A week ago I went to the 10-year anniversary of a group called the
Doorways-to-Dreams (D2D) Fund. D2D's goal is to foster financial innovation that helps out the everyday person; they particularly focus on innovative ways of helping lower-income families. It's a great group of smart people who really care about making a difference, and I think they've done some really great and interesting things. You should check out their website if you're interested in some of the projects they've been working on.
Anyway, as part of the celebration, they had a little panel that talked about the direction of financial innovation, and how it can benefit the consumer. As I listened to them, I thought about how things have changed in the U.S. over the past 50 years, and how innovation might help us address where we are right now.
Think of the financial world that your parents or grandparents functioned in. How does it differ from the world that we live in today? If you're like me, the first thing you think of is that finance was a lot simpler 50 years ago. It wasn't nearly as easy to invest in anything back then, mortgages pretty much came in only one flavor (30-year fixed), credit cards were non-existent, and your employer likely had a pension plan that would cover you in retirement without you ever having to think about it. There's a lot of financial theory that says that all of the changes that have happened since then have been great for society as a whole. For example, anyone can get an E-Trade or Fidelity account and invest in a wide array of markets. Having that option can't be a bad thing, can it? Or, people now have several options when they look at a mortgage, and that added flexibility can only help the home-buyer.
The idea that additional choices can only be a good thing makes a lot of sense in nearly every context except finance. How can adding access or options hurt someone? How can giving them more control over their own lives make them worse off? And yet, I think that there are a significant number of people who pine for the good old days of plain white-bread finance. Why do so many of us wish for that? I think that there are two really big issues that mess things up for people when it comes to finance:
1. Many people lack the knowledge necessary to really manage their finances.
2. We're not quite as clear-thinking and rational as we need to be. To give just a few examples, we lack self-control and don't save enough or get into too much debt, we're overconfident in our abilities, we are prone to overweight recent events, etc.
If we could solve these two problems, we could have the best of both worlds: great flexibility and variety in financial services, but the ability to use them to our benefit. That's where financial innovation can step in and hopefully help us out. And I think there are reasons to be optimistic about the direction things are heading.
Here are a couple of examples of innovative ideas to illustrate what direction personal finance is heading in:
- Prize-linked savings accounts: instead of earning a tiny bit of interest each month, you are entered into a sweepstakes to win a grand prize. This makes savings fun, and attracts a lot more people into savings (instead of throwing away their money on, say, lottery tickets).
- Credit cards with self-imposed limits: You tell your bank to deny your credit card if you spend too much money in a given month, or on a given product category.
- Competitive savings: You compete with your friends to save money. Every time you do something that helps you save money, your friends get a text saying what you did.
- Investing with Celebrities: You get to put your money in the same fund that, say, George Clooney has his money in, and you can tell all your friends that you invest with George Clooney.
As you can see, people are getting pretty creative, and I think that some of these ideas will actually work really well. I'm excited to see these things come out and whether they can actually improve people's lives.
The real problem that I see is that nearly all of the new stuff that people are doing focuses on problem #2 above--they sort of trick us into doing what we know we should be doing but can't make ourselves do. I don't think anyone has cracked the tough nut of how to actually teach people about basic finance. I'm not talking about derivatives or the Black-Scholes formula. I'm talking about basics like: How do interest rates work? What is a stock? How does inflation affect your finances? What happens if I file for bankruptcy? Isn't it kind of shocking to you that we require high school seniors to be able to do trigonometry, but they aren't required to know what a credit score is? Recent studies suggest that financial literacy in the U.S. is abysmal. For example,
this survey asked people 5 basic finance questions (covering: interest rates, inflation, bond prices, mortgages, and risks). Less than 10% of respondents got them all right, and for no single question did more than 70% get it right!
I think that entrepreneurs, policy makers, and academics are all still struggling to figure out the best way to education us about personal finances. It's not an easy task. Some high schools do actually have personal finance courses, and the research that I've seen indicates that students in those schools don't end up any better off financially that students who didn't have the education. So, maybe education isn't the way to go about it. But we need to provide at least a foundation of knowledge, at the very least so that people will know when they need to seek out help. It's kind of like a high school health class. I don't know that health classes make us any healthier, but at least we know the basics of how our bodies work and what things will harm them. We don't have an equivalent of that for finance.
What do you think? How can we increase the financial literacy in America? Should it be the government's responsibility? Can private businesses find a creative (and profitable) way to educate us?
