Empowering women

Today is International Women’s Day and I want to write a blog about a topic that has occupied a lot of my research in the past few years: gender differences in financial literacy. Starting from the very first paper I wrote on financial literacy, I found over and over that women were less likely to answer correctly to financial literacy questions. I did not focus on that finding until more recently, when I performed an international comparison of financial literacy. I found the same finding in as many as eight countries: women were less likely to answer correctly to the same financial literacy questions I had asked in the United States. And strikingly, in countries as different as Sweden, Italy, Japan, Russia, the Netherlands, New Zealand, and Germany, women answered in the same way to the financial literacy questions: they said they “did not know” the answer to the questions (the paper is posted on-line at: http://www.financialliteracyfocus.org/alusardi/Papers/FLAT/FLat_World.pdf).

I remember sitting in front of my computer and looking at the papers that became part of a special issue of the Journal of Pension Economics and Financeand comparing the tables across so many countries. It was so clear, so stunning, so evident; yet I had not seen when I considered the data from one country only. It took that comparison, which was done for a completely different set of reasons, to unveil that striking gender difference in financial literacy.

The finding can be interpreted in different ways and this is what my current research is exploring. First, women may simply be aware of their lack of knowledge and they are willing to admit it. This is consistent with some of my other data that show that women tend to give themselves low rating when assessing their financial knowledge. So, women know that “they do not know.” This may, in fact, be the first step to acquire or want to acquire knowledge. Second, women may have financial knowledge but are less confident in their knowledge and are less willing to guess or choose an answer when they are not sure it is the correct one. Some may view this attitude as a drawback, but I see it as a potential advantage. It takes gut to admit one does not know or does not know enough. Humility in the world of finance may give better results than being bold, assertive, and.. well wrong. In case you did not notice, we have experienced a lot of that in the past few years. Third, women may be less comfortable with the jargon that is used in finance. We assume that people know the technical financial terms, few bother to explain them, but most people do not have a clue about what inflation, real interest rates, and risk even mean, and women are willing to say “I do not know.”

What makes this result so important is that women may be the ideal target for financial education programs. Why attend such a program when one thinks he/she knows (according to my findings, only one third of the population has a very basic knowledge of financial literacy; believe me, that program is so much needed!). Many studies have found that women are not only more likely to attend financial education programs (in the program that I myself run, the large majority of participants were women), but women are also more likely to change their behavior after attending the program.

In summary, empowering women with the financial knowledge, the confidence, the terms that are used in finance could be a powerful tool; women may willing to use it. Happy International Women’s Day.

Vote for financial education

The Economist posted a recent “Where Do you Stand?” feature that goes like this:

Here is a question: Suppose you had $100 in a savings account that paid an interest rate of 2% a year. If you leave the money in the account, how much would you have accumulated after five years: more than $102, exactly $102, or less than $102. . . . A survey found that only half of Americans aged over 50 gave the correct answer. . . .  The solution seems obvious: provide more financial education. . . . A survey by the Federal Reserve Bank of Cleveland reported that: 'Unfortunately, we do not find conclusive evidence that, in general, financial education programmes do lead to greater financial knowledge and ultimately to better financial behaviour.'  So should we give up on financial education? Please vote.

A friend had forwarded me the link to this feature (http://www.economist.com/economist-asks/should-we-give-up-financial-education), and when I read it, I had a good laugh. What a way to frame a question: Here is some medicine that does not work. Would you take it? Please vote, because we are really interested in publishing your opinion.

I was nevertheless very pleased with the feature. The question that was cited was one that I designed (with Olivia Mitchell) for the Health and Retirement Study, a US survey that covers respondents 50 and older. However, it appears that whoever authored the feature forgot to read my paper because the statistic that is reported is, in fact, wrong. Not half but 67% of older Americans gave the correct answer. This does not mean that financial literacy is high. Nevertheless, it is good to check sources.
I went and searched for the Federal Reserve Bank of Cleveland survey to check it out. The link to the survey report is noted below. I mean this in a friendly way, but it’s worth noting that the Economist’s citation is from an unpublished paper written five years ago and covering only a handful of financial education programs. While the title of the paper may look attractive, I am not sure I would consider it the authoritative source on financial education. (I Googled the authors and it appears they have not written any other papers on this topic nor published that paper.) There are more recent and published papers, some of them pointing to the same result. I would have quoted those.

