Category Archives: Financial Literacy

Qualitative Research Proposal on Attitudes Toward the Working Poor

This is a research proposal that I completed on 2017-12-06 for the class, EDF 7475: Qualitative Research in Education taught by David Boote, Ph.D. at University of Central Florida. Note that I do not intend to conduct this research.

EDF 7475 Qualitative Research Proposal on Attitudes Toward the Working Poor
Richard Thripp
University of Central Florida

Financially, many Americans are not only unprepared for retirement, but also the day-to-day surprises of life. When Americans are asked whether they can “come up with” $2000 within 30 days, nearly half say they could “probably not” or “certainly not” do so (Lusardi, 2011). While this is troubling, one way we can shed light on this phenomenon is to research Americans’ approach to saving and perceptions toward others who are financially struggling.

Purpose

My proposed study is to conduct semi-structured interviews with working-class and privileged Americans about their approach toward saving and their perceptions of others who are struggling financially. My interest here was crystallized from analyzing employee–employer reviews of Rent-A-Center (Glassdoor, 2017) that I selected for complaints about taking advantage of customers (e.g., repossessing children’s beds). However, to my surprise, when coding these interviews, there were more statements deriding the customers as “liars and thieves,” the “worst specimens of humanity,” and as deserving their fates due to their lack of personal responsibility. While in part, this may be due to racism toward African Americans (Gilens, 1996), surprisingly, welfare recipients themselves may tend to consider other welfare recipients “dishonest and idle” (Bullock, 1999). The purpose of this study is to learn, via qualitative methods, about attitudes toward people with financial difficulties from individuals of two socioeconomic strata. A semi-structured interview approach will yield richer data and useful insights that would not appear in a simple questionnaire.

Research Questions

1. What are privileged and working-class Americans’ thoughts toward others who are financially struggling, and how do these attitudes differ between group?
2. How do privileged and working-class Americans differ in their approaches to saving?

Significance of the Project

This study will contribute to research on financial psychology, such as with respect to spending behavior (e.g., Soman, 2001). A wealth of survey data shows a lack of financial literacy in the United States, Europe, and beyond (Lusardi & Mitchell, 2014). Educators and policymakers erroneously presume that financial education is efficacious (Fernandes, Lynch, & Netemeyer, 2014). Meanwhile, inequity in the United States is growing at a breakneck pace, which financially disenfranchises a large proportion of the population (Lusardi, Michaud, & Mitchell, 2017). Looking at differences between the rich and poor in their beliefs about the financially downtrodden may yield useful insights.

Literature Review

When comparing the working poor to the financially privileged, it is important to recognize the two groups are not at all on equal footing. For instance, while using a tangible or immediate payment method like cash or a debit card results in reduced spending (Soman, 2001), the tendency for the working poor to use debit cards, rather than credit or charge cards, engenders delinquency and overdraft fees. Stango and Zinman (2009, 2014) lament that consumers pay an annual average of about $150 per checking account in overdraft fees, and more than half of these are “avoidable,” meaning the consumer has funds available elsewhere that could have paid for their purchase. Moreover, the working poor are disproportionately affected, which may be due to a lack of attention due to many other pressing financial concerns (Stango & Zinman, 2014), and because a $35 overdraft fee does not scale with financial privilege. In fact, banks may be more willing to refund such a fee for those who need it least.

Lusardi and Mitchell (2014) discuss a saddening finding from the U.S. Financial Capability Study (www.usfinancialcapability.org): While 70% of Americans rate their financial knowledge highly, only 30% can actually answer a small number of quite basic financial questions correctly. Less education and being in a vulnerable group, such as African Americans, women, young or old, and rural residence, are all correlated with less financial literacy and by consequence, financial struggles. At a macro level, this undermines American economic stability and perpetuates wealth inequality, including the subjugation and disenfranchisement of vulnerable and protected groups (Lusardi et al., 2017).

Sadly, financial education courses, at least in their present form, do not have lasting beneficial impact on financial behaviors (Fernandes et al., 2014; Mandell, 2012). On the other hand, regulatory reforms (Grubb, 2015) and “nudging” the working poor toward better choices (Thaler & Sunstein, 2008) have merit. However, a complete analysis of the plight of the financially disadvantaged must include our attitudes and attributions. Financial education may implicitly embody these perceptions, thereby patronizing and alienating its intended population, or at the very least, lacking relevance.

Americans tend to have negative attitudes toward the poor. If they believe in the Protestant work ethic or the “just-world” hypothesis, which claims that good and evil actions are eventually rewarded or punished, they may be more likely to blame the poor for their situation (Cozzarelli, Wilkinson, & Tagler, 2001). Individuals who are homeless have been shown to be stigmatized as much or more than the mentally ill, with a general attitude that they should blame themselves for their situations (Phelan, Link, Moore, & Stueve, 1997). “Black welfare mothers” are stigmatized and derided far more than their white counterparts, in part because of availability bias due to politicization (Gilens, 1996). While welfare recipients tend to blame structural rather than individual factors for poverty, they surprisingly view other welfare recipients as dishonest and lazy to a greater extent than middle-class respondents (Bullock, 1999). This finding is in line with my observation of Rent-A-Center employees’ (Glassdoor, 2017) derogatory views toward customers, given Rent-A-Center is not a high-paying job and thus most employees could be classified among the working poor. Attitudes toward poverty, including differences between the poor and financially advantaged, deserve further inquiry.

