As I walk through college campuses this fall, I can easily spot the freshmen. They are identifiable not so much by age (although they look younger every year) but by the look on their faces: that unique mixture of surprise, excitement, and fear that accompanies the start of the first year of college. There is so much to do and to learn and there’s no shortage of advice being directed at college freshmen, but I am going to add my piece anyway, and it is not only a suggestion about what students should do but who most needs to do it.
My recommendation is simple: if your school offers a financial education course, take it. If it does not, take a basic economics course (Economics 101 or Principles of Economics). Financial knowledge has become an essential life skill; just as it is necessary to be able to read and write (and use Twitter and Facebook), it is essential to have basic financial knowledge. Financial decisions are made every day, from how much to borrow on a credit card to how to manage a checking account to whether to pay for dinner on a disappointing date. And the responsibility of making good decisions has been shifted onto individuals. Both government and employers are increasingly asking citizens and workers to take care of their own financial security. Like it or not, the benefits and risks associated with financial decisions are now yours. And you have just embarked on one of the biggest investments of your life: the investment in education (in case you are not aware of just how big an investment it is, ask your parents, but only after they recover from the shock of paying the first round of bills for tuition, room, and board). In my view, education is one of your best investments, with returns in higher lifetime wages and likely entry into more stable sectors of the job market. (There tends to be lower unemployment among jobs requiring a college education.) And there are many intangibles, too, that command a value, from gaining a network of smart and educated friends to having the opportunity to experiment and gain knowledge in many fields, under the guidance of experts.
In the same way that low educational attainment may mean a lifetime of low and erratic wages, so low financial knowledge has been found to be associated with poor financial decisions, from excessive borrowing to lack of participation in financial markets to inadequate wealth accumulation for retirement. The costs of poor decisions can be high, particularly when dealing with debt: choosing the wrong mortgage can push people into poverty or bankruptcy, and according to the research I did with Peter Tufano from Harvard Business School, those who display low levels of financial literacy are likely to pay 50% more in credit card interest and fees than those with higher levels of financial literacy.
While a course in financial literacy or in basic economics can benefit all students, based on my years of research, I recommend it most strongly to the following students:
Women: According to my research, women are much less financially literate than men. I do not know why this is the case, but one worrisome finding is that there is a gap in financial knowledge between women and men not only among young people but also later in life. This likely means that women face fewer opportunities to become financially knowledgeable than men do, for example by interacting with groups (perhaps other women) who are less likely to talk about finance. Enrolling in a college-level economics or financial literacy offers a chance to counteract that tendency.
African Americans and Hispanics: There is a wide gap in financial knowledge between whites and African-Americans and Hispanics, even after accounting for the many demographic differences in these groups, including income and wealth. Again, this may be the result of fewer learning opportunities over the lifetime. A college course in economics or finance can start to make up for this gap.
Students whose parents are not financially sophisticated: According to my research, as well as research from the Jump$tart Coalition for Personal Financial Literacy, the (small) percentage of students who are financially knowledgeable are disproportionately white males with college-educated parents (in particular, college educated mothers) who had stocks and retirement savings when their children were teenagers. This means that a lot of financial knowledge is learned at home. If you are among the first generation in your family to go to college and your parents have never invested in stocks, you start at a disadvantage in terms of financial knowledge with respect to your peers. Take the opportunity now to make up for that gap.
Students who hate economics and finance: If you think that the study of economics and finance is for uncreative people, and is evil and will only teach you to work on Wall Street and exploit poor people and poor countries, then you, too, should sign up for a basic economics or financial literacy course. In my experience, people who express disdain for economics tend to make poor and costly financial decisions. Take advantage of a chance to offset that tendency.
Let me finish by adding that there is a risk in taking a course on financial literacy and economics: You may actually find that you like it!
Kamis, 16 September 2010
Kamis, 09 September 2010
Comparing financial literacy of young people across countries
One of the new tasks I have taken on is to chair the Financial Literacy Experts Group at the OECD, which has been put in charge of designing a module on financial literacy for the Programme for International Student Assessment (PISA). The Programme is a worldwide evaluation of 15-year-old students’ scholastic performance, evaluated first in 2000 and repeated every three years. A new module will be proposed for the 2012 survey to measure financial literacy among 15-year-olds in 19 countries (the countries which so far have agreed to participate are Albania, Australia, Belgium, Brazil, China, Colombia, Croatia, Czech Republic, Estonia, France, Hungary, Israel, Italy, Latvia, New Zealand, Slovack Republic, Slovenia, Spain, and the United States).
