Building Financial Capability During a “New Normal” in

Personal Finance

Barbara O’Neill, Ph.D., CFP®, CRPC®Professor II, Rutgers University

oneill@aesop.rutgers.edu

2

What is Financial Capability?• New buzz word that is replacing “financial literacy”

• It is not just what you know but what you do with what you know (i.e., focuses on behavior)

– Financial literacy is the ability to understand personal finance concepts

– Financial capability refers to an individual's ability to make informed judgments and effective decisions about the use and management of their money

• President's Advisory Council on Financial Capability renamed in January 2010

• National Financial Capability Challenge

– http://www.challenge.treas.gov/

3

FINRA Financial Capability Study (2009)

• Four key components

– Making Ends Meet

– Planning Ahead

– Managing Financial Products

– Financial Knowledge and Decision-Making

• Study Results:

http://www.finrafoundation.org/web/groups/foundation/ @foundation/documents/foundation/p120535.pdf

4

Key Survey Findings (N =1,488)

• 49% reported difficulty keeping up with monthly expenses (14% very difficult; 35% somewhat difficult)

• 23% reported occasionally overdrawing checking account

• 16% were late with a mortgage payment at least once in last two years (including 10% late > once)

• Only 41% reported having college savings for children

• Only 49% had an emergency fund of 3 months expenses

• 23% used high-cost “alternative” borrowing methods (e.g., payday loans and pawn shops)

5

Four Presentation Topics

• “New Normal” financial realities

• Pre- and post-financial crisis research findings

• 10 “New Normal” student financial learning needs

• YOUR personal and professional “New Normal”

6

Let’s Start With an Analogy

The “New Normal” and the Trump Plaza Hotel (Atlantic City, NJ)

7

What is the “New Normal”?

• A constellation of economic events coming together

• Different trends than those experienced previously

• Puts a “framework” on recent events– People like to identify patterns to make sense of them

• Instructive but always subject to change– Dangerous to assume that “New Normal” will last indefinitely

– Some emerging trends will have long-lasting impact, however (e.g., questioning benefit sustainability)

8

Characteristics of the “New Normal”

An extended period of:

• Slow U.S. economic growth and deleveraging

• Low single-digit average annual stock returns

• Stubbornly high unemployment levels

• Precarious job security (public and private sector)

• Tightened credit standards

• Increased government regulation

• Increased precautionary household savings and debt repayment

• Decreased household spending

• Ultimately, when financial crisis abates, higher inflation (? ) (minority view: deleveraging will negate government debt)

9

Why a New Normal?

We didn’t just have a perfect storm…

…We had a perfect TORNADO!!!

10

Recent Financial Shocks

• Recession/Shrinking economy (GDP)

• Collapsed and merged investment banks

• Bank failures and government takeovers

• Increasing cost of basic necessities

• Mortgage defaults and high foreclosure rates

• Declining home values

• High unemployment rates, flat wages

• Bear market/stock market volatility

• Increased poverty rates and rich-poor “wealth gaps”

• “The Paradox of Thrift”

11

The “Paradox of Thrift” (Economic Term)

What’s good for individuals (saving more and spending less) is bad for the economy when everyone does it.

12

A “New Normal” Was Inevitable

• Previous economic trends were unsustainable

– “Housing (real estate) bubble” (inflated prices)

– “Credit bubble” (household overspending and reckless lending)

– Securitization turned toxic (subprime mortgages)

– Risky pools of derivative securities tied to toxic mortgages (e.g., credit default swaps, credit default obligations)

• Increased post-crisis government oversight

• Reaction (over-reaction?) by financial services firms

13

Four Common Aftermaths of Financial Crises

• Deep and prolonged asset market collapses– Housing prices– Stock market indices

• Profound declines in output (deleveraging)

• High unemployment (in both public and private sector)

• Explosion in government debt as tax revenues decline

14

2011 Federal Reserve Study• Re-interviewed almost 4,000 families in 2007 SCF from

7/09 to 01/10 to examine effects of financial crisis

• Fourth Quarter 2007:– 3% annual growth rate in U.S. GDP

– 5% unemployment rate

• First Quarter 2009:– Continued GDP declines

– Extreme stock market volatility

– Unemployment rate continued to rise

• Fourth Quarter 2009:– Strong GDP growth and sizable equity market gains

– 10% unemployment rate

15

So What Exactly Happened?• Median income declined slightly: $50,100 to $49,800

• 62.5% of families had wealth declines; sizable % gained

• Median percentage change was -18%

• Largest dollar decline was for primary residences

• Median total debt rose from $70,300 to $75,600

• Wealthiest families took the largest hit– Disproportionate losses in capital gains and business income

• Younger respondents had smallest change in wealth

• Majority of families passively accepted changes in portfolio driven by changing asset prices

http://www.federalreserve.gov/pubs/feds/2011/201117/201117pap.pdf

16

Baby Boomers and Older Gen Xers Especially Affected By the Financial Crisis

• Fully experienced, not just one asset bubble- BUT TWO- during long stretches of their working lives– “Tech Bubble” and extraordinary run of double-digit stock

market returns in late 1990s– “Housing Bubble” during much of the 2000s

• Limited recovery time for battered investments

• Money Magazine (April 2009):

“A generation of Americans grew into middle age thinking that they had more wealth than they really did and their future was a lot more secure than it really was.”

