Advice to rookies

If you’re a regular reader of my blog, you’ll know that I have become a football fan. People change over the course of their life and pick up new hobbies and interests. For me, it’s football. So this Sunday, I watched the Ravens score a crushing victory against the Steelers. It was a beautiful game! I also watched the kickoff last Thursday. Two games in a week; that is pretty good for a rookie fan, no?

In this new season, with rookie players on their field for their first games, there is an abundance of discussions and articles about these newcomers. In the New York Times yesterday, there was an article about finance and financial advice to the rookies. The link to the article “Financial Lessons from Sports Stars’ Mistakes” is at the end of this post.

As I have mentioned in previous posts, the statistics about football players mismanaging their money are pretty staggering. The article mentioned several star athletes who have had brushes with bankruptcy: Michael Vick (recently acquired by the Philadelphia Eagles); Bernie Kosar, formerly of the Cleveland Browns; and Mark Brunell of the New York Jets.

Some have argued that the behavior of football players is similar to those who win the lottery. Flushed with large sums of money that come to them suddenly, players squander it and are left with little or nothing a few years out. I do not think that this is a good analogy. One difference between football players and lottery players is that we know the former are very talented people: Who else could do the things they do when they are out in the field? Moreover, these people know discipline; they show up to practice every day. They also know the correlation between efforts and outcome; if one works steadily at something, he will get better. These are great skills that can be applied not only to playing football but also to managing money.

So, why do we see players going bankrupt? One of the reasons why people (including football players) make mistakes is because they lack financial knowledge. This problem can be particularly acute for young, inexperienced people whose highest earnings are concentrated at the beginning of their career. But this is not an impossible problem to fix, and the New York Times article outlined a set of lessons that could be learned from some players’ mistakes.

I have three pieces of advice for rookies. (There is more advice to give, but let me start with this simple list; I will follow up in future posts.)

1) Do not spend it all. The career of football players is short and risky; you want and need to have provisions for the future and for uncertain events. An example? The recent lockout. What would have happened if the lockout had continued? Another example? Even superstars have injuries and/or cannot play for health reasons. Peyton Manning, for example, just had neck surgery.

2) Take it in your hands. Money management is too important and too personal to be delegated entirely to someone else. You are the one who knows your needs, your aversion to or love of risk, your objectives for the future. If you leave it to others to manage your money, chances are they will not make the decisions you had wished for. Even if you seek financial advice, rely on reputable experts and stay involved in the process. After all, it is your future that is at stake here.

3) Be humble about finance. My research repeatedly shows that the majority of people are overconfident about what they know of finance. Four out of five Americans gave themselves high financial knowledge ratings but, when asked questions about basic concepts, they answered incorrectly. And ignorance hurts. Study after study documents that it is those with low financial knowledge who pay more for financial services and who are more likely to end up in financial distress. Do not be afraid to speak up about what you do not know; it is not a weakness, it is a strength, and you will intimidate anyone around you when you admit it. Most people do not have that kind of courage. Do not jump into projects or investments you do not understand well. Tell people around you, “I want to be smart about my money.” Over time, you will be.

When I got my first job as an assistant professor at Dartmouth College about twenty years ago, I showed up in the Human Resources office and was given all of these forms to fill out, requiring me to indicate which of the three pension providers I wanted and how I would allocate my pension money. I remember feeling puzzled that such an important decision would be asked of me without inquiring about my knowledge and whether I needed any help. Throughout the years, I have worked to change that process and, with the collaboration of some great people at Dartmouth’s HR office, there are now programs in place to help new hires. I take a little pride in that.

The NYT article is posted here:
http://www.nytimes.com/2011/09/10/your-money/financial-lessons-from-sports-stars-mistakes-your-money.html?pagewanted=all

Think big, in a practical way

I left for Italy in mid-August feeling pretty discouraged. Most of the recent discussions I had heard about financial literacy were focused on cost. This is clearly an important concern, but, in practice, when people talk mostly about costs, it often means they are not interested in “buying” it. And while the cost of improving financial literacy is a very legitimate concern, how about the cost of this financial mess we’re in. How about that?

The discussion around some financial education programs was also not a mood booster. Some of the papers I saw presented this summer covered programs in which individuals—often impoverished and with little education—were brought to a classroom and given a few hours of “financial education.” The expectation was that those few hours would transform people into savvy entrepreneurs or investors. And what was the main discussion around this? How much these programs cost!

