State “Capital”

By Nevin Adams, EBRI

Adams

This past week I had the opportunity to attend the National Financial Capability Study Roundtable, where a variety of researchers (including EBRI’s Sudipto Banerjee) presented, discussed, and challenged a variety of research papers on topics ranging from financial literacy and retirement planning to financial advice, and from financial literacy and financial behavior to “Prohibition, Price Caps and Disclosure.” Taken as a whole, the day’s discussions focused on ways to better understand and measure the factors that appear to influence individual behaviors regarding their finances.

Simply stated, financial literacy is generally described as the ability to understand finance. More recently, some have begun to focus on financial capability.¹ Research has shown that people with higher levels of financial literacy approach retirement with much higher levels of wealth. However, a growing body of research also suggests that most Americans have limited knowledge about concepts such as inflation, compound interest, and risk diversification at a time when they face an increasingly complex financial planning process alongside an expanding set of saving, investment, and decumulation options.

Drawing on data from the National Financial Capability Study (NFCS),² designed by the FINRA Investor Education Foundation (an ASEC-member firm), Dr. Banerjee’s report³ noted that the chances of having a bad financial behavior decreases with age, and that the chances of exhibiting a bad financial behavior go down with education and income. Interestingly enough, full-time and part-time workers, homemakers, sick or disabled, and unemployed or laid-off individuals were all more likely to have bad financial behavior than self-employed people.

That said, the report specifically examined the role of where you live—specifically the state in which individuals live—in explaining financial literacy and behavior. It also ranked all U.S. states in terms of financial literacy and financial behavior of its residents.

Financial literacy and financial behavior are strongly associated with an individual’s age, income, education and other demographic characteristics. The study shows that, after controlling for the effect of these individual demographic characteristics, most bottom-ranked states had a statistically significant effect on their residents’ financial literacy and almost all states have a statistically significant effect on their residents’ financial behavior. However, the chance of exhibiting “worse” financial behavior increased as the financial behavior ranking dropped.

According to the report, this suggests that there might be factors shaping individual financial literacy and behavior other than individual demographic characteristics–and they might be influenced by the state in which people live.

Notes

¹ The National Financial Capability Study identifies four key components of financial capability as (1) making ends meet, (2) planning ahead, (3) managing financial products, and (4) financial knowledge and decision-making. The report is online here.

² The National Financial Capability Study is available online here.

³ Banerjee’s paper, including the state rankings, is online here.  See also “How Do Financial Literacy and Financial Behavior Vary by State?” in EBRI Notes, November 2011, online here.

What’s Next?

By Nevin Adams, EBRI

Adams

In just a couple of weeks, tens of thousands of students (including a daughter of mine) will graduate from college. For most, it’s a journey of joys, trials and tribulations, an education, not just from a textbook or a professor’s wisdom, but the insights that one can only get from actually living through a different stage of life. Those students set out upon that journey years ago, and, doubtless following careful deliberation and the counsel of friends, families, and a few trusted advisors, a course was set. A course that many “adjusted”—by choice and sometimes of necessity—over the course of the last few years, but a course for their future, nonetheless.

Now the question is—what will they do next?

As parents, we spend a lot of time, energy, and money trying to help our children make good choices, but at a certain point, most of us step back, grit our teeth (and sometimes close our eyes), and hope that they do. Those decisions aren’t always the ones we would make—but, ready or not, they are made, sometimes for the better, sometimes not.

Similarly, this industry has expended a lot of time, energy, and money over the years to try and help individuals make good decisions about preparing for retirement. A growing number of individuals are now entering this new stage in their lives, and we ask ourselves, “Are they ready?”

In answer to that question, we can look at their individual situations and make certain projections about that readiness, based on their health, their gender, their income levels pre-retirement, and their likely levels of spending post-retirement, among other things.(1)   But what will ultimately matter is what they do next—and that’s a factor not just of how much savings they have (or think they have) at the point of retirement, or the amount of other resources they may have available then (and thereafter), but how those resources are now invested, how they are invested over time, and how—and when—those resources are spent.

The factors that influence those decisions, as well as their results and potential consequences will, of course, continue to be a key focus for EBRI(2)  in the years to come—just as EBRI’s nonpartisan gathering, analyzing, and modeling the impact of behavioral, plan design, and regulatory influences has provided critical insights on those individual preparations for nearly 35 years now.

It matters because knowing what this generation does “next” is likely to be an important part of helping the next generation do better.

Endnotes

1) See the July 2010 EBRI Issue Brief for more information on the EBRI Retirement Readiness Rating,™ online here.  The 2010 update uses the most recent data and considers retirement plan changes (e.g., automatic enrollment, auto-escalation of contributions, and diversified default investments resulting from the Pension Protection Act of 2006) as well as updates for financial market performance and employee behavior (based on a database of 24 million 401(k) participants). Results will be updated next month, in our May EBRI Notes.

2) More information on the EBRI Center for Research on Retirement Income is available online here. For information about becoming a Research Partner, contact Nevin Adams, at nadams@ebri.org