12/6/2013 4:30 PM ET|
15 ways financial decisions cost us
Decisions about money are some of the hardest we make in our lives. Do you have all the information you need to make sound financial choices?
Chances are, you sweat over how to pay the bills, keep a roof over your head and maybe set aside a few bucks for a retirement that seems to recede further in the distance with every birthday you celebrate. While you've been going about your life, a small army of economists and behavioral researchers have been studying what you do and don't do, what you know about finances and how you make important money decisions.
Foremost among them are academics Annamaria Lusardi at the George Washington University School of Business and Olivia S. Mitchell at the University of Pennsylvania's Wharton School. Frequently doing joint research projects, the two have amassed an enormous body of work about the level of consumer financial literacy, which is generally abysmal, its consequences and what we should do about it.
Their findings are important to consumers for two powerful reasons: First, if people understand exactly what their poor decisions cost them, perhaps they'll do something about it, and second, the experts' views on consumer behavior increasingly wind up turned into a law that forces consumers to do certain things because they're deemed not capable of making good decisions on their own. Welcome to the world of behavioral economics.
In a recent paper for the National Bureau of Economic Research, Lusardi and Mitchell reviewed the growing research evidence of how low levels of consumer financial literacy lead to money-losing decisions. Here is a "hit parade" of sorts of how we shortchange ourselves:
- Those who are more financially literate are also more likely to undertake retirement planning, and those who plan also accumulate more wealth.
- More financially literate individuals are more likely to choose pension accounts with lower administrative fees.
- More financially sophisticated individuals are less affected by the choices of peers in their financial decisions.
- Even just learning about the concept of compound interest produces a sizeable increase in pension contributions.
- Those with lower incomes and less education (characteristics strongly related to financial illiteracy) are less likely to refinance their mortgages during a period of falling interest rates. The cost of such inaction is $50 billion to $100 billion a year in higher mortgage interest payments.
- Those unable to correctly calculate interest rates end up borrowing more and accumulating less wealth.
- The least financially savvy incur high transaction costs, more for products, services and related fees.
- The least literate are also more likely to borrow against their 401k and pension accounts.
- Those who are less financially literate are substantially more likely to use high-cost methods of borrowing, such as payday loans, pawn shops, auto title loans, refund anticipation loans, and rent-to-own shops.
- Financial literacy can explain more than half the wealth inequality observed in U.S. data.
- In a Dutch study, being in the 75th versus the 25th percentile of a financial literacy index was equal to about 3.5 times the annual net disposable income of a median Dutch household.
- The least financially literate are more likely to pay higher investment fees and expenses.
- Of course, the least financially literate also left the stock market and have stayed away, costing them about 4 percent of their wealth as market values recovered from the recession.
- Failing to have a diversified investment portfolio costs financially inexperienced investors a substantial amount of investment income.
- The average credit-card fees paid by those with low knowledge are 50 percent higher than those paid by the average cardholder.
The decision-making landscape to prepare for retirement is particularly challenging, according to Lusardi and Mitchell. "Retirees must look ahead to a future of uncertainty when making irrevocable choices with far-reaching consequences. For instance, people must forecast their (and their partner's) survival probabilities, investment returns, pension income, and medical and other expenditures," they write.
"Moreover, many of these financial decisions are once-in-a-lifetime events, including when to retire and claim one's pension and Social Security benefits," they note in their paper. "Accordingly, it would not be surprising if financial literacy enhanced peoples' ability to make these important decisions later in life."
While there have been gains in school-based financial literacy courses, research findings give broad-based educational efforts low marks. To be effective, financial education must be targeted to the precise needs of those being taught. And it should go into some detail about personal finance as well.
It is tempting to say that financial literacy is generated by personal needs. A high-earning individual who wants to invest in the stock market is more likely to learn about investing than a lower-income person with no funds to invest. However, the two economists say, financial literacy also improves outcomes in its own right. "The causality goes from knowledge to behavior," they write.