I voted, of course. (In case you want to know, I voted that we should not give up on financial education; I have read a lot more papers on financial education than the one reported here.) After casting my vote, I was able to see percentage of votes in favor of and opposing financial education. Even before seeing the result, however, I could have made an educated guess as to the outcome. The ING Financial Competence Survey asked “Do you think financial education should be taught in school?” In all of the 11 countries that were surveyed, about 90% of respondents answered yes (the report’s link is noted below). Notably the UK ranked second, with 94% of respondents answering yes. After I voted on the Economist’s question, I could see that 84% had voted in favor of financial education.

By the way, methodologically it is not very useful to ask about choices without mentioning costs. Decisions depend both on preferences and budget constraints. Would I give up cable? No. Would I give up a land-line phone? No. Would I give up on financial education? No. Why should we give up on anything without knowing the costs of doing so? We cannot learn much from asking these types of questions. It is Economics 101. 

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1118485
http://www.ezonomics.com/ing_international_survey/financial_competence/

A tribute to Ray Lewis

Tomorrow will likely be the last game where we will see Ray Lewis play, the unforgettable number 52, who sometimes seems to fly. Even for a person like me, born and raised in Italy, with little knowledge of American football until some years ago, Ray Lewis represents what is special about the game.
 

Ray Lewis has been considered one of the best defense players, a linebacker who can put up an insurmountable barrier for the rival team, who can tackle like no one else. Watching him play, you forget he is often one of the oldest players on the field, as his age is not apparent from the way he runs, jumps, and catches. But perhaps because he has played for so many years, he knows spectators are there to see a good game, and he makes the game special. On the field, he dances, he screams, he prays, but in particular, he gives it his all.

What is special about Ray Lewis is not just his talent, but his passion, his motivation, his iron will. We have seen him motivate the Ravens before a game and console them after a loss. We can hear his screams when he comes onto the field, when he goes back into the locker room. We can hear the passion in his voice.

What I like the most about Ray is the message he has been delivering throughout the years. You want success? You have to work hard, very hard. You have to stay focused; do not take your eye off what you are doing. You have got to practice, get better every day. And most importantly, do not give up, never give up.

It is a message I like to tell my students (including the MBAs), my nieces (even if they do not play football), and, sometimes, myself, too. It turns out that Ray Lewis is also passionate about financial literacy, and about promoting financial literacy among underprivileged children.  Imagine combining passion with knowledge: what a combination that would be!

But tomorrow is a big game, an ending game, it is Super Bowl. Good luck tomorrow, and thank you, Ray Lewis!

Financial Literacy or Financial Capability?

There has been a lot of debate about the definition of financial literacy and whether policy and research should focus on financial literacy or on financial capability. Many institutions have opted for the latter arguing it is more encompassing and we should focus on behavior. I am going to argue in favor of financial literacy, for three main reasons.

First, nobody knows what financial capability really means. What are the set of behaviors that make a person financially capable? Is it that a person save? Well, there are times in the life cycle when we should borrow rather than save. Is it that a person is always paying credit cards in full? There are times when liquidity constraints are tight and borrowing on credit cards is appropriate. Is it that a person has a bank account? A bank account may be not practical if the bank is 50 miles away (think rural areas) and one cannot maintain a large enough balance to avoid paying a monthly fee. I could go on and on. The point I want to make here is that what is “good” behavior or, as we economists like to call it, “optimal” behavior, depends on a lot of factors, making it very hard to come up with a set of behavioral guidelines that are applicable to everyone. Moreover and most importantly, behavior depends on preferences in addition to economic circumstances, and this makes it very hard to judge what “good” behavior is and to recommend what people “should” do. For example, I should not invest in education if my passion is to tinker with tech devices in my garage, particularly if those devices one day become known as Macintosh computers. When policy tries to dictate behaviors, the risk of becoming paternalistic is very high. And mistakes have resulted from the trumpeting of “good behavior,” for example, the recommendation that everyone should own a house. (We saw what a good idea that was!)

The financial literacy approach recognizes that it is the individual who is in charge of making decisions and is the one we are putting at the center of the attention. It also recognizes that people are different and that one size is very unlikely to fit all, contrary to many recommendations that advocate for what we all “should” do. Empowering people may be a modest step, but even ice cream comes in many flavors (Italian gelato even more and very good too!), so it is not clear why we should have a single-flavor recommendation. We can choose according to our tastes.

