By: Julie Heath
The FINRA Investor Education Foundation recently released the results of their national 2012 survey on financial capability. The results are cause for concern, as the area’s citizens are still struggling with their financial lives in the aftermath of the recession. More than 25,500 adults participated in the survey, their financial capability measured along five dimensions—the extent to which they: spend more than their income; have unpaid medical bills; do not have a rainy day fund; only pay the minimum on their credit card balances; and can correctly answer five questions on basic financial literacy.
Spending More Than Income
Let’s start off with some good news. Relative to the national averages, the Tristate region compares favorably with respect to the percentage of the population that is spending less than their incomes. Spending more than income (excluding the purchase of a new home, car or other big investment) or breaking even means that saving is not occurring. Living paycheck-to-paycheck (or worse) leaves individuals vulnerable to short-run financial surprises, but also results in long-term instability as they are unable to adequately prepare for retirement or college educations for their children.
Unpaid Medical Bills
Now the news gets steadily worse. Residents of Kentucky, in particular, struggle with medical debt, ranking 3rd worst in the country:
Medical debt can negatively impact credit scores, reducing individuals’ ability to obtain affordable (or any) credit.
Rainy Day Funds
Another measure of good financial behavior is the existence of a rainy day fund, defined as three months of living expenses saved for emergency purposes. Again, the Tristate fares worse than the rest of the nation. In Ohio, Kentucky, and Indiana, 58 percent, 62 percent, and 63 percent, respectively do not have rainy day funds, compared to 56 percent nationally:
Individuals without a rainy day fund risk significant financial instability in the case of unexpected personal events or an economic downturn. As a result, the economic stability of the country as a whole is undermined.
The inability to withstand financial emergencies often leads to the use of payday and other non-bank lenders, so it is not surprising that the region’s use of these entities was greater than the national average:
Non-bank borrowing includes payday and auto title loans, tax refund advances, using pawn shops and rent-to-own stores. These methods are accompanied by high interest rates or fees and often lead the borrower into cycles of use, or “churning”, in which many times the original amount is owed.
Paying Only Minimum Credit Card Payments
Nationally, almost half of Americans say they pay their credit card balances in full each month, an increase from 41 percent in the 2009 survey. Closer to home, the news is not as good. In Ohio, while 47% say they pay their bill in full each month, 41% indicate they only pay the minimum required, a practice that increases the costs of borrowing and can negatively affect credit scores. Again, this high percentage of those paying only the minimum pushes Ohio to the bottom tier of states in this dimension. In Kentucky, 31 percent report only paying the minimum balance, while in Indiana, it is 36 percent.
Results of Tests of Financial Literacy
With respect to financial literacy, the primary concern is with capability (the behaviors that people engage in) rather than knowledge (scores on a test). However, test results can be illuminating, as the FINRA study shows. Here are the questions (answers at the end of the post).
1.) Suppose you have $100 in a savings account earning 2 percent interest per year. After 5 years, how much would you have?a.) More than $102
b.) Exactly $102
c.) Less than $102
d.) Don’t know
2.) Imagine that the interest rate on your savings account is 1 percent a year and inflation is 2 percent a year. After one year, would the money in the account buy more than it does today, exactly the same or less than today?a.) More
d.) Don’t know
3.) If interest rates rise, what will typically happen to bond prices? Rise, fall, stay the same, or is there no relationship?a.) Rise
c.) Stay the same
d.) No relationship
e.) Don’t know
4.) A 15-year mortgage typically requires higher monthly payments than a 30-year mortgage but the total interest over the life of the loan will be less.a.) True
c.) Don’t know
5.) Buying a single company's stock usually provides a safer return than a stock mutual fund.a.) True
c.) Don’t know
With the possible exception of the question about the relationship between interest rates and bond prices, these are very basic questions. In Ohio, 67 percent of the population answered 3 or fewer questions correctly, making the state the 4th worst in the country on this measure. In Kentucky, 66 percent answer 3 or fewer questions correctly, while in Indiana, the corresponding proportion was 62 percent.
Poor performance on questions that individuals would likely encounter in everyday life, such as compound interest, effects of inflation and principles relating to risk and diversification, means that they are not prepared to make the most basic of financial decisions.
Financial capability and financial knowledge are the cornerstones of individual well-being and the region’s (and nation’s) economic growth. Financial literacy does not happen by accident, or by osmosis. If we are truly committed to improving our region as a whole, and giving individuals and families the tools to make appropriate decisions, we must be deliberate about teaching our children the economic and financial literacy foundations in school- in every grade, in multiple settings, integrated across the curriculum. Our region languishes at the bottom in the FINRA survey. We will stay there unless we make economic and financial literacy a priority.
(Answers to quiz: 1(a); 2(c); 3(b); 4(a); 5(b))