Americans aren’t saving enough for retirement. That’s a trite statement. Precisely how great the shortfall is, is in dispute, of course, as is the question of what remedies, if any, should be undertaken. But what’s the reason for this savings shortfall? Discarding specifics like “no more traditional pension plans,” there are three potential reasons, each taking some portion of the blame, and each interconnected with the other:
Americans don’t have the knowledge needed to save for retirement. Americans don’t have the self-discipline to save for retirement. Americans don’t have the excess funds to save for retirement.
“Financial literacy” is the catch-all name for initiatives around education that, it’s hoped, will remedy the first of these problems — education that, it’s hoped, will occur in schools, through high school graduation requirements which exist or are slated to come into effect in 21 states, according to Pew, but also through employer-sponsored programs, which are in place at 63% of employers according to the publication Plan Sponsor.
And just how financially illiterate are Americans? The standard measurement, as developed at the Global Financial Literacy Excellence Center (GFLEC), is a set of three questions. In May I wrote about a recent study comparing Americans’ ability to answer these questions, relative to the rest of the developed world. 74% of Americans answered a survey question about compound interest correctly (about average globally); 53%, one on inflation (the global average was 63%); and 46%, one on risk diversification (again, right about at the average).
Are these valid questions, and valid measures of financial knowledge? The experts in the field certainly believe so. But here’s the actual text of the questions:
- Suppose you had $100 in a savings account and the interest rate was 2 percent per year. After 5 years, how much do you think you would have in the account if you left the money to grow? Answer choices: more, less, or exactly $102.
- Imagine that the interest rate on your savings account was 1 percent per year and inflation was 2 percent per year. After 1 year, how much would you be able to buy with the money in this account? Answer choices: more, less, or the same as today.
- Do you think that the following statement is true or false? “Buying a single company stock usually provides a safer return than a stock mutual fund.”
The first of these seems obvious. Surely everyone ought to understand about how interest works, right? An older version of this type of survey, from 2015, has an available download that breaks down the answers given; there, 75% gave the correct answer of “more than $102,” 8% said “exactly $102,” 5% “less than $102” and 12% said “don’t know.” One might attribute the “exactly $102” answers to a careless reading of the survey question, but what of the other wrong answers? Or are these answers simply in line with general innumeracy among a certain segment of the population?
It does strike me, though, that we have lost the very basic means of learning about interest, the humble savings account. Yes, it still exists. Yes, Americans are encouraged to have a savings account. But the interest earned in the year 2018 is so low that it might as well not exist; parents who want to teach their children about the concept of interest sometimes resort instead to creating the Bank of Mom and Dad to credit interest to money their children “save.” And if you don’t have any understanding of interest, how can you likewise understand that high interest rates on money that you borrow can add up substantially?
What of the inflation/interest rate question? In the 2015 survey, 59% answered correctly, 20% said “don’t know,” and 10% each answered more or less than today.
And the final question, about mutual funds, it seems to me, showed a general lack of understanding of the term “mutual fund” with 46% answering “false,” 10% “true” and 44% replied “don’t know” — which seems believable enough. After all, if you’re offered a 401(k) at work, you might invest there. If you watch TV, you’ll see ads for E-trade and other brokers. But it’s not obvious that people would know what a mutual fund is without directly being told about them.
But when we look at issues of financial literacy and financial education, we’re really talking about two distinct topics. First, do Americans have a good understanding of how to wisely budget their money to stay out of debt and build up reserves, and, second, do Americans understand what to do with their money, that is, how to invest rather than merely save?
The reality is that Americans continue to report living paycheck-to-paycheck. In the 2015 report, only 40% of Americans reported spending less than they earned, so as to build up a cushion. Even among the college educated, only 48% reported building up savings, and among those earning $75,000 or more annually, only 53% reported this. How much of this is because they don’t understand the long-term effect of debt, and the cost of interest?