“ Household Saving Behavior: The Roles of Literacy, Information and Financial Education Programs”

1. “Household Saving Behavior: The Roles of Literacy, Information and Financial Education Programs” by Annamaria Lusardi (Dartmouth College & Harvard Business School) Federal Reserve Bank of Cleveland April 25, 2008

2. Motivation • Major changes in the pension landscape • Shift from DB to DC pensions • More complex financial products • ARM mortgages • More choice • Proliferation of mutual funds

3. Questions • How well equipped are individuals to make saving decisions? Not well equipped! • How can we promote saving and pension participation? Automatic enrollment Simplification of saving decisions Planning aids

4. Theoretical framework Life-cycle/permanent income model posits that consumers: • Save and consume given a life-time budget constraint • Look ahead & plan for the future • Know economics principles (e.g. present discounted values, inflation)

5. A Famous Permanent Income Consumer • When he won the Nobel prize in Economics, Milton Friedman was asked how he would spend the prize money. • He replied: “I have already spent most of it”

6. Four pieces of empirical evidence • Lack of retirement planning • Lack of information about components of a saving plan • Lack of financial literacy • Lack of financial advice from experts

7. Yes (31.1%) No (67.8%) Yes (58.4%) No (32.0%) More or Less (9.0%) Always (37.7%) Mostly (50.0%) Rarely 8% Never 2.6% Retirement Planning (50+) Tried to plan Have you ever tried to figure out how much your household would need to save for retirement? Developed a plan Have you developed a plan for retirement saving? Stuck to the plan How often have you been able to stick to the plan?

8. Prevalence of retirement planners

9. Planners accumulate more wealth Median Net Worth

10. Information about pensions and SS • Pensions and SS wealth account for 50% of total net worth for median household • Half of older workers (50+) do not know their pension • They do not even know which pension they have (Gustman, Steinmeier, Tabatabai 2007) • Much less than 50% of older workers know about SS • Only 18% of all workers know the correct age at which they are entitled to full SS benefits

11. Financial literacy • Several surveys have documented financial illiteracy (NCEE, Jump$tart Coalition, Survey of Consumers) • Few surveys have information about literacy and financial behavior • 2004 HRS module on planning and literacy (now NLSY, Rand ALP, Dutch Central Bank have a similar module)

12. Measuring financial literacy (TNS survey) 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

13. Measuring financial literacy (TNS survey) 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

14. Measuring financial literacy (TNS survey) 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? • Option (a) • Option (b) • They are the same • Do not know • Prefer not to answer

15. Financial advice • Most individuals rely on family and friends • Particularly those with low literacy • Even “planners” use simple planning tools and some use no tools at all! • Many workers state they would be reluctant to follow suggestions of advisors (2007 Retirement Confidence Survey)

16. Literacy↓Planning↓Wealth

17. Takeway points • Financial literacy cannot be taken for granted. • Individuals are grossly un-informed • Literacy and planning have implications for saving behavior

18. Three initiatives to promote saving and participation to pensions • Financial education programs • Automatic enrollment • Simplification of saving decisions

19. Financial education programs • Many employers offer financial education programs/retirement seminars • Those who attend are not a random group of workers • Programs are “one-time” “one-size-fits all”

21. Automatic enrollment into pensions • Very successful to foster pension participation • Workers do not opt out in the short-medium run • Workers stick to the contribution rate and asset allocation chosen by employers “The power of suggestions?”

22. New Ways to Make People Save (Lusardi, Keller and Keller) • Use surveys, focus groups and in-depth interviews to understand barriers to saving and participation to pensions • Developed a planning aid • Distributed to new hires at a non-for-profit institution

24. 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! 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!

25. Program Effectiveness

26. A few more ideas • Simplification of saving decisions can be effective and is often cheap • “Suggestions” from experts • Information/marketing campaigns • “Financial driving license”

27. Want to read more? • More papers are available on my web site: http://www.dartmouth.edu/~alusardi/ • I write a blog on financial literacy: http://annalusardi.blogspot.com/ • My new book: Overcoming the saving slump: How to increase the effectiveness of financial education and saving programs, University of Chicago Press will be out in the Fall 2008.