This is an important initiative that shows the leadership role that the OECD has undertaken in the field of financial literacy at the international level and that will provide much needed data to improve educational policies across countries. There is a lot to be learned from these data. First, we will be able to assess the level of financial knowledge of young students, before they take on related decisions such as choosing whether to pursue a college education, in my view one of the most important decisions in a person’s lifetime. Second, we will be able to assess which students know the most and which know the least, not only across economic strata and demographic groups but also across countries. Third, we will be able to assess the link between financial literacy and mathematical ability as well as the link between financial knowledge and knowledge in other fields, such as the sciences.
The comparison across countries is particularly valuable. Not only are financial markets becoming increasingly integrated but many countries are shifting to pension systems that require increased individual responsibility. Moreover, the availability of consumer credit and the instruments associated with that credit (credit cards, short-term loans, payday loans, and so on) require that consumers have the ability to understand the terms of the contracts and their consequences. Countries in which consumer credit has expanded rapidly have also witnessed an increase in personal bankruptcy. How do countries handle the increase in individual responsibility, how much are young people prepared for the new financial systems which are becoming more global and more complex, and who are the leaders in terms of financial literacy? These are very important questions and the objective of the data is to provide countries with evidence that can guide policies toward improving financial education.
PISA data has been used in many policy assessments. Just last Sunday the New York Times had an article about the strength of Brazil’s economic expansion. While Brazil has been growing fast, the low level of education of the population (as measured by the math scores in PISA studies) is seen as a potential stumbling block both in terms of ability to produce a qualified labor force and to promote innovation. And interestingly, it is the Nordic countries (Norway, Finland, Sweden) whose students do very well in terms of mathematical ability, and perhaps it is not by accident that these countries host some of the most innovative firms, products, and ideas—Nokia, Ikea, Santa Klaus (if you believe, as I firmly do, that he lives in the North Pole).
This is clearly no small task and the Financial Literacy Experts Group is hard at work to design questions that are comparable across countries. We have representatives who come from different countries and who also bring a variety of experiences. We have not only educators but also representatives from government institutions (Treasury and Finance departments), central banks, and retirement commissions. Moreover, we have representatives from countries in which financial education in high school has been or is in the process of being implemented and countries in which financial education in school has yet to be adopted. This will allow us to examine whether the countries whose young people are exposed to financial education programs in school do better than countries in which young people learn on their own.
One other thing I’ve learned is that among Italians, one has to be careful in discussing PISA. I had hastily mentioned my new role to my father during our weekly calls, telling him that one of the benefits of the project would be a lot of travel close to my family’s home in Italy. I realized the discussion had gone astray when my sister sent me an e-mail congratulating me for joining the expert group on the Leaning Tower of Pisa and asking what, exactly, I had to do in there. We had a good laugh; this added new meaning to my father’s conviction that his daughters can do anything!
This is an important initiative that shows the leadership role that the OECD has undertaken in the field of financial literacy at the international level and that will provide much needed data to improve educational policies across countries. There is a lot to be learned from these data. First, we will be able to assess the level of financial knowledge of young students, before they take on related decisions such as choosing whether to pursue a college education, in my view one of the most important decisions in a person’s lifetime. Second, we will be able to assess which students know the most and which know the least, not only across economic strata and demographic groups but also across countries. Third, we will be able to assess the link between financial literacy and mathematical ability as well as the link between financial knowledge and knowledge in other fields, such as the sciences.
The comparison across countries is particularly valuable. Not only are financial markets becoming increasingly integrated but many countries are shifting to pension systems that require increased individual responsibility. Moreover, the availability of consumer credit and the instruments associated with that credit (credit cards, short-term loans, payday loans, and so on) require that consumers have the ability to understand the terms of the contracts and their consequences. Countries in which consumer credit has expanded rapidly have also witnessed an increase in personal bankruptcy. How do countries handle the increase in individual responsibility, how much are young people prepared for the new financial systems which are becoming more global and more complex, and who are the leaders in terms of financial literacy? These are very important questions and the objective of the data is to provide countries with evidence that can guide policies toward improving financial education.