Research Methods

My research will be organized around in-person semi-structured interviews from purposefully sampled participants who volunteer for this research by responding to solicitations.

Research Site

The research site will be my office, Education Complex, Room 123L, at the University of Central Florida. I share an office with other doctoral students, but will coordinate with their schedules to conduct interviews when I have the room to myself. Because personal finances can be a sensitive topic, this setting may be preferable to a public setting (e.g., a cafeteria) because it offers more privacy. In the office, I will interview participants across a small desk. I will use an audio recording app on my smartphone and a printed interview protocol attached to a clipboard, with space to jot down notes with a pen. This is much less intrusive than taking notes on computer or mobile device during the interview.

Researcher’s Role

I will be interviewing the participants using a semi-structured interview protocol that I developed, conducting brief follow-up contacts with participants for member checking, and conducting analysis and interpretation of the data which will include my rough notes, field notes, and audio recording of the interviews (Creswell & Poth, 2017). Overall, my positionality is as a financial expert and researcher who advocates for educational interventions and industry reforms that benefit the working poor. One weak spot is that I am not personally familiar with having financial difficulties, so it is somewhat challenging to relate to the working poor.

Sampling Method

I will solicit participants via advertisements posted in the Education Complex at UCF and at a nearby country club or other place where privileged people congregate. I may also use email or web solicitations. All solicitations will funnel prospective participants into a Qualtrics questionnaire which will use deception (with approval from the UCF Institutional Review Board) to hide the primary purpose of the research; namely, searching for differences in attitudes toward the financially disadvantaged between working class and privileged individuals. The Qualtrics questionnaire will frame the purpose of the research in general terms about Americans’ attitudes toward saving. Several questions about prospects’ financial and work situations will be included, ostensibly to gauge the financial situation of Americans. I will use responses to these questions to select a number of privileged and working-class participants to contact.

To define the construct of privileged versus working class, I will ask these questions:

1. What is your annual income?
a. $1 – $29,999
b. $30,000 – $74,999
c. $75,000 – $149,999
d. $150,000 or more

To what extent do you agree with the following statements? [Each question will be on a 1-5 Likert-type scale from Strongly Disagree to Strongly Agree]

2. I could come up with $2000 within 30 days (Lusardi, 2011).
3. I could stop working for a year and live comfortably on either accumulated savings or income from a pension, gifts from family, et cetera without going into debt.
4. I have not had significant financial difficulties in life.

Participants who have higher incomes and agree who tend to agree with the latter three questions will be considered privileged, while others will be considered working class. Participants may be any age 18 or older. I may aim for rough parity in age between groups, but am not specifically interested in age differences (nor gender, ethnicity, etc.) so this would not be preeminent.

Data Collection Methods

When contacting prospects, I will offer participants an incentive of $20 to participate in a 30-minute face-to-face interview at my UCF office. This will be explained as furthering research on financial literacy, education, and attitudes for the public’s benefit. I would likely invite 10 participants per group (privileged and working class) with a goal of five final interviews per group. Because these would already be “warm” prospects who completed a Qualtrics questionnaire that mentioned an in-person interview, conversion rates should be relatively high. For certain participants on an as-needed basis, I may conduct some interviews via recorded telephone call or Skype video chat.

Interviews will be semi-structured, first with the icebreaker question, “what would you do if you received $10,000 unexpectedly right now?” There may be interesting differences between groups in their approach to handling a small windfall. The remainder of the interview will use these guiding questions:

1. Tell me about your approach to saving money.
2. Have you had significant financial struggles in your life?
3. How do you feel about others who are financially struggling?

I will listen carefully to what participants say. Although my research questions are the primary interest, if the interview diverges, this may also be of interest. At the conclusion I will ask them to verify what I have written down (member checking) and I will take notes or make corrections as appropriate. Immediately after I will write up field notes. Later, I will transcribe the audio recording. Subsequently, I will perform thematic coding on the interviews. I anticipate an emergent coding process whereby one or several interviews are coded prior to conducting the rest of the interviews with an interview protocol that may be revised based on prior findings.

I will also be asking participants if they are interested in an optional follow-up interview which can be in-person, by phone, or Skype. Then, I hope to conduct at least one follow-up interview per group to collect more data based on findings that emerge from initial interviews.

Analysis and Trustworthiness

Data analysis plan. I will set the stage for data analysis with detailed field notes and transcripts. Then, I will code the interviews iteratively for meaningful and noteworthy statements. These will be clustered into themes regarding participants’ attitudes toward the financially struggling, in–out group bias, approaches to saving, feelings of self-determination or external locus of control, et cetera. The goal will be to reach thematic saturation, thereby exhaustively describing the phenomenon and enabling analysis of its structure (Creswell & Poth, 2017). This will be an iterative process with revisions between interviews, as I do not expect to conduct all 10 interviews at once.

Establishing validity and trustworthiness. These will partly be established from member checking at the conclusion of interviews, iterative revisions between interviews to address shortcomings, and in at least one follow-up interview per group (privileged and working poor). Conducting interviews in a private, in-person setting may enable trustworthiness by encouraging participants to be frank about their attitudes toward the working poor. Participants will have already completed a sorting questionnaire via Qualtrics, and will be assured their responses will be kept anonymous by use of aliases and, when published, masking or alteration of information that might give away their identities. In particular, this may be important for privileged participants who may be community figures. Overall, the insights from this qualitative investigation should be both practical and entertaining, with a level of validity and trustworthiness comparable to or exceeding that of similar qualitative research.

References

Bullock, H. E. (1999). Attributions for poverty: A comparison of middle-class and welfare recipient attitudes. Journal of Applied Social Psychology, 10, 2059–2082. https://doi.org/10.1111/j.1559-1816.1999.tb02295.x

Cozzarelli, C., Tagler, M. J., & Wilkinson, A. V. (2001). Attitudes toward the poor and attributions for poverty. Journal of Social Issues57, 207–227. https://doi.org/10.1111/0022-4537.00209

Creswell, J. W., & Poth, C. N. (2017). Qualitative inquiry & research design: Choosing among five approaches (4th ed.). Thousand Oaks, CA: Sage.

Fernandes, D., Lynch, J. G., Jr., & Netemeyer, R. G. (2014). Financial literacy, financial education, and downstream financial behaviors. Management Science, 60, 1861–1883. https://doi.org/10.1287/mnsc.2013.1849

Gilens, M. (1996). “Race coding” and white opposition to welfare. The American Political Science Review, 90, 593–604. https://doi.org/10.2307/2082611

Glassdoor (2017). Rent-A-Center Employee Reviews. Retrieved from https://www.glassdoor.com/Reviews/Rent-A-Center-Reviews-E3914.htm

Grubb, M. D. (2015). Consumer inattention and bill-shock regulation. Review of Economic Studies, 82, 219–257. https://doi.org/10.1093/restud/rdu024

Lusardi, A. (2011, December). Why are Americans so bad at saving? Retrieved from https://www.npr.org/sections/money/2011/12/19/143961175/why-are-americans-so-bad-at-saving

Lusardi, A., Michaud, P.-C., & Mitchell, O. S. (2017). Optimal financial knowledge and wealth inequality. Journal of Political Economy, 125, 431–477. https://doi.org/10.1086/690950

Lusardi, A., & Mitchell, O. S. (2014). The economic importance of financial literacy: Theory and evidence. Journal of Economic Literature, 52, 5–44. https://doi.org/10.1257/jel.52.1.5

Mandell, L. (2012). School-based financial education: Not ready for prime time. CFA Institute Research Foundation, 2012(3), 107–124.

Phelan, J., Link, B. G., Moore, R. E., & Stueve, A. (1997). The stigma of homelessness: The impact of the label “homeless” on attitudes toward poor persons. Social Psychology Quarterly, 60, 323–337. https://doi.org/10.2307/2787093

Soman, D. (2001). Effects of payment mechanism on spending behavior: The role of rehearsal and immediacy of payments. Journal of Consumer Research, 27, 460–474. https://doi.org/10.1086/319621

Stango, V., & Zinman, J. (2009). What do consumers really pay on their checking and credit card accounts? Explicit, implicit, and avoidable costs. The American Economic Review, 99, 424–429. https://doi.org/10.1257/aer.99.2.424

Stango, V., & Zinman, J. (2014). Limited and varying consumer attention: Evidence from shocks to the salience of bank overdraft fees. The Review of Financial Studies, 27, 990–1030. https://doi.org/10.1093/rfs/hhu008

Thaler, R. H., & Sunstein, C. R. (2008). Nudge: Improving decisions about health, wealth, and happiness. New Haven, CT: Yale University Press.

Millionaire Planning, Not Retirement Planning

Black Branch in Smoke

One of the big problems I have been pondering lately is that people just don’t understand that “saving for retirement” should start NOW not later, because of the incredible tax advantages of Roth IRAs (which have been around since 1997), et cetera. If you haven’t started, you don’t ever get that chance to have contributed $5500 per year for prior years back. Secondly, people don’t realize these accounts are just wrappers for many types of investments. A Roth IRA in a “safe” money market fund, T-bills, et cetera is a terrible loss. These accounts provide a rare, easily accessible form of lawful tax sheltering by which no capital gains tax are assessed when withdrawals are made at Age 59.5 or older. The way to maximize capital gains over long periods of time (e.g., 15+ years) is to invest your Roth IRA in the stock market (e.g., an S&P 500 index fund). Thirdly, you can start very young, and the additive and compounding benefits are both incredible. Even a 14-year-old working at Publix can lawfully contribute to a Roth IRA, up to his/her total IRS-reported gross income for the year or $5500, whichever is less. How many parents encourage or set something like this up for their children? One broader principle here is that, for tax reasons, years where income is low are missed opportunities (e.g., the college graduate’s “late start” earnings disadvantage).

