Can Economically Vulnerable Americans Benefit From Financial Capability Services?
A look at programs designed to increase family financial security in honor of National Financial Capability Month
This analysis was updated April 7, 2017, to correct the name of National Financial Capability Month.
April is National Financial Capability Month, which presents an important opportunity to focus on the economic challenges facing many U.S. families and on the potential of financial capability programs—such as financial literacy education, counseling, coaching, and planning—to provide possible solutions to Americans’ financial insecurity.
About half of American families are financially insecure, and in March, The Pew Charitable Trusts released a report showing that more than a third (34 percent) of households experienced income volatility—gains or losses of at least 25 percent—from 2014 to 2015. These families reported lower financial well-being than those with stable income. Further, another Pew study found that financial insecurity even looms over high-income families with ample savings: One in 5 households making at least $85,000 a year that had more than $4,000 in liquid assets struggled to make ends meet after experiencing a major financial shock, such as an unexpected car repair or medical bill, or a loss of income. And according to third recent Pew analysis, 1 in 5 people (21 percent) are not planning to retire. It is not surprising then, that a whopping 92 percent of Americans would choose financial security over moving up the income ladder.
As families struggle to gain a more stable financial footing, they are looking for resources to help them plan, save, and achieve financial goals. Participants in focus groups conducted by Pew often expressed a desire for greater knowledge about money management, budgeting, financial products, and mechanisms for saving. When asked about the biggest challenge, one participant confided: “Oh, that’s easy. For me it was very low financial IQ.”
But can financial capability programs help Americans attain economic security? In practice, the components of financial capability programs are often intertwined. For example, financial planning includes elements of literacy education, coaching, and in some instances counseling. However, they have distinct purposes:
- Literacy education helps people understand financial products and services.
- Counseling aims to solve specific problems or crises.
- Coaching helps identify goals and change behaviors.
- Planning focuses on determining long-term goals and developing a strategy to achieve them.
This analysis examines each program separately to help policymakers and families understand their potential benefits and limits and to emphasize their distinct purposes, based on the available literature.
The premise behind financial literacy programs is that increased knowledge results in more informed and effective financial decision-making, which in turn improves financial security. Financial literacy education can be approached in several ways. Some experts focus on programs offered in workplaces, schools, and community organizations as the main channels for delivering financial information. Researchers at the Brookings Institution also include one-on-one credit and mortgage counseling, while the Global Financial Literacy Excellence Center emphasizes the potential of the internet as a venue for effective financial education.
Although studies have not found positive effects of simply providing general financial information on consumer behavior, recent research has shown a benefit from targeting specific populations and matching them with pertinent information when they need it. For example, a study of low-income youths in their first jobs—an important time to learn about financial products—indicated that a program developed and led by peers helped increase participants’ understanding of and ability to manage their finances. Similarly, an evaluation of a short personal finance course for Army recruits reported that the program increased participation in retirement savings plans but did not affect the volume of established emergency funds. Other research indicates that financial literacy helps individuals understand the intricate economic world around them.
When people have an immediate and specific financial problem, financial counseling designed to provide them with expert advice and help them overcome their obstacles may be beneficial. A certified financial counselor is qualified to assist families in person, by phone, or via the internet with issues such as developing financial statements and spending plans, understanding financial services and basic tax management, and managing credit and debt. Counsellors can also provide prescriptive information about renting, purchasing, and selling homes and about insurance products, and offer referrals to social or other specialized services.
Furthermore, counseling can be targeted at specific audiences. For instance, credit counseling, which often focuses on reducing credit card debt, can be offered to individuals and families struggling with debt or those at risk of falling in the red. Similarly, mortgage counseling is offered for homebuyers at two stages: before and after a home purchase to help them first evaluate their options and understand the financial commitment they are taking on, and then if they fall behind on their payments, avoid default or foreclosure. Other types of targeted financial counseling are offered to individuals struggling with a reverse mortgage, bankruptcy, student loan debt, or a first home purchase.
Rigorous research involving randomized samples and control groups indicates that counselling can lead to modest but positive changes in consumer behavior. For example, an evaluation of a pilot program for individuals transitioning off of public benefits found that participants were more likely to be current on their debt payments six and 12 months after counseling. Further, a study of clients at some credit counseling agencies found that individuals’ debt balances declined in the 18 months following the service. Another found that, for borrowers in mortgage default, each additional hour of counseling decreased the probability of facing a home foreclosure.