PISA data has been used in many policy assessments. Just last Sunday the New York Times had an article about the strength of Brazil’s economic expansion. While Brazil has been growing fast, the low level of education of the population (as measured by the math scores in PISA studies) is seen as a potential stumbling block both in terms of ability to produce a qualified labor force and to promote innovation. And interestingly, it is the Nordic countries (Norway, Finland, Sweden) whose students do very well in terms of mathematical ability, and perhaps it is not by accident that these countries host some of the most innovative firms, products, and ideas—Nokia, Ikea, Santa Klaus (if you believe, as I firmly do, that he lives in the North Pole).
This is clearly no small task and the Financial Literacy Experts Group is hard at work to design questions that are comparable across countries. We have representatives who come from different countries and who also bring a variety of experiences. We have not only educators but also representatives from government institutions (Treasury and Finance departments), central banks, and retirement commissions. Moreover, we have representatives from countries in which financial education in high school has been or is in the process of being implemented and countries in which financial education in school has yet to be adopted. This will allow us to examine whether the countries whose young people are exposed to financial education programs in school do better than countries in which young people learn on their own.
One other thing I’ve learned is that among Italians, one has to be careful in discussing PISA. I had hastily mentioned my new role to my father during our weekly calls, telling him that one of the benefits of the project would be a lot of travel close to my family’s home in Italy. I realized the discussion had gone astray when my sister sent me an e-mail congratulating me for joining the expert group on the Leaning Tower of Pisa and asking what, exactly, I had to do in there. We had a good laugh; this added new meaning to my father’s conviction that his daughters can do anything!
Kamis, 12 Agustus 2010
Blogging
I was informed recently that my blog has been listed as one of the must-read blogs in the field of economics. While I don’t know much about how this ranking was done, it did boost my ego quite a bit and I thought I would post the link:
http://master-degree-online.com/top-100-graduate-blogs-by-university-personnel/
When I started blogging some time ago, I did not know how much I would enjoy it. While my schedule has become quite busy, particularly since taking on the role of director of the Financial Literacy Center, I am trying to keep up and write as much and as often as I can. Both the financial crisis and the financial reforms have offered a lot of material to reflect upon and to write about, so I am not short on topics, even though I write exclusively on subjects related to financial literacy.
But I am posting this short blog to thank my readers for their support and also to encourage them to continue reading. Have a good rest of the summer to all. I am getting ready to go to Italy, one of my favorite vacation places, and I will write more from there.
http://master-degree-online.com/top-100-graduate-blogs-by-university-personnel/
When I started blogging some time ago, I did not know how much I would enjoy it. While my schedule has become quite busy, particularly since taking on the role of director of the Financial Literacy Center, I am trying to keep up and write as much and as often as I can. Both the financial crisis and the financial reforms have offered a lot of material to reflect upon and to write about, so I am not short on topics, even though I write exclusively on subjects related to financial literacy.
But I am posting this short blog to thank my readers for their support and also to encourage them to continue reading. Have a good rest of the summer to all. I am getting ready to go to Italy, one of my favorite vacation places, and I will write more from there.
Senin, 09 Agustus 2010
Financial education: What works?
I am just back from Denver, where I attended a conference titled “Implications of a Quarter Century of Research in Personal Finance,” organized by the National Endowment for Financial Education and Tahira Hira from Iowa State University. A group of researchers met over three days to discuss what we have learned so far on this important topic. I headed a team that addressed the question, “What learning strategies, interventions, and delivery methods hold the most promise for effective financial education outcomes?”
As we reviewed the many papers that have been written on this topic, we faced the difficulties commonly encountered when looking at the existing work. Navigating the bulk of existing literature and figuring out the common findings is a challenge, but our analysis of that extensive literature led us to what we called a “cautious optimism” about the effects of financial education. Along with this optimism, we are mindful of several difficulties inherent in evaluating financial education interventions. First is the issue of self-selection: i.e., are the people who attend financial education programs those with an existing interest in the subject, and is it their interest or the content of a program that motivates them to make certain financial decisions? Second is the dearth of details regarding program content, frequency, delivery method, and goals (to improve knowledge or change behavior or to satisfy a legal requirement) of the programs that are reviewed in the literature. This lack of information makes it hard to evaluate what makes a program effective (or ineffective). Third, one has to be mindful of the size of the intervention. Small interventions, for example, providing information on a particular issue cannot transform naïve investors into Warren Buffetts.
