Americans aren’t saving nearly enough for retirement. Dozens of statistics bear that out, but here are just two from our retirement slideshow, which borrows data from both Fidelity and GoBankingRates.com: 1) Nearly three-fourths of Americans (74%) have saved less than $100,000 for their golden years; and 2) one in three have nothing.
There are many causes for this problem, including flaws in our psychological make-up, such as the tendency to think we’re smarter than we really are, and a difficulty envisioning ourselves in the future. These flaws are at the heart behavioral finance.
There is also the real-world trend of declining defined-benefit plans in America, which creates an unfortunate circle. Employers have largely replaced those pensions with 401(k)s, putting the onus for making smart investment decisions on workers. In their turn, the employees often ignore the situation. If they face it all, they bring their flawed, human thinking to bear.
As important as those trends are (indeed, behavioral finance will be our editorial focus next month), a shocking lack of financial literacy is a root cause of low retirement savings. No matter how rational your decision-making may be, if you don’t understand the concept of simple interest (not the math, mind you, just the concept) or basic illustrations of how inflation impacts savings, you have little chance of organizing your finances in a sensible way.
Consider a recent financial literacy survey from FINRA. After answering just 5 questions (and in some cases, a 6th bonus question), only 37% of respondents were deemed financially literate, which required at least 4 correct answers. The average result was 3.16, and the low scores were widespread. FINRA offered a state-by state breakdown. To cite just one example, New York state, home of the center of the financial world, averaged 2.91, even lower than the national average.
In a release announcing the survey, FINRA said that the findings “reveal that many Americans demonstrate relatively low levels of financial literacy and have difficulty applying financial decision-making skills to real-life situations.”
Bear in mind, the test was not asking MBA-level questions. One involved $100 in savings with a 2% annual interest rate and asked how much the saver would have after 5 years. Put away the calculators and exponents before you see the possible choices: More than $102, exactly $102, less than $102 and don’t know.
One more, even easier, question: Imagine the interest rate on your saving is 1% and inflation is 2% per year. After 1 year, how much would you be able to buy with the money in your account? Choices: More, same, less and don’t know.
So, why should you care? If bank advisers focus on the mass-affluent who have enough money to make the service lucrative, other clients are left to fend for themselves. After all, they can always use robos and buy broad index funds for pennies.
There’s some truth in that. Indeed, much of the problem falls in demographics that most advisers don't serve, such as the mass market and even the "underbanked."
QuoteAt least one part of the financial literacy results that should catch your attention: millennials. FINRA cited that demographic for scoring particularly poorly on the test.
Still, there is one part of the financial literacy results that should catch your attention: millennials. FINRA cited that demographic for scoring particularly poorly on the test.
If you’re thinking long-term, there's a good chance these younger investors are part of your business plan. They’ll need decades of advice and, despite all the “millionaire millennial” stories, they haven’t saved much yet. (Again, from our slideshow, 70% of them have saved less than $10,000.) And if the literacy surveys are to be believed, they don’t know where to begin. So whether they’re the kids of your older clients, or new prospects you’re hoping to land to grow your book, teaching them the basics of finance is job one.
There could be a silver lining to this. We hear all the time from advisers who say they differentiate themselves and offer some bit of service that nobody else does. But when we ask for details, it almost always turns out that they're simply doing a good job of offering the same thing as other good advisers.
But financial literacy could be an area where you really can differentiate. You can empower clients if you offer even a basic level of education. Advisers often talk about keeping it simple. Here’s a chance for them to put their money – or their business – where their mouth is.
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