17

How People Receive “Bad News” DABDA Model (Elizabeth Kubler-Ross Model)

18

For Some, the Dream of Upward Mobility Appears to be Slipping Away

19

The “Retirement Planning Grief Cycle”• Denial: “Not to Worry. This is just a blip and things will get back to

normal soon” OR “I’ll be OK. I’ve had this job for 20 years”

• Anger: “This isn’t fair. They’re taking away [X]” OR “I’m really mad. They’re cutting my retirement benefits”

• Bargaining: “Maybe they won’t lay me off if I agree to a pay cut” OR “I’ll ask the union to demand they exempt older employees from this change”

• Depression: “It’s hopeless. I’ll never be able to retire” OR “I’ll probably end up a bag lady when I’m older”

• Testing: “If I adjust my spending or work a little longer, I could probably still retire comfortably” OR “I’ll do some work on the side to make up for what I lost from the pay freeze”

• Acceptance: “I’m OK. I have a new financial plan for my retirement” OR “I’ve figured out a few good ways to live on less”

20

10 Key Student Financial Learning Needs

1. “The Basics” (e.g., expense tracking, emergency funds, goals)

2. Creative frugality (e.g., “stepping down,” substitutions)

3. Entrepreneurship skills (increased self-employment is predicted)

4. Budgeting for variable incomes (“cash flow calendar”)

5. Changing employee benefit plan options

6. Defining “success” in non-economic terms

7. Investment characteristics and techniques

8. Human capital investments (increases resilience)

9. Health-wealth relationships

10.The power of optimism, focus, and planning

21

“New Normal” Learning Needs

1.“The Basics” (e.g., expense tracking, emergency funds, goal-setting with specific targets)

– Planning increases control and success, reduces stress

2. Creative Frugality (e.g., “stepping down,” living on a reduced income, reduced spending)

3. Entrepreneurship Skills (more self-employed predicted; up to 40% of U.S. workers by 2020)

4. Budgeting for Variable Incomes (“cash flow calendar” with surplus and deficit months)

22

More “New Normal” Learning Needs

5. Changing employee benefit plan options

– NN Reality: Future benefits will be less attractive

6. Define “success” in non-economic terms

– Relationships, creative frugality, less “stuff”

7. Investment characteristics, techniques– Historical asset returns; dollar-cost averaging

– Young adults may be shying away from stock market: http://www.newsweek.com/2010/09/07/young-adults-invest- conservatively-post-recession.html

23

Still More “New Normal” Learning Needs

8. Human capital investments – Increases resilience during tough times

– Experts recommend personal “branding” strategies

9. Health-wealth relationships– Cost of smoking, obesity, poor health habits

10. The power of optimism, focus, planning– In NN, easy to feel that the future will be worse

– Rutgers research: students feeling unfulfilled expectations: http://news.rutgers.edu/medrel/news- releases/2011/05/unfulfilled-expectat-20110523

24

Research Study (O’Neill & Xiao): Are Post- Financial Crisis Financial Practices Any Different?

• Data collected from online Financial Fitness Quiz

• URL: http://njaes.rutgers.edu/money/ffquiz/

• Quiz includes 20 recommended financial practices

• Total quiz scores can range from 20 to 100

• “Time stamp” tells when data were collected

• N = 10,661 respondents (1/1/05 – 12/31/10)– 5,440 from 1/1/05 - 12/31/07

– 5,221 from 1/1/08 – 12/31/10

– Self-reported financial practices

• Chose 12/07 as cut-off: NBER declared recession

25

12 Financial Practices Showed Significant-But Very Modest- Time Period Differences

• Have enough money to pay for an emergency

• Written financial goals with a date and cost

• Written spending plan (budget)

• Net worth calculation

• Three months expenses set aside

• Increase savings with salary increase

• Adequate insurance for big expenses

• Have a current will

• Less than 20% of take-home pay spent on consumer debt

• Pay credit card bills in full to avoid interest

• Comparison shop for major purchases

• Avoid impulse buying & recreational shopping

26

So Welcome to the “New Normal”New economic patterns have been evolving in the wake of the financial crisis:

• Credit is tight• Spending is constrained• Frugality is “in,” (usually out

of necessity, not desire)• Contingent employment is

increasing• Unemployment rate is high• Employee benefits are

decreasing• Lots of uncertainty on the

horizon (e.g., taxes and inflation)

In times of crisis and uncertainty, knowledge is power!

27

What is YOUR “New Normal,” Personally and Professionally?

28

Don’t Get Too Comfortable, Though (Things Will Change….Again)

29

For Further Information

O’Neill, B. Financial Education in 2010 and Beyond: Helping Consumers Adapt to a ‘New Normal.’ (2010) Journal of Consumer Education, 27, 1-15. http://www.cefe.illinois.edu/JCE/archives/

Hughes, J.W., & Seneca, J.J. (2009), 2009: The shape of new normal. Sitar-Rutgers Regional Report, 12(1). http://www.policy.rutgers.edu/reports/sitar/sitarfeb09.pdf

30

Questions and Comments?

Barbara O'Neill, Ph.D., CFP®, CRPC

Extension Specialist in Financial Resource Management and Professor II Rutgers University

Phone: 732-932-9155 Extension 250

E-mail: oneill@aesop.rutgers.edu

Internet: http://njaes.rutgers.edu/money2000/

Twitter: http://twitter.com/moneytalk1