Sunday, June 5, 2011

Some thoughts on Financial Literacy and Boomers

I am currently reading the task force report on Financial Literacy that was published in Feb 2011. I find the report interesting but I am sure that many of my generation may not want to read it so over the next few weeks I will be highlighting aspects of the report and how I think it affects us.
I was struck by the fact that we are much better off then we think, according to the report:

"Canada’s retirement income system is designed to ensure universal coverage and to protect the incomes of particularly vulnerable groups (for instance, individuals with interrupted labour force participation or those with low incomes) and performs well relative to those of its peers in this regard (Whitehouse, 2009). Characterizing the precise level of income adequacy in retirement is a complex empirical undertaking, but general indicators of retirement living standards show that, on average, Canada’s retirees are relatively secure (Mintz, 2009; Whitehouse, 2009; Baker and Milligan, 2009). Poverty rates among elderly Canadians are low relative to international standards. Over the period of 2000-2009, the rate of poverty among elderly Canadians was, at 4.4 per cent, approximately one-third of the OECD average and one-sixth of the comparable figure in the United States" Page 6 Retirement Preparedness and Individual Decision-Making Implications for Canada by Joanne Yoong, RAND Corporation,arch paper prepared f
I am sure that this is a surprise to most seniors but if  you are one of the 4.4% I don't think it is helpful to know you are not as worse of as our American neigbours.

 "Using Canada Revenue Agency data from 2006, Horner (2009) estimated that, for almost 70 per cent of Canadian households, savings in retirement plans would be sufficient to fully maintain consumption levels in retirement, while almost 80 per cent would be able to achieve a 90 per cent replacement rate." Page 7 Retirement Preparedness and Individual Decision-Making Implications for Canada by Joanne Yoong, RAND Corporation,

What I found interesting is that in spite of the "strong safet net many of us are still nervous about retirement funding and some of us may have to sell our homes to meet ends meet in retirement.  "... the proportion of retirement income from private sources is also among the highest in the OECD and is characterized by a relatively small but increasing share of defined-contribution plans (OECD, 2009). In the 2009 CFCS, over 80 per cent of labour force participants indicated that they expect to draw savings from RRSPs, while 26 per cent expected to do so from the sale of other financial holdings, and 16 per cent from other non-financial assets such as homes or other tangible assets (Schellenberg and Ostrovsky, 2010). The insolvency of several major defined-benefit plans, coupled with significant losses in the value of private pension funds overall, have intensified concerns with respect to moderate-income households about retirement savings adequacy; these concerns pre-date the financial crisis of 2008 (Mintz, 2009)". Page 8 Retirement Preparedness and Individual Decision-Making Implications for Canada by Joanne Yoong, RAND Corporation,

The question I have is how do we make the decisions about what we will sell or do to make ends meet in retirement.  Morris Altman has some ideas in his report for the committee called: Behavioural Economics Perspectives. In his report Altman shows the different approaches to Economic Decision making that Economists believe people use. These ideas are important because they are used to shape government policies for the left and right of center parties. I have highlighted ideas I will talk about in upcoming blogs

Conventional  economic theory
  •  Individuals make intelligent decisions, and they do not regret them. Their choices reveal informed and well-considered preferences
  • An ideal decision-making environment is assumed.
  • Education and training (referred to as human capital formation) are regarded  as important means of enhancing productivity. But no clear theoretical mechanism is specified linking improvements in the quantity and quality of education and improvements in decision making. Human capital formation provides important theoretical space for explaining errors or less than ideal decisions, a space well-taken by behavioural economics.
  • Financial decision-making is assumed to be best-practice unless distorted by government interventions in the market and in decision making
Behavioural economics: Kahneman-Tversky, Errors and Biases Approach
• Individuals tend to make irrational, error-prone decisions, which they  eventually regret.

• Errors and biases in decision making are wired into the brain architecture.

• It is possible for the decision-making environment to be less than ideal.

• Individuals often do not know what is in their own best interest.

The benchmark for rationality in decision making is based on conventional  economics and focuses upon calculating behaviour.

• Decision-making shortcuts are regarded as typically error-prone.

Individuals are easily fooled and deceived by how questions are framed and  often reverse their preferred decisions with inconsequential changes in how  questions or options are framed.

• Education can sometimes improve decision making.

Government intervention in decision making is often thought to be the best practice  route to take for ideal choices to be made.

Financial decision-making will be biased and error-prone without government  intervention in choice behaviour.

• Some success predicted for improvements in the decision-making  environment, less for the improvements to financial education.

Behavioural economics: Simon, Bounded Rationality, Rational Individuals
      Individuals are assumed to make rational decisions as a result of how the brain  is wired and the decision-making environment.

      Conventional benchmarks for rational or intelligent decisions are often  rejected.

      Decision-making shortcuts are rational more often than not, even when they  contravene conventional economic benchmarks.

      Individuals are not easily fooled, but they can be misled.

      Individuals can make decision-making errors and these can lead to decisions  that are subject to regret.

      A major source of decision-making errors is a less than ideal institutional  environment.

      Education can have important effects on decision making.

      Government plays an important role by establishing an ideal institutional  environment and by providing the education required for ideal choices to be  executed.

      Government should not intervene in individual choices unless these choices  can be shown to cause harm to others.

      Financial decision-making can be improved by improving the decision-making  environment and through improvement to financial education.

      Government intervention in choice behaviour is not considered to be best practice  if individuals make decisions in an ideal decision-making environment  and with appropriate levels of financial education

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