FINANCIAL ADVICE: WHAT ABOUT LOW- INCOME CONSUMERS?

Transcription

1 FINANCIAL ADVICE: WHAT ABOUT LOW- INCOME CONSUMERS? Nng Tang (correspondng author) San Dego State Unversty Mare-Eve Lachance San Dego State Unversty Ths paper uses data from the Natonal Fnancal Capablty Study (NFCS) to analyze the determnants and benefts of fnancal advce use, wth a specal emphass on the low-ncome group. Whle, as expected, ths group fares worse fnancally, we also fnd that they have dfferent needs and prortes. For example, they use less nvestment advce than nsurance advce. A dscrmnant analyss reveals that cost plays a lesser role n ther decson to seek advce. Usng an nstrument varable strategy, we conclude that certan types of advce mprove clents fnancal behavors, wth greater benefts for the low-ncome group. Introducton Hstorcally, low-ncome communtes have had lmted access to fnancal servces, affordable credt, and nvestment captal (Rubn, 2007). Ths s especally the case n the professonal fnancal advce ndustry, whch has targeted manly the hgher end of the market. From the supply perspectve, pursung clents wth modest accounts s not proftable when compensaton s based on a percentage of the assets under management. However, as Rubn (2007) ponts out, the rch and the poor both have the need and the desre to buld fnancal assets to enable them to meet mportant lfe goals. Access to captal and basc fnancal servces s a crtcal component of achevng such goals. Numerous products, programs, organzatons, and polces have been desgned to 121

2 122 Journal of Personal Fnance address the fnancal excluson of low-ncome ndvduals and communtes. It s more and more clear that, gven ncentves and provded wth fnancal educaton, low-ncome ndvduals can change ther fnancal behavor, and they need such changes (Schrener, Clancy, & Sherraden, 2002; Mlls, Patterson, Orr, & DeMarco, 2004). To better address the problem of low-ncome consumers' lmted access to fnancal servces and products, to serve them more effcently, and to effectvely advocate for a relatvely new low-ncome fnancal servce market, we need more nsghts nto the fnancal behavor of low-ncome consumers. In partcular, we need to know how the fnancal condton of low-ncome ndvduals compares to that of people wth hgher ncomes, ther fnancal advce-seekng behavor, and the effect of fnancal advce on ther fnancal lteracy and behavor. Unfortunately, the lterature has not provded much nformaton on these areas. Although there are a number of studes explorng who uses fnancal advce and what factors contrbute to consumers advce-seekng behavor, none of these examne the dfference n advce-seekng behavor between low- and hgh-ncome groups. Consderng that lowncome consumers have dfferent fnancal exposures and needs, fndngs from the prevous lterature on wealther ndvduals may not readly apply to them. In addton, due to the lmtaton of data and methodology, very lttle s known about the effects of varous knds of fnancal advce on ndvduals fnancal lteracy and behavor and whether these effects are the same among dfferent ncome groups. The unque Natonal Fnancal Capablty Study (NFCS) dataset allows us to fll the gap n the lterature by addressng the above ssues. Specfcally, the paper fnds that 122

3 low-ncome ndvduals fare worse fnancally than hghncome ones: they have lower levels of fnancal knowledge and ablty, acheve fewer fnancal plannng goals, and have less access to fnancal servces and products. Meanwhle, they are usng less fnancal advce and have less favorable atttudes towards the ndustry than ther hgher-ncome counterparts. We fnd that low-ncome consumers have dfferent demand compostons of fnancal advce and consder dfferent factors than hgh-ncome consumers when seekng such advce. Sx percent more low-ncome consumers use nsurance advce than use savngs/nvestments advce, whle the advce most demanded by hgh-ncome consumers s savngs/nvestments advce. In addton, by ncorporatng demographc, socoeconomc, psychosocal factors and fnancal lteracy and capablty n one model, dscrmnant analyss shows that the cost of seekng fnancal advce s less mportant to low-ncome earners than to hgh-ncome earners. Last, we examne whether fnancal advce s benefcal n terms of mprovng fnancal knowledge (objectve and selfassessed) and a broad set of fnancal behavors. When performng ths type of exercse, a common lmtaton s that reverse causalty and selecton may cause based estmaton. We use an nstrument varable strategy to address the problem. We observe that those who receved fnancal advce report hgher levels of self-assessed fnancal knowledge, but they do not score hgher on a set of objectve fnancal lteracy questons. In most cases, all types of advce help clents mprove postve behavors, but only savngs/nvestments and tax advce help avod negatve behavors. In a second set of regressons, we nteract fnancal advce wth a low-ncome 123

