Financial Literacy and Household Stability on Shaky Ground
by Ryan W. Smith
Financial literacy and household financial stability among Americans has rebounded slightly in recent years, according to an under-reported tri-annual report from FINRA, but several emerging trends are beginning to take hold in the American economy. Medical bills and a spending/saving imbalance are among the more significant findings, with one in five Americans reporting an overdue medical bill and another one in five reporting spending more than they earned, the beginnings of a domino effect that prevents many households from meeting their monthly obligations.
FINRA, the investment advisory regulator, has an ongoing financial quiz found at http://www.usfinancialcapability.org/quiz.php, and it releases the results every three years. Previous results were released in 2009 and 2012, with the most recent data from 2015.
News of this study barely rippled in the media, but results show further stagnation, more households struggling with debt and an average family overburdened with monthly expenses. For example, in 2015, 18% of U.S. households spent more than they took in. This is actually a decrease in years past, where 2009 and 2012 showed 20% and 19% of households spending more than they made, respectively. Specifically factored out of this calculation were larger purchases of cars and houses, so these numbers would be worse.
A big part of the reason households are having difficulties with expenses is because of overdue medical bills. Over one-fifth, 21%, of Americans face an overdue medical bill in 2015, down from 26% in 2012, which makes saving money for an emergency much more difficult. Yet, the percentage of Americans with emergency savings is up quite significantly since FINRA’s 2009 results were published.
Compounding these issues is the stabilization of non-bank lending among American households. In 2012, 28% of Americans had a payday loan, credit through a rent-to-own company, a pawn shop or an auto title loan. That percentage only dropped to 26% by 2015, meaning that these high interest loans are continuing to proliferate into the normal course of debt creation in the country.
Another trend that has continued to get moderately better, yet still poses a significant risk to household financial stability is the percentage of households making only minimum monthly payments on their credit cards. In 2009, 40% of American households could only make the minimum payment on at least one of their credit cards. In 2012, that number slipped to 34% and in 2015, fell slightly further to 32%, still nearly one-third of all households. Making only minimum credit card payments damages credit ratings, further compounding the needs for alternative non-bank loans mentioned above or continued minimum payments.
Perhaps the greatest damage to American households in the aftermath of the Great Recession of 2007-2010 is the percentage of homes still underwater even as the housing market rebounds to, and surpasses, its pre-crisis level. These mortgages, where the remaining mortgage balance exceeds the value of the home providing collateral for the loan, have fallen from 14% of all mortgages in 2012 to 9% of mortgages by 2015. However, another 7% of mortgages are “in balance”, meaning any fall in house prices will cause these loans to underperform as well. Homes that are underwater financially do not see many of the benefits of home ownership. Refinancing is much more onerous. Necessary repairs cannot be made, improvements are never considered and the likelihood of default or a forced sell, a short-sale, to satisfy creditors is always just a few bad weeks away.
Most distressing to the financial advisory industry however, is the financial literacy survey results. The link embedded above leads to an on-going five general questions about economics and finance. These questions cover topics from compound interest, inflation, risk and diversification principles, the relationship between bond prices and interest rates as well as the impact of a shorter loan term on total interest paid on a mortgage. While never solid, the results of this questionnaire have gotten worse in recent years.
In 2009, well over half, 58%, of Americans answered 3 or fewer of the 5 questions correctly. This number rose to 61% in 2012 and to nearly two-thirds, 63%, by 2015. This lack of basic financial and economic knowledge is one that further compounds the issues and deficiencies listed above, leading a cycle of rising debt and lower expectations, less ability to save for emergencies or retirement.
These results cannot be construed as a positive except for one aspect. For financial advisors, this can be seen as a wonderful opportunity for new business. While there might not be a plethora of potential clients with resources to invest or save for retirement, there will definitely be some new clients to be found within the results of this survey. Furthermore, since the results of this survey show a majority, in most instances, are able to save for emergencies, save for retirement, accumulate equity in their homes and pay down credit cards, there are many in the middle class in need of financial assistance.
For nearly all groups in this study, there is a potential use for AdvisoryWorld software to assist in education, perspective and analysis. The portfolio analysis tool for SCANalytics has a Monte Carlo feature which is often used for forward-looking cash projections for retirement accounts. This tool can be modified to show how compound interest works or how making additional payments will severely reduce loan payoff time. Issues like inflation and the proper diversification of assets are also items that the program excels in showing.
Portfolio analysis tools like SCANalytics can also show various retirement scenarios, how much a household might need to save, how much they are likely to spend over a given time horizon. The possible added impact of medical expenses, costly home repairs or other expensive outlays can be factored in as well.
While the economy has improved, house prices and employment rates have recovered, it is still very apparent that the Great Recession of 2007-2010 still has significant overhang within the economy. There is ample opportunity for financial advisors to educate and assist new and existing clients pay down debt and save for the future.