Additionally, I think financial education has so butchered the topic of “retirement” that people do not understand what they are missing out on. Looking at retirement planning as something nebulous or that something one can “catch up” on later, after their immediate financial challenges are overcome (news flash: never), is common among American young and middle-aged adults. This perception is atrocious and must be eradicated. Perhaps we should call it “millionaire planning” or “the guaranteed path to being rich” to capture people’s attention. Secondly, people are living longer, and many will keep working past 59.5, 65, 70, et cetera. We could reasonably replace the idea that you are planning for retirement with the idea that you are planning to be wealthy, free, and financially independent at a time when you might still have 30–40 good years left.

To facilitate this change in perception, we need to stop calling the Age 50+ IRA contribution limits “catch-up limits.” Unless the U.S. government is going to start letting people contribute for prior missed years (and even then, lost capital gains would be enormous), there is NO catching up, because you could have contributed the maximum in all prior working years PLUS the catch-up maximum each year after Age 50. A simple change wording change to “increased limits” might suffice. Behavioral economics shows us that people, including even experts, cannot reliably assess opportunity cost. We need to get people picturing tax-advantaged retirement contributions visually as buckets for each year where the lid for the 2017 bucket gets permanently sealed on 4/17/2018 and whoops, you just lost $50K+ by not contributing $5500 to your IRA for 2017. Simultaneously, we must convincingly convey that the optimal solution is to contribute the maximum this year and every year going forward—prior missed opportunities should not be an excuse to throw one’s hands up in defeat, nor to say things like “you’ve got to live your life sometime” or “I deserve a new car” rather than contributing to one’s tax-advantaged retirement account. Sadly, the phrase “retirement planning” and even the word “retirement” itself have been poisoned in the minds of many Americans—forever consigned to the status of should-but-won’t-do.

Photo by Richard Thripp, © 2012. Every year you do not contribute to a tax-advantaged retirement account is akin to money going up in flames.

Consumer Susceptibility to Bank Overdraft Fees: Evidence and Implications

Consumer Susceptibility to Bank Overdraft Fees: Evidence and Implications
Richard Thripp
University of Central Florida

Even in 2001, Soman noted the dizzying array of payment mechanisms available to consumers. While traveler’s checks have vanished, many more mechanisms have emerged—near-field communication (NFC) payment methods like Apple and Android Pay, mobile apps, Bitcoin, PayPal, and digital gift cards, to name a few. Nevertheless, the factors that Soman (2001) experimentally substantiated remain—the “learning and rehearsal of the price paid” and “immediacy with which wealth is depleted” (p. 466). Cash has both, paper checks have the former, and credit cards and many emergent payment methods have neither. The presence of these factors makes spending painful, while their absence encourages buying by making it less real, including by bundling the purchases together to be paid at a later date. However, a consideration Soman (2001) did not examine is that debit cards’ direct connection to one’s bank account engenders delinquency and overdraft fees—a fee of about $35 a bank charges for your account going negative. At times, immediacy can do this—a credit card is paid monthly in a lump sum, which gives just one opportunity for overdraft. At other times, delayed or recurring debits, due to their lack of immediacy and/or variability in cost, can cause costly overdraft fees.

Stango and Zinman (2009, 2014) lament that consumers pay an annual average of about $150 per checking account in overdraft fees, and more than half of these are “avoidable,” meaning the consumer has funds available elsewhere that could have paid for their purchase. They recruited panelists who not only completed questionnaires, but also provided access to their transaction-level checking account data. Their 7448 panelists participated for a median of 16 months, with over 95% reporting having only one checking account. A majority (52%) incurred an overdraft fee during the panel or in the past. Questionnaire responses revealed that 60% attributed overdrafts to mental overestimation of available balance, while the remainder generally reported deposit holds or other unexpected liquidity irregularities. An economist who erroneously models humans as rational maximizers might surmise that consumers pay overdraft fees because the marginal utility of the debit exceeds the sum of the debit amount and overdraft fee—but Stango and Zinman’s (2014) data and questionnaires point toward a limited attention model, meaning consumers simply are not paying close enough attention to their checking accounts. However, drawing consumers’ attention to overdraft fees via questionnaires was found, by examination of their transaction-level bank data, to result in fewer overdrafts in subsequent months.