Despite these positive evaluations, consumers should be cautious when selecting a counsellor. The Federal Trade Commission observed that some credit counselling organizations “charge high fees, which they may hide; others might urge their clients to make ‘voluntary’ contributions that can cause more debt.”
Financial coaching helps people practice self-identified healthy financial behaviors and is becoming an increasingly popular approach to improving Americans’ management of their money and wealth. A financial coach predominantly supports clients in setting goals and motivates them to solve economic problems, such as by building savings or reducing debt, on their own. Coaches are not necessarily financial experts. Rather they are individuals trained to provide encouragement, monitor performance, and offer constructive feedback. Generally, coaching is targeted not to specific demographic groups, but instead, as one expert explains, to people with stable financial situations in moments of transition, such as getting married, having a baby, or retiring. Clients tend to have basic financial knowledge and some experience building wealth, such as by saving.
Financial coaching is most often offered in person and in a one-on-one setting, but experts at the 2016 Assets Learning Conference emphasized that other options are also available. For example, remote coaching—over the phone or online—helps reach more clients, peer coaching pairs program alumni with new clients, and automated coaching sends clients electronic prompts and reminders. Group coaching is also offered.
Coaching is a new approach in the field of personal finances, but the early evaluations suggest positive results. In the first randomized study using control groups, researchers analyzed two programs and found some beneficial effects for clients. For example, the study reported increases in the number of savings deposits and the likelihood of having a budget and reduced debt, late fees and levels of financial stress. However, the evaluation showed no effect on other outcomes, such as retirement savings or income-to-expense ratio. The results also were often inconsistent between the two programs.
Further, a randomized study comparing the effectiveness of remote coaching to an in-person approach found similar results regardless of the mode of delivery. This suggests that the remote model is a viable option that can help reach homebound, rural, and other location-constrained clients.
Like coaching, the purpose of financial planning is to help clients achieve short- and long-term goals, but planning is more investment-oriented and the cooperation between adviser and client is expected to last many years. A professionally designed financial plan is a customized roadmap to maximize the client’s existing resources and ensures that adequate insurance and legal documents are in place to protect the client’s family in case of a crisis. For example, a planner may collect financial information and inquire about short- and long-term expectations to recommend the most suitable investment solutions for those goals. The adviser also monitors and reviews the plan periodically, adjusting it as needed.
Although financial planning generally targets higher-net-worth clients, options also are available for economically vulnerable families. For example, the Foundation for Financial Planning connects over 15,000 volunteer planners with underserved clients to help struggling families take control of their financial lives free of charge.
Research has shown a correlation between financial planning and wealth aggregation, with some caveats. People who plan their financial futures are more likely to accumulate wealth and invest in stocks or other high-return assets. A survey using questions designed to capture people’s propensity to plan indicated that a higher tendency is associated with more wealth, and another study found that planning is a predictor of saving and correlated with financial literacy.
Many professionals specialize in such areas as retirement, asset management, divorce, or entrepreneurship, while others provide more holistic guidance. Further, advisers operate under a range of professional circumstances. Many financial information providers can be considered planners, regardless of their credentials. To differentiate themselves in the marketplace, therefore, many trained advisers pursue a certified financial planner designation, which sets a standard of excellence and requires an extensive exam, continuing education, a minimum amount of experience, and consistent adherence to ethics provisions. However, this credential is not a guarantee of high standards. Some advisers’ compensation depends on sales of specific financial products; as a result, some experts have raised concerns that in such cases the advice may be biased or fail to represent the client’s best interest.
Pew research has found that families fall short of meeting their own financial recommendations: For example, across all household types and income levels, survey respondents said families should have substantial levels of easily accessible savings, but of those, 8 in 10 had less household liquid savings than they recommend for families like their own.
More research is needed to evaluate the effectiveness of financial education, counseling, coaching, and planning over the long term and to determine the most efficient mode and duration of these services. Nevertheless, the existing research is reason for cautious optimism.
Clinton Key is a research officer and Joanna Biernacka-Lievestro is a senior research associate with The Pew Charitable Trusts’ financial security and mobility project.
Changing household balance sheets and the effects of financial shocks
An examination of gains, losses, and household economic experiences
Perception and reality