This dominant concern about cost obscures the fact that we face a very important and challenging problem in need of a solution. But we need to think big; we need creative ideas that can help overcome big barriers. Lack of financial knowledge is not something that can be tackled by bringing the adult population back to a classroom for a lecture or two on financial education. We need to be practical, too, regarding what can be implemented. As my college friend—a successful entrepreneur I get together with every time I return to Italy—put it: "think big, in a practical way."

Being in Italy, with a break from my daily routine, allowed me to focus on big ideas, and I have some recommendations, that are also practical, to at least start the discussion, and I would like to hear from others.

Big Idea #1: TEACH THE YOUNG. Financial literacy needs to be implemented in schools. It is too difficult to reach the adult population and it is hard to do any teaching if there is little or no base to start from. Also, we need people to be financially literate before rather than after they engage in financial transactions. There will and should be costs of educating the young. It is meaningless to mandate financial education without, for example, training the teachers to teach those courses. Mandates do not make people any smarter, but having a well-developed curriculum that is followed by trained teachers might.

Big Idea #2: FOCUS ON WOMEN. Women have low levels of financial literacy (lower than men), but they also know that they lack knowledge. Moreover, they want to be “treated”; in most financial programs I have been involved with or read about, the majority of participants have been women. It is going to be much easier to reach and deliver to a population who is interested in financial literacy. This is a simple truth that has been mostly ignored. There are costs of only thinking about costs!

Big Idea #3: MAKE IT SIMPLE. Some financial decisions are truly complex, but there are universal concepts that are at the basis of most financial decisions and that can and should be explained in very simple ways. I am talking about the power of interest compounding, the effects of inflation, and the benefits of risk diversification. In fact, even this is economic jargon we can get away from. Let’s use plain English and explain these ideas in very simple ways. We can even come up with ways to tell stories to teach the concepts so that even a five-year-old could learn them.

Speaking of five-year-olds and of being practical, I was given the following test to see whether one can think practically. Here it is: How do you put a giraffe into a refrigerator? The answer is at the end of the post, but please do not look before you come up with your own solution. I thought about it for five minutes and came up with a method about as simple as putting a man on the moon. That evening, I saw my little niece Giorgia drawing a picture of the family dog, depicting him with 9 legs and 2 enormous eyes. I thought she would be an ideal person for the giraffe test, so I asked her very innocently: “Giorgia, how do you put a giraffe into a fridge?” She looked up, gave me a big smile, jumped from her chair, and ran to the fridge. Moral: you can never beat the creativity of a five-year old!

Question: How do you put a giraffe into a refrigerator? Answer: You open the door and put the giraffe in.

Ten questions and things to know about financial literacy

While on vacation under the Italian sun, I was asked a lot of questions about financial literacy. Rather than writing a blog post about a single topic, I thought it might be useful to answer some of the questions I’ve been asked in order to hit on a lot of general information about financial literacy. So, here is my list of the top ten questions and things to know about financial literacy:



1) What is financial literacy?

Financial literacy is like reading and writing. It is the knowledge of basic but essential concepts that are needed to be able to operate in today’s society.



2) How do I know whether I am financially literate?

You can take a test here:

http://www.rand.org/labor/centers/financial-literacy/widgets/financial-knowledge-test.html



3) How do I compare with respect to others?

The above test will tell you how the average American responded to five financial literacy questions. If you live in the U.S. and you want to know how financially literate people in your state are, check here:

http://www.usfinancialcapability.org/



4) How does financial literacy in the United States (or Italy) compare with respect to other countries?

We have done a comparison of financial literacy across eight countries (the U.S., Italy, Germany, the Netherlands, Sweden, Russia, Japan, and New Zealand). In a nutshell, the world is flat in terms of financial literacy! You can read about this work here (warning: these are long papers but still fun to read)

http://www.financialliteracyfocus.org/academics/FLatW.html



5) Why should I become financially literate? Can’t I be happily ignorant?

There are costs of being financially illiterate. Studies show that those who have low financial literacy are less likely to take advantage of the opportunities offered by financial markets (for example, refinancing mortgages when interest rates go down or getting higher returns by investing in stocks and bonds), are less likely to invest in mutual funds with low fees, and are more likely to have problems with debt and to pay higher borrowing costs. Overall, ignorance is not bliss.

An overview of these studies is provided in this paper:

http://www.financialliteracyfocus.org/files/FLatDocs/Lusardi_Mitchell_Overview.pdf



6) Where do I go for information if I want to improve my financial literacy?

