Academic journal article Social Education

Why Don't People Save When They Know They Should? (Raising Interest in Economics)

Academic journal article Social Education

Why Don't People Save When They Know They Should? (Raising Interest in Economics)

Article excerpt

A growing body of evidence suggests that young people have a low level of financial understanding and that they are making poor financial choices. It is a development reflected in part in savings rates. Personal saving is calculated as disposable income less personal spending. The U.S. personal savings rate has fallen since the early 1990s. From 1990 to 1995, the average annual rate of personal savings was 8.72 percent. From 1997 to 2001, the average annual rate was 3.32 percent. This percentage of savings suggests that American households are financially overextended.

The problem is also reflected in various measures of students' knowledge. Lewis Mandell, dean of the university at Buffalo's School of Management, has conducted a national survey on the financial understanding of twelfth grade students for the Washington, D.C.-based nonprofit Jump$tart Coalition. (1) The survey, carried out in 1997, 2000, and 2002, measures twelfth graders' knowledge of money, income, saving, spending, and credit; it also inquires about students' personal finance such as use of money and credit. The 2002 survey was administered to 4,024 twelfth graders in 183 schools nationally; on average, these students answered 50.2 percent of the questions correctly. The average score in the 2000 survey was 51.9 percent; in 1997, it was 57.3 percent. Students' knowledge and understanding, as measured by the Jump$tart survey, has been declining nationally.

A study conducted for Northwestern Mutual Financial Network by the market research firm Harris Interactive, titled Generation 2001: The Second Study, (2) focused on a national, representative sample of college seniors. It was a follow-up to a study conducted in 1997 when the students of the class of 2001 were freshmen. The results offer some insight into the attitudes of this generation, including attitudes related to financial matters. Here the results reveal important knowledge gaps and a disconnect between attitude and behavior:

* Nearly half (48 percent) of college seniors felt "not very knowledgeable" or "not very knowledgeable at all" regarding financial matters.

* Despite their lack of knowledge, nearly three-quarters believed it was very likely that they would eventually be able to afford the life-style of their childhood.

* While college students rated home ownership, life insurance, 401(k)s, and IRAs as important financial instruments, far fewer expressed high levels of knowledge about these instruments.

* These college students held, on average, three credit cards each, and most had already incurred a significant debt load.

Why Do People Appear to Fail to Act in Their Financial Best Interest?

A basic assumption of economics is that people act in their own best interest. But the evidence discussed previously suggests that when it comes to saving, investing, and credit management, people's knowledge is minimal and their actions may not be in their best interest. Why?

Let's look more closely. We know that in other arenas, people often engage in risk-oriented behavior. Some people play football or compete in rodeos when they know they might injure their knees and backs, or worse. Some people smoke when they know smoking causes cancer and heart disease. Some people drive fast and change lanes recklessly even when they know that, in doing so, they could kill themselves and others. People do many things that do not appear to be in their best interest. They also incur risk by virtue of what they do not do-not eating a diet rich in fruits, vegetables, and fish, for example, despite well-known evidence about the health benefits associated with such a diet.

Why might people fail to act in the best interests of their own health? Consider the costs and benefits involved-as they might be assessed by the people whose behavior seems, in these cases, to be irrational. For many among us, the cost of eating a healthful diet is immediate and real. …

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