4 124 Journal of Personal Fnance dummy and fnd greater mprovements n certan fnancal behavors for the low-ncome group. The paper s structured as follows. Secton 2 descrbes the data, and Secton 3 compares the fnancal condton of low-ncome and hgh-ncome ndvduals. Secton 4 analyzes the determnants of fnancal advce adopton and how they dffer between low- and hgh-ncome groups. Secton 5 uses the nstrument varable strategy to examne the effects of fnancal advce on clents fnancal lteracy and behavor, and Secton 6 concludes. Data Ths paper uses the Natonal Fnancal Capablty Study (NFCS) dataset, whch was commssoned by the Investor Educaton Foundaton of the Fnancal Regulatory Authorty (FINRA). Intervews were conducted between May and October The dataset collected nformaton from about 500 respondents n each state (28,146 observatons n total) regardng ther demographc characterstcs, use of fnancal advce, fnancal lteracy and other aspects of fnancal plannng. 19 In partcular, the survey asks respondents In the last 5 years, have you asked for any advce from a fnancal professonal about any of the followng: 1) debt counselng, 2) savngs or nvestments, 3) takng out a mortgage or a loan, 4) nsurance of any type, 5) tax plannng? 20 In addton, the survey records consumers atttudes towards fnancal advsors. In terms of fnancal lteracy and capablty, the survey features 19 Personal-plannng topcs nclude cash management, retrement plannng, home and auto acquston, credt management, and nsurance plannng. 20 We do not use the queston for mortgage and loan advce n our analyss because mortgages and loans are very dfferent n nature, whch makes the nterpretaton of the results dffcult. 124

5 fve questons that measure fnancal lteracy and asks the respondents to self-assess ther fnancal knowledge and capablty, ncludng the ablty to deal wth day-to-day fnancal matters, ther math sklls, and whether or not they keep up wth economc news (see Appendx for exact queston wordng). The rch dataset coverng varous aspects of fnancal well-beng at the ndvdual level allows us to explore the fnancal condtons and use of fnancal advce among lowncome and hgh-ncome consumers separately. The demographc composton of the sample s smlar to that n the 2010 Amercan Communty Survey, wth the excepton of an underrepresentaton of the group wth less than a hgh-school degree. Fnancal condton of low- and hgh-ncome consumers To explore the use of fnancal advce and ts effect on consumers behavor among low- and hgh-ncome consumers, t s necessary to frst nvestgate the dfferent fnancal condtons wthn these two ncome groups. Ths s necessary because ther fnancal condton and what they beleve about fnancal servces wll largely determne ther choce of professonal fnancal advce and the effects of such advce. Wth the unque dataset, we can examne fnancal lteracy and capablty and fnancal condtons and atttudes towards professonal fnancal advce among low- and hgh-ncome earners separately. We defne low-ncome consumers as those wth an annual household ncome lower than $25,000 (7,013 observatons) and hgh-ncome consumers as those wth an annual ncome hgher than $75,000 (7,779 observatons). These low- and hgh- ncome groups correspond, respectvely, to the frst and fourth quartles of the ncome dstrbuton n our sample. 125

6 126 Journal of Personal Fnance Table 1 Fnancal Condton of Low-Income and Hgh-Income Consumers Mean Mean Dfference Fnancal lteracy Fnancal lteracy score *** Self-assessed fnancal knowledge *** Good at day-to-day fnancal matters *** Good at math *** Keep up wth fnancal news *** Cash flow management Have emergency fund 19.4% 59.9% -40.5% *** Spend more than ncome 27.4% 13.4% 14.0% *** Overdraw checkng account 31.5% 20.1% 11.4% *** Savngs and nvestments Save for chldren's college 15.5% 55.3% -39.8% *** Have 529 plan 14.0% 45.2% -31.2% *** Retrement plannng Fgured out need for retrement 23.8% 64.9% -41.1% *** Use Soc. Sec. to decde retrement age 27.5% 26.6% 0.9% Calculate wthdraw amt. after ret. 44.3% 74.5% -30.2% *** Contrbute regularly to retrement 46.4% 85.5% -39.1% *** Rebalance retrement account 24.9% 57.9% -33.0% *** Hardshp wthdrawal from ret. account 12.9% 4.9% 8.0% *** Credt management Checked credt score n past one year 35.9% 61.6% -25.7% *** Compare auto loan provders 39.0% 50.6% -11.6% *** Compare mortgage provders 48.2% 70.9% -22.7% *** Consder mtg. pmt. as % of ncome 80.5% 81.7% -1.2% Have hgh cost loans 35.0% 11.1% 23.9% *** Late wth mtg. pmt. n past 2 years 33.1% 12.9% 20.2% *** Foreclosure process n past 2 years 2.7% 2.0% 0.7% *** Credt card penalty 34.9% 21.9% 13.0% *** Insurance plannng Compare nsurance provders 67.4% 70.7% -3.3% *** Revew nsurance coverage 53.8% 76.0% -22.2% *** General Drop n ncome n past year 48.9% 28.3% 20.6% *** Savngs and nvestments Have checkng account 82.2% 98.8% -16.6% *** Have savngs account 56.3% 93.1% -36.8% *** Investment outsde ret. account 14.9% 65.9% -51.0% *** Investment outsde ret. account (n $) 4,188 69,271-65,083 *** 126

7 Retrement plannng Have employer-sponsored ret. plan 18.2% 84.8% -66.6% *** Non employer-sponsored ret. account 7.5% 53.2% -45.7% *** Retrement account amount (n $) 24, , ,604 *** Stock n retrement account (yes=1) More than half 38.7% 62.0% -23.3% *** