AEI event targets financial illiteracy

WASHINGTON — Few people are financially literate enough to cope with saving and investing for retirement, and the…

WASHINGTON — Few people are financially literate enough to cope with saving and investing for retirement, and the problem is worse for women, minorities and low-income people, a Dartmouth College economics professor said at a meeting here June 14.
Many people are unfamiliar with the basic economic concepts needed to make savings and investment decisions, such as the effects of compound interest, inflation and risk diversification, Annamaria Lusardi said at the American Enterprise Institute for Public Policy Research meeting titled “Financial Literacy and Planning: Implications for Wellbeing,” while presenting her findings on financial literacy.
The AEI is a Washington-based free-market-oriented think tank.
Segmenting the population
Those people are less likely to save and invest for retirement, Ms. Lusardi said during a panel discussion. The problem is worse for women, older people and minorities, even when income and education levels are accounted for, she said.
Segmenting the population to provide simplified education programs for groups that are less financially literate should be employed, Ms. Lusardi said.
In addition, “a market for financial advice might be important,” she said.
“This market is pretty small at the moment,” Ms. Lusardi added. “I don’t think that we should transform everybody into a financial expert.”
The consequences of financial illiteracy can be grave, because people can make mistakes they won’t be able to overcome, Christopher Carroll, an economics professor at Johns Hopkins University in Baltimore, said during the panel discussion.
Requiring people to annuitize their 401(k)s and other retirement savings when they reach retirement age would help alleviate the problem of poor planning, he suggested. The government could encourage that by allowing tax deductions only for 401(k) or other pension contributions that are pledged to annuities in advance, Mr. Carroll said.
Some studies have shown that 65-year-olds who are asked how much they could spend annually over their lifetimes if they had $1 million “tend to say things like $300,000, $400,000 a year,” he said.
“Having a requirement that they annuitize means that they will know what the answer is to that question” by ensuring they will have enough income for life, Mr. Carroll said.
Requiring disclosures to let people know about how much money they will have at retirement, based on current savings levels, should be considered, as well, he said.
Employer-based programs?
Providing people with financial education, such as through employer-based education programs, can lead them to plan and to save better, University of Chicago international business and economics professor Steven Davis said during the panel discussion.
“That might then give them the wherewithal to make plans. They then start to accumulate some wealth,” Mr. Davis said.
“As they accumulate wealth, it becomes more valuable to them to think more carefully about how they manage their financial assets,” he said. “This can lead to very different wealth accumulation behavior.”
Automatic enrollment in employer pension plans using default investment options designed by experts can overcome many of the problems of financial illiteracy, Mr. Davis said. That approach “preserves individual choice [and] individual liberty,” since workers can elect not to participate in the plans.
Allowing some type of personal accounts in the Social Security system would “encourage people to think actively about planning for their own future. If you just give them a defined benefit, as our current Social Security system [does], you make them wards of the state,” Mr. Davis said.
A personal-account system “is a device for encouraging people to become informed and to plan for the future. I think that’s the right path to take to try to mitigate these financial illiteracy problems,” Mr. Davis said.