The team identified places where financial education seems most effective and methods to make financial education more effective. The most effective place for financial education was concluded to be the workplace; important methodology was judged to be that relating to adult education and to informal learning.
There are many (some obvious) reasons why the workplace is an ideal venue in which to provide financial education. First, this is where many adults are and also where many important financial decisions are made, e.g., how much to contribute to a retirement account, how to invest retirement wealth, whether to annuitize retirement wealth, and the list goes on. There are also benefits to employers in making sure that workers save for retirement and avoid financial problems, as financial problems and/or worries can affect worker productivity and morale. One benefit to both employers and employees, which in my view is not discussed enough, is that financial education can make people aware of and able to take advantages of benefits an employer offers (for example, employer matches of retirement contributions) or better understand and take advantage of tax-favored assets.
Financial education has normally been conceived of as being delivered in a classroom, but one has to think more broadly and creatively about adult education. In contrast to young students, adults have a rich set of experiences that shape how they view their financial situation. Additionally, financial education can be made more effective with reference to theories of learning that offer important suggestions and insights. One such theory is Mezirow’s transformative learning theory. This theory has been around for over 30 years and has been used as a framework to help make sense of learning and teaching in numerous disciplines—health and medical education, intercultural relations, psychology, environmental sciences, higher education, instructional technology, archaeology, human resource development, just to mention a few. I mention the importance of theory here because, in my view, one of the reasons why financial education has not been as effective as it could be or has not been given the attention it deserves is because it is not considered within a rigorous and theoretical framework.
Even within such a framework, it is possible to incorporate different ways of learning, including informal learning. Informal learning is increasingly becoming recognized as significant to workplace education. Instead of having employees participate in traditional workshops or training sessions, employers are creating conditions in which workers can learn from each others. Financial educators, policy makers, and program planners will do well to recognize that financial education efforts can be successful outside of the formal settings that are the traditional venue for financial education.
As I have mentioned in previous blogs, to run a successful conference you need to have good people, good papers, and good food. Having provided, I hope, a little glimpse of the energetic discussion that went on throughout the meetings in Denver (as well as the informal learning that occurred outside of the meeting rooms!), let me turn to the topic of food. Our meals were a blend of French and Italian cuisine. We went to a wonderful French bistro one night where we tried pâté, saucissons, onion soup, and a wonderful pistachio-crusted trout. The Brown Palace hotel, where we stayed, provided us with succulent breakfasts. At a lunch one day we had gourmet pizza. Some were surprised by this lunch choice. Not me. Give me pizza, and I am happy!
As we reviewed the many papers that have been written on this topic, we faced the difficulties commonly encountered when looking at the existing work. Navigating the bulk of existing literature and figuring out the common findings is a challenge, but our analysis of that extensive literature led us to what we called a “cautious optimism” about the effects of financial education. Along with this optimism, we are mindful of several difficulties inherent in evaluating financial education interventions. First is the issue of self-selection: i.e., are the people who attend financial education programs those with an existing interest in the subject, and is it their interest or the content of a program that motivates them to make certain financial decisions? Second is the dearth of details regarding program content, frequency, delivery method, and goals (to improve knowledge or change behavior or to satisfy a legal requirement) of the programs that are reviewed in the literature. This lack of information makes it hard to evaluate what makes a program effective (or ineffective). Third, one has to be mindful of the size of the intervention. Small interventions, for example, providing information on a particular issue cannot transform naïve investors into Warren Buffetts.
The team identified places where financial education seems most effective and methods to make financial education more effective. The most effective place for financial education was concluded to be the workplace; important methodology was judged to be that relating to adult education and to informal learning.
There are many (some obvious) reasons why the workplace is an ideal venue in which to provide financial education. First, this is where many adults are and also where many important financial decisions are made, e.g., how much to contribute to a retirement account, how to invest retirement wealth, whether to annuitize retirement wealth, and the list goes on. There are also benefits to employers in making sure that workers save for retirement and avoid financial problems, as financial problems and/or worries can affect worker productivity and morale. One benefit to both employers and employees, which in my view is not discussed enough, is that financial education can make people aware of and able to take advantages of benefits an employer offers (for example, employer matches of retirement contributions) or better understand and take advantage of tax-favored assets.