For readers in the United States, a reliable and independent source of information is www.mymoney.gov. One of the best web sites for financial literacy is New Zealand’s national site. Here is the link (after all, we are going global!):

http://www.sorted.org.nz/



7) What if I want to have fun while I’m learning?

Excellent idea! Doorways to Dreams has designed financial literacy games, so you can become financially literate while having fun. Here is their financial entertainment website:

http://financialentertainment.org/



8) What do I do to promote financial literacy and to become financially literate?

Ask for financial literacy programs in your school, your workplace, and your local library. Become an ambassador for financial literacy.

Three examples of initiatives or tools to use are here:



http://www.math.dartmouth.edu/~mqed/FinancialLiteracyProject/



http://nyse.nyx.com/financial-fitness-kit



http://www.finra.org/Newsroom/NewsReleases/2011/P122886



9) Who is promoting financial literacy? Just academic nerds like you?

Are you kidding me? Here is a list of people (and one puppet) who are promoting financial literacy.

(i) Elmo, puppet and TV celebrity (for you younger readers):

http://video.nytimes.com/video/2011/04/15/business/100000000776361/talking-money-with-elmo.html?hp



(ii) Ben Bernanke, Chairman of the Federal Reserve. You can read one of his recent speeches here:

http://www.federalreserve.gov/newsevents/testimony/bernanke20110420a.htm



(iii) Ray Lewis, football star. You can read about one of his talks here:

http://articles.nydailynews.com/2011-04-29/sports/29510296_1_ray-lewis-uaf-financial-literacy



(iv) Both President Bush and President Obama have been supporters of financial literacy, via, for example, the President’s Advisory Council on Financial Literacy

http://www.treasury.gov/resource-center/financial-education/Pages/Advisory.aspx



10) Are there any big initiatives happening on financial literacy?

Yes, there are many. One important initiative is that of the OECD (Organisation for Economic Cooperation and Development). Starting in 2012, the OECD’s Programme for International Student Assessment (PISA) will measure financial literacy among 15-year-olds in 19 countries. You can read more about this important initiative here:

http://www.pisa.oecd.org/dataoecd/8/43/46962580.pdf

No Roman Holidays

I am in Italy where, it has been said, even the statues go on vacation in August. While this is the feeling one normally gets in the summer, the Italian government, under pressure from the European Central Bank, has just—in a short period of time—put together a series of decisive reforms. Little was left untouched, from cuts that reached into the pockets of politicians, from whom many privileges have been taken, to the abolition of small provinces to reduce the costs of local governments to tax increases —including a new “solidarity fund” which will require temporary tax increases for those whose income is above 90,000 Euros—to increases in the pension age for women (a gradual move from age 60 to age 65).



This was no Roman holiday (for those of you who have seen the wonderful movie with Audrey Hepburn and Gregory Peck) for the Italian politicians, who have used all of the tools at their disposal to rein in the deficit and tackle a public debt as high as 120% of GDP. And for those who think these are the reforms that Socialist Europe makes, I want to remind readers that Italy, in fact, has a right-wing government. For those who wonder why this was not done before, I would argue that this is a good way to use a severe crisis (no crisis should be wasted) to convince both citizens and politicians that changes are necessary.



The reason I have chosen this topic for this blog posting is that in many countries around the world the crisis has profound consequences, with or without changes in government policies. In the newspapers, the first pages are now dedicated to economic news. Long articles are written about the reactions of the financial markets, about the spreads in the government bonds of different countries, and about the economic measures that countries have taken in reaction to a severe crisis.



This is another reason why we need financial literacy. Every day we read and hear economic news. This news is not only affecting or reflecting the macro economy but has an effect on our lives. The behavior of financial markets is affecting our savings, our cost of traveling abroad, our capacity to retire or to donate to the initiatives we deem important. Similarly, the changes in economic policies are affecting the services that we get from the government, our income, our capacity to find a job or to get a good education. We need to be able to understand what this news means, we need to be able to take advantage of the opportunities offered by the financial markets, we need to be able to understand the causes and consequences of the economic reforms that governments are proposing to us. And it is perhaps in a time of economic crisis that we need financial knowledge the most.



So, while Italy pauses during this national holiday, I am writing a new blog post about financial literacy because it is a regular Monday in other countries, because many stock markets are closing with moderate gains today, and because economic crises may even bring good things, for example new and much-needed economic reforms.



