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

• by
• Annamaria Lusardi
• (Dartmouth College Harvard Business School)
• Federal Reserve Bank of Cleveland
• April 25, 2008

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Motivation

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

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Questions

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

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Theoretical framework

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

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A Famous Permanent Income Consumer

• When he won the Nobel prize in Economics, Milton
  Friedman was asked how he would spend the prize
  money.
• He replied I have already spent most of it

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Four pieces of empirical evidence

• Lack of retirement planning
• Lack of information about components of a saving
  plan
• Lack of financial literacy
• Lack of financial advice from experts

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Retirement Planning (50)

• Tried to plan
• Have you ever tried to figure out how much your
  household would need to save for retirement?

Developed a plan Have you developed a plan for
retirement saving?
Stuck to the plan How often have you been able
to stick to the plan?
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Prevalence of retirement planners
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Planners accumulate more wealth

Median Net Worth
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Information about pensions and SS

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

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Financial literacy

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

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Measuring financial literacy (TNS survey)

• Suppose you owe 1,000 on your credit card and
  the interest rate you are charged is 20 per year
  compounded annually. If you didnt pay anything
  off, at this interest rate, how many years would
  it take for the amount you owe to double?
• 2 years
• Under 5 years
• 5 to 10 years
• More than 10 years
• Do not know
• Prefer not to answer

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Measuring financial literacy (TNS survey)

• You owe 3,000 on your credit card. You pay a
  minimum payment of 30 each month. At an Annual
  Percentage Rate of 12 (or 1 per month), how
  many years would it take to eliminate your credit
  card debt if you made no additional new charges?
• Less than 5 years
• Between 5 and 10 years
• Between 10 and 15 years
• Never
• Do not know
• Prefer not to answer

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Measuring financial literacy (TNS survey)

• You purchase an appliance which costs 1,000. To
  pay for this appliance, you are given the
  following two options a) Pay 12 monthly
  installments of 100 each b) Borrow at a 20
  annual interest rate and pay back 1,200 a year
  from now. Which is the more advantageous offer?
• Option (a)
• Option (b)
• They are the same
• Do not know
• Prefer not to answer

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Financial advice

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

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Literacy?Planning?Wealth
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Takeway points

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

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Three initiatives to promote saving and
participation to pensions

• Financial education programs
• Automatic enrollment
• Simplification of saving decisions

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Financial education programs

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

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Total sample 1st quartile median 3rd quartile
a. Financial net worth
Total sample 17.6 78.7 32.8 10.0
Low education 19.5 95.2 30.0 8.8
High education 13.1 70.0 19.4 10.2
b. Total net worth
Total sample 5.7 29.2 8.7 0.5
Low education 3.4 27.0 7.1 4.0
High education 7.3 26.5 6.5 3.6
c. Total net worth Pensions and Social Security
Total sample 16.0 18.6 20.4 17.2
Low education 12.7 14.7 12.7 9.5
High education 17.7 25.4 25.8 17.0

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Automatic enrollment into pensions

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

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New Ways to Make People Save (Lusardi, Keller and
Keller)

• Use surveys, focus groups and in-depth interviews
  to understand barriers to saving and
  participation to pensions
• Developed a planning aid
• Distributed to new hires at a non-for-profit
  institution

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Most people plan on electing a supplemental
retirement account, but feel they dont have the
time or information right now. We have outlined
7 simple steps to help you complete the election
process. It will take between 15 30 minutes,
from start to finish. It will take
less time for you to start to insure
your future than it takes you to unload your
dishwasher!

• Dont give up! Contact the Benefits Office
  (6-3588) if for any reason you could not complete
  the online application.

It takes no time to prepare for your lifetime!
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Program Effectiveness
30 days After Hire 60 days After Hire Number of Observations
Control Group 7.3 28.9 210
7-Step Planning aid 21.7 44.7 166
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A few more ideas

• Simplification of saving decisions can be
  effective and is often cheap
• Suggestions from experts
• Information/marketing campaigns
• Financial driving license

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Want to read more?

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