levels of financial knowledge across the U.S. population. Only one-third of respondents were able to apply concepts of interest compounding to everyday situations or understand the workings of credit cards. While many American families use credit cards and carry balances, only a minority of respondents knew that borrowing at an interest rate of 20 percent, compounded annually, will lead to a doubling of debt in fewer than five years. Lack of financial literacy is particularly severe in groups that are already financially vulnerable: women, the elderly, minorities, and those who are divorced or separated. And the less financially knowledgeable pay dearly for their ignorance: the credit card fees paid by a low-knowledge individual are 50 percent higher than those paid by an average cardholder.
The Credit CARD Act of 2009 makes important strides in that it requires credit card companies to include, in the billing statement, the number of months it will take a consumer to pay off the balance if he or she makes only the minimum monthly payment. Making it easier for consumers to process information is an effective way to aid in financial decision-making.
Simplification can be taken much further: an example is the auto-enrollment IRA, one of the initiatives that the White House pushes for in its report. Automatic enrollment in pensions has been a way to substantially increase workers’ participation in defined-contribution pensions. However, this can fall short of securing retirement needs. Workers who carry credit card balances should reduce their debt rather than enroll in a pension. And automatic enrollment in pensions and IRAs is not a substitute for retirement planning; workers need to ensure they are saving for a retirement that meets their needs and goals, an objective that a one-size-fits-all automatic enrollment program might not achieve.
Increasing regulation of consumer financial products and circumscribing the set of products available to consumers, either by requiring businesses to provide “plain vanilla” financial products or by outlawing products that are deemed manipulative or misleading, as the White House outlines in its report, can be effective in limiting the scope of financial mistakes that consumers can make. However, these measures are not enough to promote long-term financial well-being.
Consumers engage in such a varied and increasingly complex array of financial transactions that it is not feasible to circumscribe and regulate all possible actions in every possible financial area, nor is it desirable. Instead, policymakers need to equip consumers with enough financial knowledge to make them capable of effective financial decision-making.
To this end, the Obama administration’s plan deserves praise for recognizing the importance of promoting financial education: the White House report envisions the Consumer Financial Protection Agency taking a “leading role” in educating consumers about finance. Consumer protection is a two-way street: it requires not just regulation and oversight of businesses but also ensuring consumers are adequately equipped to confront the array of financial choices available to them. Navigating today’s financial markets is not unlike navigating busy roads: putting up more road signs, increasing patrolling, and restricting traffic can limit accidents but if people do not know how to drive, they are still going to crash. Promoting financial literacy needs to remain not just an afterthought, but a top priority.
Are You Debt Literate?
Individuals need financial skills—perhaps more now than ever before. Financial competence has become more essential as financial markets offer more complex choices and as the responsibility for saving and investing for the future has shifted from government and employers to individuals. As the credit crisis shows, borrowing decisions are also critical. Rapid growth in household debt and its link to the current financial crisis raises the question of whether lack of financial knowledge led individuals to take out mortgages and incur credit card debt they could not afford.
To assess how much knowledge individuals have with respect to debt, Peter Tufano of Harvard Business School and I designed and fielded a survey focused specifically on debt literacy, which is an important component of overall financial literacy. (The survey was conducted in partnership with the commercial market research firm Taylor Nelson Sofres [TNS] Global. It was fielded in November 2007, with data collected via phone interviews with a representative sample of 1,000 U.S. residents.) “Debt literacy” refers to the ability to make simple decisions regarding debt contracts, applying basic knowledge about interest compounding to everyday financial choices.
Our approach to measuring debt literacy has two components. First, we asked participants to judge, or “self-report,” their financial knowledge. Second, we devised questions to assess key debt literacy concepts, such as the power of interest compounding. These questions, measuring actual financial knowledge, can be solved with simple reasoning and do not require a calculator. Take a moment to answer the questions below, then compare your results to those we obtained in the survey.
Self-reported financial knowledge:
On a scale from 1 to 7, where 1 means very low and 7 means very high, how would you assess your overall financial knowledge?
Actual financial knowledge:
A) 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?
(i) 2 years;
(ii) Less than 5 years;
(iii) 5 to 10 years;
(iv) More than 10 years;
(v) Do not know.
(vi) Prefer not to answer.
B) 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?
(i) Less than 5 years;
(ii) Between 5 and 10 years;
(iii) Between 10 and 15 years;
(iv) Never, you will continue to be in debt;
(v) Do not know;
(vi) Prefer not to answer.
C) You purchase an appliance which costs $1,000. To pay for this appliance, you are given the following two options: a) Pay 12 monthly installments of $100 each; b) Borrow at a 20% annual interest rate and pay back $1,200 a year from now. Which is the more advantageous offer?