Second, knowledge is power. Rather than focusing on behavior (whose optimality is in the eye of the beholder), financial literacy makes us focus on the inputs that shape behavior. One of those inputs is knowledge. We require and want knowledge in almost every field I can think of that requires some judgment, from driving a car to working in a factory to extracting a tooth (try that on my niece Giorgia and you will get a lesson!). The world has changed and we require new skills to be able to succeed in today’s society. I love the definition that the Programme for International Student Assessment (PISA) has used to measure students’ knowledge: “Are students well prepared for future challenges? Can they analyze, reason and communicate effectively? Do they have the capacity to continue learning throughout life? The OECD PISA answers these questions and more, through its surveys of 15-year-olds in the principal industrialized countries. Every three years, it assesses how well students near the end of compulsory education have acquired some of the knowledge and skills essential for full participation in society.” This is not a definition of financial literacy, but it could well be as it articulates what people need today to “participate in society.” Also, note that we are able to articulate what a financially literate person should know. As I have mentioned in a previous post, we have just finished writing a set of national standards, which will be soon be available from the Council for Economic Education.

Third, simply stated, the reason I favor financial literacy is because it is easy to understand, we know what we are talking about, and it is the term that successful organizations have used in describing their programs. One of the most successful countries with regards to financial literacy, i.e., New Zealand, has the “Commission for Financial Literacy and Retirement Income.” The OECD as well, which has been a pioneer in this field, is all about financial literacy and financial education programs.

Let me close by saying that we need to be humble when it comes to guiding individuals via policy and information. We need to respect people’s unique characteristics and their differences, but we must have the audacity to aim high, believe that we can empower people to make good decisions. In my view, this is what financial literacy is all about.

A national standard for financial literacy

I spent a lot of time on a beach in Italy in August building sand castles with my niece Giorgia. It was not an easy operation and required a lot of time and patience, particularly in my case, given that as I finished one part of a castle and started building another, the first part would collapse. But since it takes so much time and patience to build a sand castle, I had a lot of time to reflect on things that had been on my mind.

I thought a lot about the ideal content for a course in financial literacy. I had recently finished teaching just such a course (see my previous blog post), but it was a crash course with only four 3-hour classes. While it’s possible to pack a lot into those hours, a full-length course would provide much more time. What else could be added to such a course? What are the financial literacy topics we “must” teach?

When I started designing my short course, I searched for syllabi on the web. In browsing materials, including what is covered in high school classes, I was struck by how much material is out there and how many different courses there are and the variety of topics these courses cover. I also looked at books on personal finance (and it is a jungle out there—everybody, including people who have gone bankrupt, wants to tell their story and teach you how to be financially savvy). Some of the material I found seemed very good, some covered topics I thought would better be in a history course (for example, how to balance a checkbook), and some material was offered in the way you’d teach basic cooking or household plumbing—a lot of how-to’s that are supposed to make people smart.

I was also struck by how much courses differed, even though they were all supposed to cover financial literacy. Part of this is a reflection of the fact that we do not yet have a definition of what financial literacy is. This is a topic I will come back to in future posts, but differences in curricula across schools and states reflect the lack of a national standard on financial literacy.

I am, thus, very happy to report that the Council for Economic Education (CEE) has put together a team of experts to address this gap in the national standards. As I have mentioned in previous posts, financial literacy is no different in Vermont than it is in California, and it is not clear why we have so many different curricula in different states. A group of experts coordinated by the CEE will work together to create a single National Standard for Personal Finance. I am delighted to have been asked to participate in that work and very happy that many of the stakeholders involved with financial education are part of the teams of experts—not just academics but also high school teachers, representatives of not for profit institutions working to promote financial literacy, and so on.

My contribution to this initiative is twofold. First, I want to make sure that the financial literacy topics that are covered are rigorous and that we help students be decision makers. We need to give them tools to understand a world that continues to change. And we need to stay away from teaching rules, such as “you should save 3% of your salary”; teaching rules is not teaching, it is preaching. I also want to make sure we can use and incorporate some of the work done by the group of financial literacy experts in the Programme of International Student Assessment (PISA), which had the ambitious task of measuring financial literacy of high school age students across countries. The world is global and our students have to conform to standards not just in the United States but across the world.

This is the thinking I was doing while developing my sand castle building skills. And while I was admiring my finished work one afternoon, smiling with satisfaction, Giorgia—the little rascal—looked at my many hours of work and declared that my caste looked like “un gigante zoppo.” ( For those of you who don’t speak Italian, she said my sand castle looked like “a lame giant.”)

So, here are my three reflections:

1) Having national standards for personal finance will simplify the work of educators and help ensure the teaching of common concepts so that financial literacy is covered in a similar way across states and countries.

2) A unified national standard will likely result in the teaching of more rigorous concepts than we currently see in existing courses.

3) Never put a five-year-old on a team of judges at a sand castle building contest.

