Impatience, Financial Literacy Could Be Strong Reasons for Retirement Savings Inadequacy

“Both financial literacy and short-run impatience play important roles in determining retirement saving, even after controlling for education and income,” researchers say in a study report.

Researchers set out to determine how financial literacy and impatience (present-bias) affect retirement savings behaviors.

They used experimental evidence derived from the 2009 Chilean Encuesta de Protección Social (EPS or Social Protection Survey) to evaluate how financial literacy and impatience predict saving decisions and investment in health. The EPS is similar to the U.S. Health and Retirement Study, and it is a nationally representative panel of respondents followed every two years, fielded by the University of Chile’s Microdata Center in cooperation with the University of Pennsylvania.

First, the researchers administered a battery of financial literacy questions from which they developed a literacy index which can be used as a predictor of retirement saving and other key outcomes. Second, the researchers implemented an experiment in which respondents could fill out a questionnaire immediately and hand it in for a gift card or fill it out later, mail it in, and receive a gift card for a higher amount.

The results show that the measure of impatience is a strong predictor of retirement saving and investment in health. Financial literacy is also correlated with accumulated retirement saving though it appears to be a weaker predictor of sensitivity to framing in investment decisions.

Those who chose to immediately turn in the gift card also have less saving. Those with higher financial literacy scores are also more likely to have higher saving accumulations. Comparing the impact of financial literacy versus choosing “now” versus “later” for the gift card found impatience lowers saving as much as a 2.5 point reduction in the financial literacy score. “In other words, this provides support for the hypothesis that both financial literacy and short-run impatience play important roles in determining retirement saving, even after controlling for education and income,” the researchers write.

They say their results should interest policymakers seeking to determine how to better shape the environment in which individuals undertake saving and investment choices. The results imply that it may be useful to facilitate decision making, particularly among the less-educated, as well as to facilitate people committing to and carrying out long-term financial decisions.

“As individuals are being asked to exert more control over their own retirement accounts (e.g., 401(k)’s) and other household investments, this raises a concern about whether consumers are capable of making optimal investment and saving decisions. Further, the development of ever-more complex financial products makes it difficult for consumers to use these sensibly,” the researchers say. “What we have shown is that participant awareness of higher net-return funds can be greatly enhanced when information on fees is simplified in terms of likely gains from selecting higher net return funds. The impact of fund fee framing is largest for the least financially literate and the lowest-educated groups.”

The full research report is here.