(i) Option (a);
(ii) Option (b);
(iii) They are the same;
(iv) Do not know;
(v) Prefer not to answer.
Analysis of responses to these questions is not heartening. We learn that the large majority of Americans do not know about the power of interest compounding, do not realize that one can never eliminate credit card debt by making minimum payments equal to the interest payments on the debt, and do not understand the time value of money. On question A, only about 36% of respondents knew that it would take less than 5 years for debt to double if one were to borrow at an interest rate of 20%. Even though about 80% of individuals have credit cards (and usually more than one card!) and have to decide frequently whether to pay off the card or carry a balance, only 35% knew the correct answer to question B—that one can never eliminate credit card debt by making minimum payments equal to the interest payments on the debt. A meager 7% of respondents chose the most advantageous option of those presented in question C: to buy an appliance and pay $1,200 a year from now. Many preferred to give money early to the retailer. Moreover, as many as 40% of respondents indicated that paying in one lump sum or in 12 monthly payments is the same option, thus overlooking the time value of money.
Notwithstanding the poor scores on these questions, when assessing their own financial knowledge, most respondents picked values of 4 or above: in other words, most people thought they were above the mean in their financial knowledge!
This is only part of the research we have been able to do on these data, but the findings are worrisome. We are confronted every day with decisions about how to shop, how to pay for what we buy, how to manage debt. The results of this study show that Americans are not as debt literate as we think we are. Knowing what we do not know can be a first step in acquiring the knowledge we need in order to make better financial decisions.
To assess how much knowledge individuals have with respect to debt, Peter Tufano of Harvard Business School and I designed and fielded a survey focused specifically on debt literacy, which is an important component of overall financial literacy. (The survey was conducted in partnership with the commercial market research firm Taylor Nelson Sofres [TNS] Global. It was fielded in November 2007, with data collected via phone interviews with a representative sample of 1,000 U.S. residents.) “Debt literacy” refers to the ability to make simple decisions regarding debt contracts, applying basic knowledge about interest compounding to everyday financial choices.
Our approach to measuring debt literacy has two components. First, we asked participants to judge, or “self-report,” their financial knowledge. Second, we devised questions to assess key debt literacy concepts, such as the power of interest compounding. These questions, measuring actual financial knowledge, can be solved with simple reasoning and do not require a calculator. Take a moment to answer the questions below, then compare your results to those we obtained in the survey.
Self-reported financial knowledge:
On a scale from 1 to 7, where 1 means very low and 7 means very high, how would you assess your overall financial knowledge?
Actual financial knowledge:
A) 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?
(i) 2 years;
(ii) Less than 5 years;
(iii) 5 to 10 years;
(iv) More than 10 years;
(v) Do not know.
(vi) Prefer not to answer.
B) 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?
(i) Less than 5 years;
(ii) Between 5 and 10 years;
(iii) Between 10 and 15 years;
(iv) Never, you will continue to be in debt;
(v) Do not know;
(vi) Prefer not to answer.
C) You purchase an appliance which costs $1,000. To pay for this appliance, you are given the following two options: a) Pay 12 monthly installments of $100 each; b) Borrow at a 20% annual interest rate and pay back $1,200 a year from now. Which is the more advantageous offer?
(i) Option (a);
(ii) Option (b);
(iii) They are the same;
(iv) Do not know;
(v) Prefer not to answer.
Analysis of responses to these questions is not heartening. We learn that the large majority of Americans do not know about the power of interest compounding, do not realize that one can never eliminate credit card debt by making minimum payments equal to the interest payments on the debt, and do not understand the time value of money. On question A, only about 36% of respondents knew that it would take less than 5 years for debt to double if one were to borrow at an interest rate of 20%. Even though about 80% of individuals have credit cards (and usually more than one card!) and have to decide frequently whether to pay off the card or carry a balance, only 35% knew the correct answer to question B—that one can never eliminate credit card debt by making minimum payments equal to the interest payments on the debt. A meager 7% of respondents chose the most advantageous option of those presented in question C: to buy an appliance and pay $1,200 a year from now. Many preferred to give money early to the retailer. Moreover, as many as 40% of respondents indicated that paying in one lump sum or in 12 monthly payments is the same option, thus overlooking the time value of money.
Notwithstanding the poor scores on these questions, when assessing their own financial knowledge, most respondents picked values of 4 or above: in other words, most people thought they were above the mean in their financial knowledge!
This is only part of the research we have been able to do on these data, but the findings are worrisome. We are confronted every day with decisions about how to shop, how to pay for what we buy, how to manage debt. The results of this study show that Americans are not as debt literate as we think we are. Knowing what we do not know can be a first step in acquiring the knowledge we need in order to make better financial decisions.