A new course in financial literacy

I was asked to teach a quick course to our new batch of Global MBA (GMBA) students. The idea was to refresh their math and economics skills, and thus it was named “Jumpstart.” I resisted doing it with all my strength. The course was scheduled for the first week of August and I had my sandcastle-building supplies together and was ready to head to the Italian beaches. But the faculty dean knows my weaknesses and told me I could use the course to teach financial literacy. So, I put aside my swim suit and sun block and started designing and preparing for this short course (in case you were wondering why I have not been writing my blog. . . ).

As you can imagine, the challenge was what to teach to students who come from all over the world and who have different backgrounds, in particular now that our dean is set to admit only students who want to change the world. (I am not kidding, and he says this when he meets the students; it is impossible not to like him.) But I discovered that this is an ideal group to teach financial literacy to; after all, this is a topic based on rigorous and universal concepts (interest compounding is the same in the US as it is in China), and I do not have to hold back the math.

The course was structured in four classes of three hours each. In case you think this allows for little time, let me assure you that there is a lot you can teach in three hours; the difficult part was choosing what is most important. I structured the course to cover the following topics: 1) understanding interest compounding and the time value of money; 2) understanding probabilities and risk; 3) essential macro concepts; 4) applications to personal finance and macro problems.

I have had many discussions at conferences with people who assert that one cannot teach (and people cannot learn) interest compounding. I cannot disagree more. This is a fundamental concept and is at the basis of every financial decision. If there was one thing, and one thing only, that I could teach in a course, this is what I would choose. It is only by appreciating the power of interest compounding that one learns the importance of starting to save early in life or of being careful when borrowing, given that interest rates charged on borrowing are often much higher than interest rates earned on assets. Most importantly, because our financial resources are spread over time, we need to be able to understand that a dollar tomorrow is worth less than a dollar today, and how much less depends on whether the interest rate is high or low. We cannot sum values due at different points in time (for example, our earnings each year); we need to discount future values to the present, and we do so simply by applying the formula of interest compounding. Because financial decisions are essentially about shifting resources over time, we need to have a basic understanding of interest compounding.

As an aside, I would like to remind those who think that people cannot understand or learn interest compounding that we let students take up large loans to pay for their education and that we have put people in charge of saving for their retirement. It is scary to think that people can and do make these sorts of decisions without understanding interest compounding; if we do not teach them, we all are going to pay for it. I told this to the GMBA students, too, since they are charged with the small task of changing the world. Giving people an understanding of this concept seems to bring results. I will not know what my students end up doing with this knowledge yet, but according to a recent paper describing a field experiment in China, teaching people living in rural areas about interest compounding increased their pension contributions by 40% . How about that! (The link to the paper is at the end of this post).

Teaching the concept of risk was the most difficult part of the course. In the many surveys I have conducted to assess financial literacy across countries, questions covering the concept of risk always get the smallest percentage of correct answers. This is why I covered this topic in the second rather than the first class and why I provided many examples—some of which involved dealing with pirates, just to remind students that finance has a wide range of applications. Like interest compounding, risk is an essential concept; most financial decisions have to do with the future, but the future is uncertain. Thus, we need to reason in probabilistic ways. For example my income next year may be, say, $50,000, but I also face a probability (about 8%) that I will be unemployed; and, while the interest rate on my bond is set at 5% for next year, there is also a chance that the issuer will default (yep, and these issuers can be governments…). It is critically important not only to grasp the concept of risk but also to know how to deal with it. While we all face risk, there are ways we can reduce it and minimize its impact. In fact, an important component of personal finance is not only to grow assets (using the power of interest compounding) but also to protect those assets (using the concept of risk diversification). One of the applications the students most enjoyed were the lotteries; they may be fun, but if you plan to become rich by winning the lottery, you are in dire need of taking this course!

And speaking of the future, one thing that changes over time is prices, for example, the prices of the goods we normally buy (this is what the Consumer Price Index, or CPI, measures). This is a bummer, because it means that if our money does not grow, our dollar today will buy less tomorrow. In other words, to make financial decisions we need to understand inflation and what inflation does to our purchasing power. This is why in the third lecture I turned to macroeconomics, and we studied inflation and the difference between nominal and real interest rates. It was also a lecture designed to teach the critical role of central banks and why we need these institutions in the economy. I hope my students have a better understanding now of the Herculean job that Chairman Bernanke and President Draghi have at the helms of the US Federal Reserve and the European Central Bank, respectively. Given that, by this time, students knew about interest compounding, we also covered economic growth (it is the same formula!) and calculated when China’s economy is expected to surpass that of the US. Write me a note if you, too, want to know this.