Financial education has normally been conceived of as being delivered in a classroom, but one has to think more broadly and creatively about adult education. In contrast to young students, adults have a rich set of experiences that shape how they view their financial situation. Additionally, financial education can be made more effective with reference to theories of learning that offer important suggestions and insights. One such theory is Mezirow’s transformative learning theory. This theory has been around for over 30 years and has been used as a framework to help make sense of learning and teaching in numerous disciplines—health and medical education, intercultural relations, psychology, environmental sciences, higher education, instructional technology, archaeology, human resource development, just to mention a few. I mention the importance of theory here because, in my view, one of the reasons why financial education has not been as effective as it could be or has not been given the attention it deserves is because it is not considered within a rigorous and theoretical framework.
Even within such a framework, it is possible to incorporate different ways of learning, including informal learning. Informal learning is increasingly becoming recognized as significant to workplace education. Instead of having employees participate in traditional workshops or training sessions, employers are creating conditions in which workers can learn from each others. Financial educators, policy makers, and program planners will do well to recognize that financial education efforts can be successful outside of the formal settings that are the traditional venue for financial education.
As I have mentioned in previous blogs, to run a successful conference you need to have good people, good papers, and good food. Having provided, I hope, a little glimpse of the energetic discussion that went on throughout the meetings in Denver (as well as the informal learning that occurred outside of the meeting rooms!), let me turn to the topic of food. Our meals were a blend of French and Italian cuisine. We went to a wonderful French bistro one night where we tried pâté, saucissons, onion soup, and a wonderful pistachio-crusted trout. The Brown Palace hotel, where we stayed, provided us with succulent breakfasts. At a lunch one day we had gourmet pizza. Some were surprised by this lunch choice. Not me. Give me pizza, and I am happy!
Senin, 19 Juli 2010
Some comments about "Greater Foools"
I am happy to post on my blog a comment by Nan Morrison, President and CEO of the Council for Economic Education, on the article "Greater Fools" published in the New Yorker.
James Surowieki’s financial page piece “Greater Fools” unfortunately quite accurately diagnoses the depths of America’s struggle with financial literacy and its costs to society. And without significant changes, our children may face an even worse fate than their parents. Nellie Mae reports that on average, incoming freshmen now bring an average of $1,585 in credit card debt to college.
Yet despite the extent of this problem, according to a CEE / State Farm survey, only 21 states require an economics course to be taken in K-12, and only 13 states require a course in personal finance. Even fewer require testing of these concepts. But requirements need trained teachers, and to make matters worse, as a society, we are not preparing teachers to deliver this vital content with confidence. In a recent survey by the National Endowment for Financial Education (NEFE), less than 20 percent of teachers reported feeling competent to teach basic personal finance topics. Furthermore, even many teachers of high school economics have taken two or fewer semesters of economics in college.
In our eyes, the real question is “How, as a society, can we improve our economic and financial literacy and what benefits might we see in future generations as a result?” Our answer at the Council for Economic Education (CEE) – equip and enable teachers to educate our children in basic personal finance and economic concepts in school from kindergarten through 12th grade. Why? Good habits are built early, just like brushing your teeth.
America is about economic opportunity – our kids need to be financially fit and economically literate to grasp that opportunity. As consumers, investors, entrepreneurs, and voters we all make decisions that involve finance and economics every day. If every parent, school and state, made economic and financial education a priority in schools from K-12, perhaps more Americans would be able to ensure their financial well being in a changing and complex world. Improving our collective economic and financial literacy is vital to our economic growth, job creation, and prosperity. Many in government, education, and financial services, across our nation support those goals, as they are good business and good citizenship well as essential ingredients in a stable financial system.
Nan J. Morrison
President & CEO, Council for Economic Education
James Surowieki’s financial page piece “Greater Fools” unfortunately quite accurately diagnoses the depths of America’s struggle with financial literacy and its costs to society. And without significant changes, our children may face an even worse fate than their parents. Nellie Mae reports that on average, incoming freshmen now bring an average of $1,585 in credit card debt to college.
Yet despite the extent of this problem, according to a CEE / State Farm survey, only 21 states require an economics course to be taken in K-12, and only 13 states require a course in personal finance. Even fewer require testing of these concepts. But requirements need trained teachers, and to make matters worse, as a society, we are not preparing teachers to deliver this vital content with confidence. In a recent survey by the National Endowment for Financial Education (NEFE), less than 20 percent of teachers reported feeling competent to teach basic personal finance topics. Furthermore, even many teachers of high school economics have taken two or fewer semesters of economics in college.