Employing the inattention model, one is empowered to advocate for regulatory reform to improve social welfare (Grubb, 2015). The Federal Reserve took an important step when they required banks to make opting in the requirement for overdraft protection on debit cards. This nudge (Thaler & Sunstein, 2008) prevents many overdrafts, and the requisite fees, at the point of sale. However, it does nothing for recurring intrabank transfers, automated clearinghouse transactions, or checks, all of which may still trigger overdraft fees. Notably, in addition to attention, quantitative literacy and numerical skills have been shown to positively correlate with financial behaviors that are future-oriented, rather than impulsive (Nye & Hillyard, 2013).

Lusardi and Mitchell (2014) discuss a saddening finding from the U.S. Financial Capability Study (www.usfinancialcapability.org): While 70% of Americans rate their financial knowledge highly, only 30% can actually answer a small number of quite basic financial questions correctly. Less education and being in a vulnerable group, such as African Americans, women, young or old, and rural residence, are all correlated with less financial literacy and by consequence, susceptibility to overdraft fees. At a macro level, this undermines American economic stability and perpetuates wealth inequality, including the subjugation and disenfranchisement of vulnerable and protected groups (Lusardi, Michaud, & Mitchell, 2017).

Implications and More Evidence

Here is a simple inductive leap: If consumers cannot even manage their bank accounts prudently, how can we expect them to accumulate wealth judiciously and copiously? “Retirement”—which might be characterized as a prolonged period of reduced earnings subsidized by decumulation of capital—is a pricey proposition. Financial literacy education (FLE), or, providing students and consumers with general-purpose instruction on relevant financial topics, intuitively appears to be a practical and effective solution.

However, L. E. Willis argues, with astonishing prolificacy, that financial literacy education (FLE) is misguided and pointless (e.g., Willis, 2008). A law professor, she paints personal finance as a fast-moving river where yesterday’s advice—and regulations, for that matter—are soon stale and even detrimental, in part because the financial services industry prospers on complexity and chaos. For example, adjustable-rate mortgages were rare before the mid-2000s, and sadly, homebuying education only warned strenuously about such mortgages after the crisis. Of course, mistaking your mortgage broker for a fiduciary (i.e., Ross & Squires, 2011) transcends FLE—avoiding confidence tricks requires a different set of psychosocial skills that only partially overlaps with financial literacy.

While it would be disingenuous to depict Willis’s dourness as more than a fringe view, the coalition behind FLE can rightly be depicted as Pollyannaish—or even, in certain quarters, diabolical (cf. English, 2014). When Fernandes, Lynch, and Netemeyer (2014) completed their meta-analysis of FLE interventions, they found FLE curdles like milk—even sprawling, semester-long courses do nothing to improve behavior two years in the future. In fact, complementary to Willis (2008), they propose to disembowel FLE right in their abstract— “just-in-time” FLE is their neutered, potentially-useful alternative. Even Lewis Mandell, professor emeritus, at the forefront of financial education and research for over 40 years, in 2012 called for a moratorium on mandatory financial literacy courses in secondary school, because “successful implementation of [financial] educational programs has not occurred” (Mandell, 2012, p. 107)— they simply do not work as presently conceived.

What We Can Do

In the field of instructional design, there is a widely voiced reverence for principles over technology. While technologies are like rapids, principles—such as the alignment of assessment tools with learning objectives—are timeless. In a similar vein, to encourage avoidance of bank and credit fees, we might focus on teaching strategies rather than financial content. For instance, numeracy and quantitative literacy are important (Nye & Hillyard, 2013), yet distinct from FLE and perhaps not actually taught in most FLE programs.

Ironically, Willis (2009) proposes a promising yet untested alternative: financial norms education (FNE). FNE principles, or benchmarks[1], are more accessible, memorable, and require less cognitive load (e.g., Drexler, Fischer, & Schoar, 2014). For bank fees, you could start with a piece of empirical evidence from Stango and Zinman’s (2009, 2014) research: 83% of panelists who incurred overdraft fees regularly let their balance slip below $100, while only 56% of panelists who did not incur overdraft fees did so. Consequently, a teachable benchmark would be to maintain a cushion of at least $100 in your checking account. Instructionally, you could integrate this with stories and videos from individuals who did not keep $100 in their checking account, and suffered the consequences.

The inattention model (Grubb, 2015; Stango & Zinman, 2014) serves as a useful and empirically supported framework for characterizing susceptibility to overdraft fees. In fact, it could be applied to many other personal-finance issues such as late payment fees, not knowing terms of loans or interest rates, failure to shop around for insurance, and misplaced priorities when acquiring income, making purchases, or paying debts. Surprisingly, if we compare to Fernandes et al.’s (2014) findings, salience—merely bringing a matter to the student’s attention—may be more important than education when it comes to overdraft fees.

Finally, credit unions—which are widespread, not-for-profit alternatives to banks—might borrow a page from Thaler and Sunstein’s (2008) “nudge theory” by displaying members’ checking account balances in red with a warning message when below $100. We can expect Bank of America to continue their Better Money Habits educational program—corporate citizenship has little cost if Fernandes et al. (2014) holds true. However, being that bank overdrafts are a $30–40 billion annual industry (Stango & Zinman, 2014), nudging customers away from making the bank money is a hard sell to executives and shareholders. Thus, we might suggest another benchmark to financial students: Join a credit union. Even if FLE is dead, the outlook for research, innovation, and real progress in financial education are optimistic—but only if effective strategies are employed.

