BOX 7-2The Impact of Financial Literacy on Retirement Adequacy and Retirement Confidence

Prior research has concluded that financially literate individuals are more likely to plan for retirement, and in turn, to save effectively to that end. Yet a recent nationally representative study of young Americans found that a disturbingly high fraction of people aged 23–28 were unable to answer three simple questions about simple interest, inflation, and risk diversification (Lusardi, Mitchell, and Curto, 2010). The specific wording of the questions was as follows:

(1)

Interest rate. 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: more than $102, exactly $102, or less than $102? {Do not know; refuse to answer}

(2)

Inflation. Imagine that the interest rate on your savings account was 1 percent per year and inflation was 2 percent per year. After 1 year, would you be able to buy more than, exactly the same as, or less than today with the money in this account?

(3)

Risk diversification. 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.”

Strikingly, one-fifth of the population could not provide a correct answer to the simple interest question; almost half did not understand inflation; and more than half did not understand risk diversification. Moreover, men were substantially better informed than women, and whites were more knowledgeable than blacks or Hispanics (Table 7-2-1).

Low financial literacy will affect workers' and retirees' confidence in the retirement savings decisions they make and their ability to adjust to and recover from macroeconomic shocks. For example, the Employee Benefit Research Institute (EBRI) 2011 Retirement Confidence Survey (RCS) found that workers are more pessimistic than at any time in the two decades the RCS has been conducted, but that retirees are not more pessimistic. The EBRI main report (p. 13) states: “The percentage of retirees who are very confident that they had done a good job of preparing for retirement fell from 39 percent in 2007 to 26 percent in 2008; it has remained steady since that time (31 percent in 2011).”

TABLE 7-2-1. Patterns of Responses to Financial Literacy Questions.

TABLE 7-2-1

Patterns of Responses to Financial Literacy Questions.

From: 7, Saving and Retirement Security

Cover of Aging and the Macroeconomy
Aging and the Macroeconomy: Long-Term Implications of an Older Population.
Institute of Medicine (US) Committee on the Long-Run Macroeconomic Effects of the Aging U.S. Population.
Washington (DC): National Academies Press (US); 2012 Dec 10.
Copyright © 2012 by the National Academy of Sciences. All rights reserved.

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