In our eyes, the real question is “How, as a society, can we improve our economic and financial literacy and what benefits might we see in future generations as a result?” Our answer at the Council for Economic Education (CEE) – equip and enable teachers to educate our children in basic personal finance and economic concepts in school from kindergarten through 12th grade. Why? Good habits are built early, just like brushing your teeth.
America is about economic opportunity – our kids need to be financially fit and economically literate to grasp that opportunity. As consumers, investors, entrepreneurs, and voters we all make decisions that involve finance and economics every day. If every parent, school and state, made economic and financial education a priority in schools from K-12, perhaps more Americans would be able to ensure their financial well being in a changing and complex world. Improving our collective economic and financial literacy is vital to our economic growth, job creation, and prosperity. Many in government, education, and financial services, across our nation support those goals, as they are good business and good citizenship well as essential ingredients in a stable financial system.
Nan J. Morrison
President & CEO, Council for Economic Education
Jumat, 16 Juli 2010
Greater Fools
James Surowiecki’s recent column in The New Yorker magazine discussed the dangers of financial illiteracy in America. It is great that such a prominent and widely read magazine has featured a piece on the issue of financial illiteracy. I do not know about you, but I love The New Yorker: not only is it great reading, but it makes me dream of all the things I could do if I were living in New York! In this blog, I want to write in more detail about something that I discussed with James Surowiecki and which he reported in his column.
Of the changes that we have witnessed in the financial markets in recent decades, we have seen not only an increased complexity in financial products but also an increased reliance on the expertise (or lack thereof) of consumers. For example, individuals have been bombarded with credit card offers. One could easily sign up for a sizeable collection of credit cards and, in so doing, borrow a large amount of money. While some consumers have been targeted more than others, many are receiving printed checks in the mail. These types of offers make it very easy to borrow; and it is the individual who has to be savvy about how to use the credit cards and checks that come in the mail; the offers will keep coming, and the amount one can borrow will keep increasing, irrespective of how much one can afford.
Subprime mortgages have worked in much the same way. While banks and mortgage lenders would normally do background work in order to assess how much to lend their potential borrowers, subprime mortgages were available to almost anyone who wanted a mortgage, regardless of their ability to afford the loan they were taking on and without much or any look to proper documentation. For some, the offer came in the mail together with the credit card offer!
In other words, we have opened the doors and made credit available to a much larger number of individuals than was the case several decades ago. Moreover, while not infinite, the amount people can borrow is very large. And perhaps most importantly, it is often up to the consumers to decide what and when it is enough.
This is why financial literacy is so important and why, in my view, developments in financial markets should be accompanied with initiatives to provide the knowledge required to make good use of any such developments. One cannot trumpet how great it is to be able to buy a house at age 25 if young workers do not even know what interest compounding means. Similarly, dispensing credit cards to people who have little understanding of how fees work can be counterproductive at best and catastrophic at worst.
I have a similar view toward assets. Some have been lamenting the high proportion of unbanked individuals, in particular among certain segments of the population. I believe financial access is incredibly important, but we cannot simply give everyone a checking account and think we have improved people’s lives! Not knowing how to use a checking account to prevent overdraft fees and returned checks can quickly turn the benefits of this simple asset into a nightmare.
As we pass new legislation about financial reforms, we should keep in mind the many advantages that advanced financial markets can bring to the economy but also be mindful that without financial knowledge, people now have a much greater opportunity not only to increase wealth, but also to destroy it. As I have argued in many previous blogs, it is not enough to regulate supply, we also have to think about demand and how to empower consumers with the knowledge necessary to make proper financial decisions. We should not be talking only about banks, we should also be talking about the borrowers!
On a side note, James Surowiecki’s column was published on July 5, which also happens to be my birthday. Without knowing it, Surowiecki provided me with a very nice birthday gift by writing so proficiently about a topic I care so much about. Only a trip to New York would have made it better!