If some of you are wondering what I will do with my non-Roman holiday, I will do three things: bask in the sun, go to the opera, and of course write more blogs.

Financial literacy for politicians

I have argued in my blog postings that individuals need financial literacy because we are increasingly asked to make financial decisions that have important consequences. But there is a group for whom financial literacy is even more important, since their decisions are going to affect the whole population. These are our politicians.



As a case in point, the consequences of the standoff about the debt ceiling are severe. For the first time in history, the US debt has been downgraded from AAA to AA. This could mean higher interest rates, for example, on mortgages or car loans, and thus higher costs for many consumers. The stock market gyrated last week, dropping sharply, and it dropped more than 600 points on Monday, destroying in less than a week most of the gains that had been made slowly over many months. These are serious problems that affect real people!



When politicians make decisions with such consequential economic implications, they must be financially literate. Consumers learned about the costs of financial illiteracy during the financial crisis; politicians will likely get their lessons soon, if what they want to see is what happens to an economy in which basic economic principles are ignored.



There have been a number of statements by politicians that reveal their financial illiteracy. One example: the argument that it does not matter (or we should not care) if the world is watching or what the world thinks of how the US handles the debt ceiling. This is unfortunately wrong. A large portion of US debt is held by the Chinese, and so it does matter what other countries think of the discussion about the debt ceiling, and politicians should care—in fact, they should care a lot. Another example: the suggestion that we should let the government default to demonstrate how important it is to reign in the deficit. This is strange financial decision-making. It is the equivalent of a household wanting to burn down the house to discipline its members. I would recommend trying that strategy on a desert island but not in a country inhabited by 300 million people.



I doubt financial illiteracy is concentrated in one political party only. We have witnessed poor economic decisions a lot in the past few years. Having public debt on an unsustainable path is not only problematic, but it provides a bad example to citizens as well. Not just the federal government but also state and local governments have done a poor job in keeping their finances in order.



The decisions that politicians make have enormous implications for the economy and for all of us. We are the ones paying the cost of the decisions that are made. We should demand that the politicians we sent to represent us and who are bound to make these important decisions be financially literate and explain their decisions to us in economic terms. A fragile economy that has survived a very severe crisis and is trying to recover from a great recession needs politicians who understand basic economic principles, now more than ever.

The NFL is Back

I was very happy to hear that the NFL lockout was over, and I have been avidly reading the sports section of the newspapers. I normally read the business section, but this week I could not bear to read the discussion about the debt ceiling any longer, and it was good to go straight to the sport pages. While attending the National Bureau for Economic Research (NBER) Summer Institute last week, I startled a few economists with my conversations about football; I enjoyed that!



There are four things I like about the agreement that was reached last week:



1) Players’ safety and health. The agreement limits on-field practice time and contact. Importantly, it limits full-contact practice in the preseason and regular season. Who needs concussions? I was appalled at the statistics about injuries among football players when I read them. These are serious issues and I frankly wonder why it took so long to worry about players’ safety. This discussion has already trickled down to college football, and I was very happy to see that the Ivy League colleges have also adopted a limit to football practices to reduce head injuries. Importantly, the new agreement provides enhanced injury-protection benefits and an opportunity for current players to remain in the player medical plan for life. It also set up a fund for medical research, health care programs, and NFL Charities. These are smart features; a big thumbs up.



2) Benefits for retired players. The agreement provides additional funding for retiree benefits and sets up a fund to increase the pensions of pre-1993 retirees. This is also a good and needed program. The career of players is often very short (and cut short by injuries as well) and it is hard to accumulate a good pension during a short career (let alone think about pensions when one is 22!). We have read too many stories of players running out of money after they stop playing, and it is important to find ways to provide for the players’ future. Another thumbs up.



3) Improvements to career transition and degree-completion programs. Because, as already mentioned above, the career of players is short, it is important to provide help in their career transitions. Players have very specific skills that can be used well in sports but also in other fields, but they need help in translating those skills or simply in being connected to other fields. Some players have not completed their college education and, given the returns to higher education, it is beneficial to facilitate and help players finish their degrees. A thumbs up here as well.