References

Drexler, A., Fischer, G., & Schoar, A. (2014). Keeping it simple: Financial literacy and rules of thumb. American Economic Journal: Applied Economics6(2), 1–31. https://doi.org/10.1257/app.6.2.1

English, L. M. (2014). Financial literacy: A critical adult education appraisal. New Directions for Adult and Continuing Education, 2014(141), 47–55. https://doi.org/10.1002/ace.20084

Fernandes, D., Lynch, J. G., Jr., & Netemeyer, R. G. (2014). Financial literacy, financial education, and downstream financial behaviors. Management Science, 60, 1861–1883. https://doi.org/10.1287/mnsc.2013.1849

Grubb, M. D. (2015). Consumer inattention and bill-shock regulation. Review of Economic Studies, 82, 219–257. https://doi.org/10.1093/restud/rdu024

Lusardi, A., Michaud, P.-C., & Mitchell, O. S. (2017). Optimal financial knowledge and wealth inequality. Journal of Political Economy, 125, 431–477. https://doi.org/10.1086/690950

Lusardi, A., & Mitchell, O. S. (2014). The economic importance of financial literacy: Theory and evidence. Journal of Economic Literature, 52, 5–44. https://doi.org/10.1257/jel.52.1.5

Mandell, L. (2012). School-based financial education: Not ready for prime time. CFA Institute Research Foundation, 2012(3), 107–124.

Nye, P., & Hillyard, C. (2013). Personal financial behavior: The influence of quantitative literacy and material values. Numeracy, 6(1), 1–24. https://doi.org/10.5038/1936-4660.6.1.3

Ross, L. M., & Squires, G. D. (2011). The personal costs of subprime lending and the foreclosure crisis: A matter of trust, insecurity, and institutional deception. Social Science Quarterly, 92, 140–163. https://doi.org/10.1111/j.1540-6237.2011.00761.x

Soman, D. (2001). Effects of payment mechanism on spending behavior: The role of rehearsal and immediacy of payments. Journal of Consumer Research, 27, 460–474. https://doi.org/10.1086/319621

Stango, V., & Zinman, J. (2009). What do consumers really pay on their checking and credit card accounts? Explicit, implicit, and avoidable costs. The American Economic Review, 99, 424–429. https://doi.org/10.1257/aer.99.2.424

Stango, V., & Zinman, J. (2014). Limited and varying consumer attention: Evidence from shocks to the salience of bank overdraft fees. The Review of Financial Studies, 27, 990–1030. https://doi.org/10.1093/rfs/hhu008

Thaler, R. H., & Sunstein, C. R. (2008). Nudge: Improving decisions about health, wealth, and happiness. New Haven, CT: Yale University Press.

Willis, L. E. (2008). Against financial-literacy education. Iowa Law Review94, 197–285.

Willis, L. E. (2009). Evidence and ideology in assessing the effectiveness of financial literacy education. San Diego Law Review46, 415–458.

  1. I refrain from calling them rules of thumb because of the association with domestic violence, even though the tale has been discredited. (Return to text)

Understanding opportunity cost is pivotal to financial literacy

Opportunity cost, the trade-off of making a particular choice, is typically seen as more applicable to economics than personal finance. However, I believe understanding opportunity cost is central to being financially literate, and is sorely lacking among the general public. For example, most people are not aware of the magnitude of the “late-start” opportunity cost of obtaining a four-year degree. Many psychology doctoral graduates are overwhelmed by debt and wish they hadn’t stayed in school so long. While other factors are partly responsible, on the whole, college attendees do not recognize the sky-high value of their late teens and twenties, nor the opportunity cost of their decision. Moreover, delay discounting research shows that people frequently overvalue rewards now versus in the future, particularly if they have addictive dispositions. In part, this may be due to a lack of understanding or consideration for opportunity cost.

Research on consumer behavior shows that perceptions of value are often unduly influenced by coupons, promotions, and advertising. For example, an individual who knows that Tylenol and ibuprofen are the same might buy Tylenol with a coupon, even though the cost is still higher than the generic counterpart. The coupon is seen as a savings, when in fact it induced a purchase which was actually more expensive.

Retail gas prices are highly visible, and are given undue weight by consumers. The same consumer who purchased Tylenol might drive out of his/her way to save a few cents per gallon on gas, or might experience psychological distress at observing a lower price at another gas station subsequent to fueling up. However, the opportunity cost of the price difference is almost certainly inconsequential. In fact, the unhappy feelings themselves are more costly and are antithetical to rational choice theory, because they irrational and counterproductive. An understanding of opportunity cost can make this irrationality explicitly visible.