Read James Surowiecki’s column here: http://www.newyorker.com/talk/financial/2010/07/05/100705ta_talk_surowiecki
Of the changes that we have witnessed in the financial markets in recent decades, we have seen not only an increased complexity in financial products but also an increased reliance on the expertise (or lack thereof) of consumers. For example, individuals have been bombarded with credit card offers. One could easily sign up for a sizeable collection of credit cards and, in so doing, borrow a large amount of money. While some consumers have been targeted more than others, many are receiving printed checks in the mail. These types of offers make it very easy to borrow; and it is the individual who has to be savvy about how to use the credit cards and checks that come in the mail; the offers will keep coming, and the amount one can borrow will keep increasing, irrespective of how much one can afford.
Subprime mortgages have worked in much the same way. While banks and mortgage lenders would normally do background work in order to assess how much to lend their potential borrowers, subprime mortgages were available to almost anyone who wanted a mortgage, regardless of their ability to afford the loan they were taking on and without much or any look to proper documentation. For some, the offer came in the mail together with the credit card offer!
In other words, we have opened the doors and made credit available to a much larger number of individuals than was the case several decades ago. Moreover, while not infinite, the amount people can borrow is very large. And perhaps most importantly, it is often up to the consumers to decide what and when it is enough.
This is why financial literacy is so important and why, in my view, developments in financial markets should be accompanied with initiatives to provide the knowledge required to make good use of any such developments. One cannot trumpet how great it is to be able to buy a house at age 25 if young workers do not even know what interest compounding means. Similarly, dispensing credit cards to people who have little understanding of how fees work can be counterproductive at best and catastrophic at worst.
I have a similar view toward assets. Some have been lamenting the high proportion of unbanked individuals, in particular among certain segments of the population. I believe financial access is incredibly important, but we cannot simply give everyone a checking account and think we have improved people’s lives! Not knowing how to use a checking account to prevent overdraft fees and returned checks can quickly turn the benefits of this simple asset into a nightmare.
As we pass new legislation about financial reforms, we should keep in mind the many advantages that advanced financial markets can bring to the economy but also be mindful that without financial knowledge, people now have a much greater opportunity not only to increase wealth, but also to destroy it. As I have argued in many previous blogs, it is not enough to regulate supply, we also have to think about demand and how to empower consumers with the knowledge necessary to make proper financial decisions. We should not be talking only about banks, we should also be talking about the borrowers!
On a side note, James Surowiecki’s column was published on July 5, which also happens to be my birthday. Without knowing it, Surowiecki provided me with a very nice birthday gift by writing so proficiently about a topic I care so much about. Only a trip to New York would have made it better!
Read James Surowiecki’s column here: http://www.newyorker.com/talk/financial/2010/07/05/100705ta_talk_surowiecki
Rabu, 07 Juli 2010
Financial Literacy Among the Young
I want to write this time about financial literacy among young people. Olivia Mitchell, from the Wharton School; Vilsa Curto, from the Education Innovation Laboratory at Harvard; and I have just published a paper in the Journal of Consumer Affairs that describes the results from the responses to three questions that we added to the National Longitudinal Survey of Youth in 2007-2008. Respondents to this survey are 23-28 years old.
These young consumers must confront complicated financial decisions in today’s demanding financial environment, and financial mistakes made early in life can be costly. Young people often find themselves carrying large amounts of student loan or credit card debt, and such early entanglements can hinder their ability to accumulate wealth or to choose their desired job. To examine how well equipped young people are to make financial decisions, we assessed knowledge of basic concepts: the ability to do a 2% calculation and the understanding of how inflation and risk diversification work.
We have three major findings:
1. Financial literacy is low among young adults. Only 27% of people age 23-28 can answer three basic questions about interest rates, inflation, and risk diversification.
2. There are large gender differences in financial literacy. Young women know much less than do young men about basic financial concepts. In another survey, we found large gender gaps in financial literacy among older respondents (51 and older), and this recent work tells us that these differences hold when we look at young people.
3. Financial literacy is influenced by parents. Those who are financially literate are more likely to have college-educated parents (in particular, college-educated mothers) and to have parents who had stocks and retirement savings when these young adults were growing up (when they were 12 to 17 years old).
I want to stress the third finding: family background is found to have a strong impact on financial literacy. A college-educated male whose parents had stocks and retirement savings when he was a teenager was about 45 percentage points more likely to know about risk diversification than a female with less than a high school education whose parents did not own retirement or risky assets. In other words, financial knowledge appears to be much higher for those who grow up with parents who are financially sophisticated.