4) Sharing among players. To those who believe players are greedy and want absurdly high wages, I would like to point out there are absurdly high amounts of money on the table, and the projections are for high growth in that money in the future as well. In fact, players have agreed not only to a stricter salary cap but a new fund will also be created to redistribute savings from the new rookie pay system to current and retired-player benefits and a veteran-player performance pool. And we have now heard news about Peyton Manning staying with the Colts but passing up being the highest paid player in NFL history. This will allow the Colts more flexibility to sign other players. This is the statement Manning made: “Whether I deserve to be the highest-paid player over the next five years is irrelevant. I would rather them use the money and keep the players they want to keep and get other players.” One thumbs up to Peyton Manning. Another thing I want to remind readers is that players donate generously. Many have their own charities and are very sensitive to social issues related, for example, to poverty, education, and discrimination. Because of that spillover, I would have preferred to see more rather than less money going to the players.



But the best news is that we will be able to go see the games. I am getting ready to not only watch them on TV but to go to the stadium. As for the other lockout (about the debt ceiling), I think politicians could learn a thing or two from the NFL.

Hopes for the Consumer Financial Protection Bureau

The Consumer Financial Protection Bureau (CFPB) officially opened its doors on July 21, 2011. Established by the Dodd-Frank Act, we finally have an institution that, as the name says, will be devoted to protecting consumers. This is an important milestone. It is not possible to live in a world of individual responsibility without at the same time having a structure in place to protect consumers. This is not just a political choice, it is an inevitable step to take when we put people in charge of their financial well-being. The shift in responsibility from governments and employers onto individuals has stemmed from changes in the age composition of the population (an increasingly elderly population) and in the increased mobility of the labor markets (which requires that pensions be portable), and I do not see a way of going back to a system dominated by, for example, defined benefit pensions. But consumers face a formidable task, particularly now that financial markets around the world have become very complex and the choice of financial products has dramatically expanded.

I have several hopes for the Consumer Financial Protection Bureau.

• First, I hope they will set the right expectations about what they can accomplish, in particular in the short run. Protecting consumers is a very complex task; it requires a combination of both regulation and financial education, and it will take time to get that combination right. Having the Bureau does not make people smarter overnight, and—given widespread financial illiteracy—the Bureau has a challenging task in front of it. I can already envision front-page news articles the next time we will experience financial troubles (and there is trouble to come; more on this below), which will argue that despite the existence of the CFPB, we have not prevented financial woes. Having the CFPB does not mean that consumers will not make financial mistakes or that the supply of financial products will have no flaws. While the Dodd-Frank Act provides guidelines on what the Bureau should do, it is very important to make clear what it can realistically aim to accomplish in the short run.

• Continuing on the previous point, I hope that the Bureau will devote ample attention to financial education. One of its mandates is to promote financial education but, as we know, education inevitably takes time—and no one has time; no one can wait. But, as Federal Reserve Chairman Ben Bernanke has said, “well-informed consumers, who can serve as their own advocates, are one of the best lines of defense against the proliferation of financial products and services that are unsuitable, unnecessarily costly, or abusive.” We need an institution that has the brains, the courage, and the vision to think beyond the short run. In this respect, the Bureau could set itself apart from other institutions intent on pleasing people, politicians, or voters, with no consideration for the future. Myopic policies are costly and these costs will eventually be paid (young people, be warned). Most of our financial decisions have to do with transferring resources to the future (for example to pay for expenses after retirement or for children’s college education), and we need institutions with a long planning horizon.

• Third, I hope that the Bureau will pay careful attention to what has happened during the recent financial crisis but it will also look ahead and be proactive in addressing potential future problems. There are early indications of serious problems brewing inside the Defined Contribution pension system. There are also problems regarding how people assume and manage debt. These are issues that emerge when looking at data, and is important to use that evidence for prevention.

• Finally, I hope the Bureau will focus its efforts on those who need protection the most. While everyone will benefit from the existence of the Bureau, it is clear that there are vulnerable groups in society that deserves particular attention. These groups include not only the young and the old, which have been shown to display alarmingly low levels of financial knowledge, but also women, those with low educational attainment, and African-Americans and Hispanics. Again, the data speak clearly about who the vulnerable groups are and also provide suggestions on how to protect those vulnerable groups.

The CFPB is an institution that can make a difference in people’s lives. I want to remind you that we are all consumers; we all make financial decisions; we all need fair treatment in the market and financial products that serve our needs well; we all have grandparents, children, and female and minorities friends who are part of those vulnerable groups. Personal finance is, well, “personal.” We should not forget about that, and we should take time to recognize that with the CFPB we have made one important step forward. It’s about time.