In the final class, we covered many applications that were also sprinkled through the other lectures. Armed with the knowledge of the fundamental concepts we had covered, there were almost no decisions we could not attack! For example, we calculated the return on the investment in an MBA degree and whether (and when) it makes sense to leave your job, pack your suitcases, and head to school again. We looked at methods of payment and when it is advantageous to lease versus pay cash and the implicit interest rates in a stream of payments required, for example, when paying back a loan. We calculated the gain from exploiting employers’ retirement saving matches and the return on contributions to Social Security under different longevity scenarios. Most importantly, we calculated what it takes to become a millionaire and discovered it is not overly complicated (again, you need to take this course if you want to know).

There were several rewards in teaching this course. First, I could finally pack my bags and head to the beach in mid August, when the sun in Italy was still burning. Second, I felt like I was making a difference—as my dean would say— if not in people’s lives, at least in their financial decisions. One student sent me a thank you note at the end of the course that was very touching and inspiring. So inspiring, in fact, that I plan to keep it in my desk drawer and read it whenever I return from conferences that discuss the futility of teaching interest compounding and the ineffectiveness of financial literacy.

For more information, see Changcheng Song (2012), "Financial illiteracy and pension contributions: A field experiment on compound interest in China."
http://www.baf.cuhk.edu.hk/research-activities/research-seminar-detaill.asp?DID=3&id=1220

The Power of Ideas

I was invited to attend the second meeting of CGI (Clinton Global Initiative) America, held in Chicago in June. I was part of the new Financial Inclusion working group that was added to the meeting this year. For those who are not familiar with CGI, it was established by former president Bill Clinton in 2011 to address economic recovery in the United States. As their web page states, “CGI America brings together leaders in business, government, and civil society to generate and implement Commitments to Action that create jobs, stimulate economic growth, foster innovation, and support workforce development in the United States.” I witnessed the importance of three principles at the meeting: (1) the power of ideas; (2) the power of translating ideas into action; and (3) the power of leadership.

The power of ideas. While the meeting had some short presentations and discussion leadership, a large amount of time was dedicated to brainstorming and generating ideas. The group at my table was a very heterogeneous bunch in terms of age, sectors of activity, and reasons for attendance. I ended up sitting near a very young man who I assumed was a college student (though he looked more like a high school student). Through my clumsy attempts to make conversation, I learned that he was 21, had finished college already, and was the founder and CEO of an education firm. It was then that I realized I might well be the dumbest person in the room. Once the discussion started flowing, it zigzagged around for hours, but several strong ideas came together and the moderator articulated them so well at the end of the discussion that it was as if many pieces of a puzzle had come together. It is, of course, part of my daily job to generate ideas, but it was particularly powerful to sit down with a group of people who have just met and are mostly non-academics and ponder and discuss ideas.

The power of translating ideas into action. As every entrepreneur knows, ideas are not worth much if they are not translated into action. A good part of the meeting was devoted to the creation of “commitments to action.” Some of these commitments originated at the meeting itself. Others had originated earlier but were announced and pledged at the meeting. Still others are in the making, as meeting attendees are now connected, and the organizers have found ways to keep participants involved in the discussions post-meeting. We heard success stories at the meeting—how some CGI groups, small and large, have been able to address specific problems. I was again struck by the many differences among the individuals—and the institutions and businesses they represented—who came on stage to speak about what they did. We had city mayors, government officials, journalists, CEOs, entrepreneurs, and young people (like the one who sat next to me) who described how they would commit to specific projects. And, as one can read from the report linked at the end of this page, from these commitments, new jobs were created and people gained access to training, to capital, and to financial services.

The power of leadership. What was most remarkable at the meeting was to see the former president reflect on the state of the economy; listen attentively to the guests he had on stage; and shake hands, hug, and thank the people who made commitments. I was impressed by his focus on education: the hard questions he asked about it and the people he brought on stage to discuss it. Neil Tyson, the charismatic director of the Hayden Planetarium at the Museum of National History, shouted: “When was the last time we longed? I have to go back to the 1960s.… The moon was in reach and we were headed there. That compelled everybody to dream about tomorrow.” So many dreams seem out of reach today, but for those of us sitting in the audience, there was comfort in watching a former president reflect on the state of the economy, and showing such concern for it. We could see, in one room, the power of leadership in action and the capacity to motivate, inspire, and bring people together to generate ideas and commit them to action.

http://www.cgiamerica.org/2012/meeting_report/