This research is consistent with the findings from the Financial Capability Survey, the results of which were released last December by Secretary Geithner together with Secretary Duncan. http://www.ustreas.gov/press/releases/tg446.htm. That survey also documents very low levels of financial knowledge, particularly among the young.
These are unpleasant findings. We have put people in charge of many important financial decisions. People must decide how much to save for retirement and how to invest that savings, yet people do not appear to understand how to diversify risk; individuals are bombarded with credit card offers, yet we are learning that many people do not know how compound interest works, so cannot calculate how their debt will grow. Research has shown that financial illiteracy can be linked to problems with debt, lack of participation in the stock market, lack of retirement planning, and lower wealth accumulation. If we do not address financial illiteracy among young people and if we do not equip young people with the tools they need to make sound financial decisions, we may pay the cost down the road.
I am worried about the implications of these findings. If financial literacy is learned at home, many young people will begin their lives at a disadvantage, as not everybody comes from a college educated family or from a family that has stocks and retirement savings. In other words, inequality may start at the very beginning of the economic life if we do not offer everybody an opportunity to learn financial literacy outside of their homes. This is one reason why it is important that our schools incorporate financial literacy into their curricula.
In my work as a college professor, I am surrounded by young people. Last month, as we bid farewell to the Dartmouth class of 2010, I could not help but wonder whether we have provided all that is needed for these students to start on their journey into adulthood. Most of them will start a job, open a new bank account, rent an apartment, get more credit cards, pay down their student loans, donate to their college (ahem . . .), and pay taxes. Are they ready?
These young consumers must confront complicated financial decisions in today’s demanding financial environment, and financial mistakes made early in life can be costly. Young people often find themselves carrying large amounts of student loan or credit card debt, and such early entanglements can hinder their ability to accumulate wealth or to choose their desired job. To examine how well equipped young people are to make financial decisions, we assessed knowledge of basic concepts: the ability to do a 2% calculation and the understanding of how inflation and risk diversification work.
We have three major findings:
1. Financial literacy is low among young adults. Only 27% of people age 23-28 can answer three basic questions about interest rates, inflation, and risk diversification.
2. There are large gender differences in financial literacy. Young women know much less than do young men about basic financial concepts. In another survey, we found large gender gaps in financial literacy among older respondents (51 and older), and this recent work tells us that these differences hold when we look at young people.
3. Financial literacy is influenced by parents. Those who are financially literate are more likely to have college-educated parents (in particular, college-educated mothers) and to have parents who had stocks and retirement savings when these young adults were growing up (when they were 12 to 17 years old).
I want to stress the third finding: family background is found to have a strong impact on financial literacy. A college-educated male whose parents had stocks and retirement savings when he was a teenager was about 45 percentage points more likely to know about risk diversification than a female with less than a high school education whose parents did not own retirement or risky assets. In other words, financial knowledge appears to be much higher for those who grow up with parents who are financially sophisticated.
This research is consistent with the findings from the Financial Capability Survey, the results of which were released last December by Secretary Geithner together with Secretary Duncan. http://www.ustreas.gov/press/releases/tg446.htm. That survey also documents very low levels of financial knowledge, particularly among the young.
These are unpleasant findings. We have put people in charge of many important financial decisions. People must decide how much to save for retirement and how to invest that savings, yet people do not appear to understand how to diversify risk; individuals are bombarded with credit card offers, yet we are learning that many people do not know how compound interest works, so cannot calculate how their debt will grow. Research has shown that financial illiteracy can be linked to problems with debt, lack of participation in the stock market, lack of retirement planning, and lower wealth accumulation. If we do not address financial illiteracy among young people and if we do not equip young people with the tools they need to make sound financial decisions, we may pay the cost down the road.
I am worried about the implications of these findings. If financial literacy is learned at home, many young people will begin their lives at a disadvantage, as not everybody comes from a college educated family or from a family that has stocks and retirement savings. In other words, inequality may start at the very beginning of the economic life if we do not offer everybody an opportunity to learn financial literacy outside of their homes. This is one reason why it is important that our schools incorporate financial literacy into their curricula.
In my work as a college professor, I am surrounded by young people. Last month, as we bid farewell to the Dartmouth class of 2010, I could not help but wonder whether we have provided all that is needed for these students to start on their journey into adulthood. Most of them will start a job, open a new bank account, rent an apartment, get more credit cards, pay down their student loans, donate to their college (ahem . . .), and pay taxes. Are they ready?
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