Human behavior when receiving a “windfall gain,” the unexpected acquisition of wealth that feels unearned, is a premier example of failure to understand opportunity cost. The opportunity cost of spending the windfall money is identical to the opportunity cost of spending any other money. However, the $3000 that is received as an IRS tax refund is spent more easily than the $3000 that is earned day-to-day, as if spending the former has less opportunity cost than the latter. Not so! Amazingly, many people will fail to understand opportunity cost even when it is merely their money that was withheld, interest-free, and is now being returned to them.

Money or items of value that are received for “free” are free only when received, but not when spent. Travel hackers who gain “free” vacations via credit card sign-up bonuses fail to recognize that only the acquisition of the rewards was trivial, but that the opportunity cost of using them for travel is what could have been received by cashing them in or selling them to mileage brokers (albeit, with varying levels of risk which should also be factored into one’s valuation). Gift card recipients spend lavishly, even when they would self-flagellate for making identical purchases with money they “earned.” However, the opportunity cost of spending money one received as a windfall or gift is usually no different from the opportunity cost of spending “earned” money.

Not only do purchasing decisions have opportunity costs, but also time-usage decisions. The opportunity cost of driving, for instance, is much greater than the cost of gas—it also encompasses maintenance, depreciation, and insurance on one’s vehicle, time spent driving, and risk of bodily harm. If one can earn $50 per hour in their area of expertise, the opportunity cost of doing one’s own secretarial or housekeeping work is quite substantial.

Investors who reject the risk of stocks for the “safety” of bonds or treasury bills do so at tremendous opportunity cost. In fact, over long time periods (e.g., over 20 years), the risk of stocks evaporates so much that one is over 99% more likely to lose money having picked the “safe” investments. Pandering to one’s psychological shortcomings comes at immense expense.

If an employer offers a 401(k) or IRA match, the opportunity cost of not taking advantage is staggering. Putting $50 per week into such an account at Age 25, which will immediately be doubled by your employer and feasibly may double every 10 years in the market even adjusting for inflation, can be equivalent to 1600 inflation-adjusted non-taxed dollars at Age 65! Even if we are conservative and halve this to $800, statistically as an American you are very likely to live past 65 and still need money at this age. Nevertheless, so many young people “need” this money to make ends meet, without even understanding the raw deal they have given themselves by not contributing.

Understanding and applying the principle of opportunity cost can literally be the difference between becoming a millionaire or pauper. In the Jump$tart Coalition’s National Standards in K–12 Personal Finance Education, 4th edition, it is mentioned only as “every investing decision has alternatives, consequences and opportunity costs” (4th grade knowledge statements; p. 24) and “every spending and saving decision has an opportunity cost” (8th grade additional knowledge statements; p. 8). Moreover, most K–12 teachers don’t even understand “technical” topics such as opportunity cost, let alone being able to teach them. What a pity.

Rebuttal to Northwestern Mutual’s 2017 Planning & Progress Financial Literacy Study

The 2017 Planning & Progress Study by the Northwestern Mutual Life Insurance Company (NWM) has a press release titled Americans Besieged by Debt: 4 in 10 Spend Up to 50% of Monthly Income on Debt Payments. The inaccuracy and uselessness of this statistic is astonishing, particularly for an in-house press release.

NWM Screenshot 01

Firstly, the statistic should be 4 in 10 among those who reported having debt. According to NWM’s 2017 Debt Dilemma presentation, they surveyed 2117 U.S. adults, plus an oversample of 632 Millennials, for a total of 2749 respondents. NWM’s slides are inconsistent—Slides 3 and 6 say “those with some debt” constituted 1086 respondents, while Slides 4–5 say 1597 respondents. I think the 1086 figure likely included the 2117 adults, while the 1597 figure likely included the 2749 adults (including the oversample), which would indicate that 511 of 632 oversampled Millennials (80.9%) reported having some debt, compared to 1086 of 2117 from the general sample (51.3%). This seems reasonable, given that Millenials are more likely to have student loan debts.

Even if we include the oversample, 1597 of 2749 respondents is only 58.1%. On Slide 4, NWM says that “more than 4 in 10 Americans with debt (45%) spend up to half of their monthly income on debt repayment.” Therefore, among all Americans, this figure should be .581 × .45 = .261 or 26.1%—only 2.6 in 10 Americans report spending up to half their monthly income on debt payments, not 4 in 10 as NWM incorrectly claims. Confusingly, the question asked respondents to exclude their primary home mortgage, yet includes a “mortgage is my only debt” choice, which 15% selected. Adding to the confusion, on Slide 3 it says the “amount of debt” question excluded mortgages, even though the question prompt is “how much do you estimate your debt to be?” without mentioning mortgages. Who knows what is going on here? Can such a survey even be cited when NWM keeps changing their story and refuses to provide the actual questions or raw data?