More from U.S. News & World Report:
VIDEO ON MSN MONEY
I'm a little leery of think-tank solutions that aren't rooted in the real world. But most of those fifteen points sound plausible even if they don't offer much tangible help. Apparently their main message is: become more financially literate!
I'm most leery of suggestion #13 - playing the Stock Market. The Stock Market is a gamble that can minimize its risk over long exposure, but it's not a sure bet. Don't forget that 4% regain after its 2008 tumble was after major losses that most people took. Will it continue to gain? Maybe, maybe not, but if you look at Stock Market performance it is not a linear rising line like this article implies. So I prefer to play only with money that I can afford to lose. I'm not saying don't play the Stock Market - I'm saying be careful and don't get swept up into market fever.
Someone - I give you a "thumbs up" for your first comment about think tanks not having all the answers.
Yet I am deeply troubled by your second paragraph. If you "play" the stock market, or believe it can be played, you are lost. Smart people "invest". That's not a subtle distinction. You find good companies with strong, repeatable earnings, and ignore all the chicken little's. When the 'market' drops, you take it as a gift to buy more of your favorite companies. That's an oversimplification in a short paragraph, but that's the general idea. I've educated myself entirely for free using the public library, MSN Money, and Motley Fool.
Free Homesteads: Attn. Secretary of State: John Kerry,
We have heard of the Revolutionary War and the reward of 20 acres for $25 dollars. Again we have heard of thee Amish and Covenant Communities. We have also heard of Jimmy Carter and Habitat for Humanity. We of recent times, have once again heard of the Homestead Act in Alaska at 20 acres for $25 dollars, with the stipulation you must dwell there (with cabin fever) for 20 years to own the property. We have in this economy, foreclosures for peanuts on the dollar? You recently heard of selling and buying a home, by lottery, that I hope will be tax exempt. Yet there has always been Biblically "God's Portion" that has been allotted to Mankind. "The Lord will Provide" but how do we tap this inexhaustible resource to attain a free, dignified home? One is to recognize your enemies... your employer! Your Banker! And just plain "saboteurs" of our inklings of hope. Once you realize there are enemies encamped around you and there is a Supreme Being of Promise, your mind will be free to seek and find your needs met. Just imagine your "sweetheart" is pregnant and life becomes a panic, for "the son or daughter of man, to rest ones head." The only logical option is an abortion, being pregnant (un-planned) out of wedlock. Sadly enough, too many of us are first ashamed of poverty and then the option of abortion. One claims: "Faith without works, is dead!" This is a lousy enslaved application of begging for a free promise, that we must climb the ladder to the median income, aka: "the old boys network." Meaning thee old boys, are ruthless, cruel, murderers, even of their own offspring. If free homesteads cannot be implemented, then there is no sane reason to believe in God! We might as well become Atheists, not as onto Job, but as a birthright, like just having a head, heart, and soul. I still believe the Supreme Being is the answer. Wasn't this already described to us in: "The Adventures of Marco Polo" and Jenghis Khan's invention of lire (money) backed by commodities (like magnets) and Jesus proclaiming: "greater exploits will we do than Him" in His meekness (wishing paradise upon us). So we have all these equations presented to us and plenty of vacant land, and computers that database most of our work for us, such as the multi-million people out of work or unemployed. Can not we allot by International Bonds homesteads for people in need or "House Stamps" that bear fruit with unstifled peace of mind and proper conduct and ability and talent, that people without homes, bloom in righteousness, for themselves and for mankind. Just like, without this computer, I could not create and interact with the huddled masses. "Paul planted, Apollus watered, and God giveth the increase." This is a pilgrim duty to write this letter. There are Free Homesteads with slavery, let us be duty-bound to conceive and receive them. These are just the first steps, you will bear fruit in your "Rocky Road Brownie Recipe:" Nigella Lawson. God made us Equal.
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