Growing financial knowledge poses challenge

As with most education, financial literacy is dependent on many personal and social factors. But now it turns out that for those living in the USA, the state in which you live may also be a determining factor.

A new study by the Employee Benefit Research Institute that finds the state in which Americans live impacts their financial behaviour and financial literacy, has serious implications for state policy makers and, as a by-product, on state pension plans.

The study uses data from the National Financial Capability Study, designed by the FINRA Investor Education Foundation, to show the difference in financial literacy and financial behaviour across states.

New Hampshire and Alaska top the financial literacy and the financial behaviour rankings, respectively; while Louisiana and West Virginia bookend the bottom of the financial literacy and financial behaviour rankings, respectively.

The study conducted regression analysis with state fixed effects and found that after controlling for demographic factors, such as age, ethnicity, education, income, marital status, and labour-force statistics, there are statistically significant state fixed effects.

It concludes that most bottom-ranked states have a significant effect on their residents’ financial literacy and almost all states have a statistically significant effect on their residents’ financial behaviour.

“In terms of building the right financial behaviour, all states face a policy issue,” the paper says.

This is important for a number of reasons.

Across the globe individuals are becoming more responsible for their own investment decisions. In part, this can be seen in the growth of defined contribution funds. While DC funds still only make up about 30 per cent of funds in the Towers Watson/P&I Top 300, they grew by 16 per cent in 2010, compared to 4 per cent growth in defined benefit funds. And it is forecast they will continue to expand.

The increase in ownership of decisions and circumstance by individuals, according to the EBRI paper, is also reflected in the US by pension systems moving away from annuity-only defined benefit plans to lump-sum distribution.

The implication for pension funds is that financial literacy and education may need to become a more significant part of their service offerings.

In many countries where the defined-contribution structure dominants the pension system, including Australia, pension funds are struggling with what level of financial aid – financial planning – to provide for members.

The result has been pension plans with varying business strategies, from complimentary in-house financial planning to fee-for-service provision by external commercial providers.

Studies have found that people that engage a financial planner are better off in retirement. A recent KPMG report (below) for instance, examines how financial advice affects savings behaviour in Australia, and found that those with a financial adviser save an additional $1590 a year, after advice costs, compared to those without a financial adviser.

Perhaps a key part of creating the “right financial behaviour” will be an increasing role for the financial advice industry. For US state pension plans it may be a necessity.

How do financial literacy and financial behavior vary by state

KPMG Econtech Value of Financial Advice