Women and Finance
Tomorrow is Mother’s Day and I want to celebrate it by writing about women. As I have documented in previous posts, there is a substantial gender difference between women and men when it comes to financial literacy: women know much less about economics and finance than men. This is true not only among older cohorts but also among younger generations. Moreover, it holds true in many of the countries in which I have studied financial literacy, including Italy, Germany, the Netherlands, and Ireland. This is not good news for anyone because women often have to fend for themselves in an increasingly complex financial world: the divorce rate is much higher than in the past, single motherhood is very high in certain demographic groups, and greater longevity for women calls for more retirement savings for women than for men. And women may be most concerned about children’s education and how to help aging parents. Being a financially savvy woman involves making difficult decisions that have important financial implications.
Despite grim statistics about financial literacy among women, in my view, the evidence about how women fare in financial decision making is far from unfavorable. Research shows that women who hold stocks trade them less frequently than men, thereby paying fewer fees and transaction costs and ending up with more wealth. Women tend to hold more conservative portfolios, and in the current environment this has worked out well. Women are also less likely to be victims of scams that seem to be disproportionately perpetrated against white men.
One reason that women might be better financial decision makers, despite displaying, in general, lower literacy than men, is that women know what they do not know. In studies of financial literacy in which participants were asked to rank their level of financial knowledge prior to being given a set of problems to measure their actual level of financial literacy, women’s low self-evaluations were fairly consistently correlated with fair to poor performance on the literacy problems. This demonstrated lack of overconfidence may prove helpful in financial decision making and in avoiding financial mistakes, and this awareness may help women to take action. As several studies about financial education show, seminars and education programs are disproportionately attended by female participants. Moreover, it is primarily women who report being affected by those programs.
A project I did here at Dartmouth College confirmed many of the findings of larger surveys and data sets. The women I interviewed consistently spoke of finance with humility and considered themselves unsophisticated investors. Yet I was struck by how articulate women were in describing their financial needs, how much they had thought about financial matters, and not only how much they cared about the financial security of their loved ones but also the provisions they made to that end.
In my view, finance is an ideal field for women. The fact that women make decisions with the well being of others in mind, that they steer clear of excessive risk, and that they do not consider themselves “financial geniuses” and “financial wizards” are characteristics that have not been fully exploited. Interestingly, women are often brought in when there is a financial crisis and confidence needs to be restored. For example, after a less than spotless record, the Securities and Exchange Commission is now headed by a woman, and its Office of Investor Education and Advocacy is also headed by a woman. Perhaps one of the ways to ensure the smooth functioning of financial institutions and contracts is to have more women in charge.
On a personal note, my mother taught me a lot about finance, and so in my family, the passion for this topic has been transmitted from mother to daughter. Happy Mother’s Day!
Despite grim statistics about financial literacy among women, in my view, the evidence about how women fare in financial decision making is far from unfavorable. Research shows that women who hold stocks trade them less frequently than men, thereby paying fewer fees and transaction costs and ending up with more wealth. Women tend to hold more conservative portfolios, and in the current environment this has worked out well. Women are also less likely to be victims of scams that seem to be disproportionately perpetrated against white men.
One reason that women might be better financial decision makers, despite displaying, in general, lower literacy than men, is that women know what they do not know. In studies of financial literacy in which participants were asked to rank their level of financial knowledge prior to being given a set of problems to measure their actual level of financial literacy, women’s low self-evaluations were fairly consistently correlated with fair to poor performance on the literacy problems. This demonstrated lack of overconfidence may prove helpful in financial decision making and in avoiding financial mistakes, and this awareness may help women to take action. As several studies about financial education show, seminars and education programs are disproportionately attended by female participants. Moreover, it is primarily women who report being affected by those programs.
A project I did here at Dartmouth College confirmed many of the findings of larger surveys and data sets. The women I interviewed consistently spoke of finance with humility and considered themselves unsophisticated investors. Yet I was struck by how articulate women were in describing their financial needs, how much they had thought about financial matters, and not only how much they cared about the financial security of their loved ones but also the provisions they made to that end.
In my view, finance is an ideal field for women. The fact that women make decisions with the well being of others in mind, that they steer clear of excessive risk, and that they do not consider themselves “financial geniuses” and “financial wizards” are characteristics that have not been fully exploited. Interestingly, women are often brought in when there is a financial crisis and confidence needs to be restored. For example, after a less than spotless record, the Securities and Exchange Commission is now headed by a woman, and its Office of Investor Education and Advocacy is also headed by a woman. Perhaps one of the ways to ensure the smooth functioning of financial institutions and contracts is to have more women in charge.
On a personal note, my mother taught me a lot about finance, and so in my family, the passion for this topic has been transmitted from mother to daughter. Happy Mother’s Day!
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