NWM Screenshot 02

Next, I turn to the elephant in the room—something that is blatantly obvious, at least to me. HOW is “up to half of their monthly income” in ANY way a useful statistic?! This only tells us they do not spend more than half their monthly income on debt payments, which is almost worthless. It would be like saying “4 in 10 Americans consume up to half their calories from donuts,” meaning that they consume anywhere from zero to 50% of their calories from donuts. The NWM statistic does not mean that 55% of Americans with debt spend more than half their monthly income on debt payments (which, if true, would be astonishing and much more meaningful). In fact, in addition to “mortgage is my only debt” (15%), “not sure” (21%) is also an option.

The egregious statistical illiteracy of NWM’s PR department is evident, as is their lack of consultation with whomever at NWM concocted this study, although NWM’s slides are also, at times, bewildering. An interesting and relevant statement would have been “among Americans with debts, 18% reported spending more than half their monthly income on debt payments.” But, “up to half” is sophomoric.

As a general trend, note also that NWM proffers only descriptive statistics rather than inferential statistics. My recent poster presentation, Relationships Between Financial Capability and Education Attainment: An Analysis of Survey Data From the 2015 National Financial Capability Study (NFCS), used inferential statistics to compare knowledge of personal finance with degree attainment. The FINRA Investor Education Foundation is government-funded and is tasked specifically with conducting surveys and statistical analyses, unlike NWM. Nevertheless, FINRA’s 2015 annual report, like NWM’s reports, is devoid of inferential statistics. This is sad. The NFCS provides detailed statistical files, so it’s tempting to argue that such analyses will come out on their own, from unaffiliated researchers. However, too often, this simply does not happen, even though there are many interesting relationships to be examined. In the NWM studies, for instance, running inferential procedures to compare the oversample of Millennials with the general population would empower us to say that Millennials are significantly different along dimensions such as debt burdens, student loans, et cetera, and provide effect sizes to boot. Surprisingly, NWM’s 2017 Planning and Progress Study provided only two reports (the Debt Dilemma and the Financial States of America), unlike past years (e.g., 2016) which had many more reports (eight in 2016), and neither of the 2017 reports include even descriptive statistics on the oversample of Millennials. Why bother collecting the data, then? Well, we know the reason. To market life insurance.

FINRA and NWM should both employ more statisticians, so they can provide insightful and detailed inferential analyses, among other useful statistics. This would greatly increase the value of their surveys to the public and to researchers, including researchers who are capable of performing the analyses but for whom it would only provide tangential value (e.g., supporting evidence for an argument in their manuscript).

NWM Screenshot 03

To complete my rebuttal, I should analyze the rest of NWM’s 2017 Planning and Progress data. Their Financial States presentation is brief, and involves only perceptions. Unlike NFCS, there are no questions that actually measure content-knowledge. The usefulness of asking respondents questions such as “my long-term savings strategy has a mix of high and low risk investments” is dubious. This is the same sample of which 21% does not even know how much debt they have. How do we know whether they consider high-risk investments penny stocks and low-risk investments to be their Bank of America 0.03% APY savings account? Their “mix” of high- and low-risk “investments” could be totally stupid. Without explicitly defining our terminology, and ideally being able to correlate responses with questions measuring financial knowledge or competence, it is difficult to draw inferences from attitudinal questions like the preceding, or questions like “the ‘American dream’ is still attainable for most Americans.” How do you define the American dream? Does it involve emitting an ungodly amount of carbon dioxide and destroying the earth? Perhaps “the ‘human existential nightmare’ is still attainable for most Americans” might be a more accurate question.

NWM Screenshot 04

I found the above figure enlightening. These responses are among the 1086 respondents with “some” debt (evidently excluding the oversample of Millennials; see my discussion earlier). Granted, this question asks “which of the following best describes your strategy for managing your debt,” and much of what is listed are non-strategies. However, the option for “pay all bills monthly/on time” is present, and was selected by only 3% of those with debts. This is horrible. “I pay as much as I can on each of my debts each month” is not a strategy, yet 35% picked it. If you pay as much as you can, how do you know you will even be able to make the minimum payments next month? What do you do for unexpected expenses? Probably payday loans, given the deplorable state of American’s financial expertise. Where is the foresight? “I pay what I can when I can” is equally bad and also a non-strategy—at least 53% of respondents endorsed non-strategies. On the other hand, while not ideal, making minimum payments each month, or focusing on high-interest debts while making at least the minimum payments on others, are strategies. Doing so protects your credit from delinquency and allows you to avail of technical tricks like credit card balance transfers (BT) to mitigate high-interest debts. You can’t get a BT offer on a new credit card if you can’t get approved because of late payments or collections on your credit report.

In conclusion, while I agree with NWM’s conclusion that Americans are a financial basket case, their methodology is idiotic and their claims are blatant statistical misrepresentations. To cap it off, NWM’s infographic below claims that Americans spend 40% of their monthly income on leisure… without mentioning that the question asked respondents to exclude spending on “basic necessities” including housing, food, and transportation! Clearly, NWM is more interested in giving bombastic, just-plain-wrong talking points to the media, rather than an accurate representation of their survey data, which actually is not even in need of embellishment.

NWM Screenshot 05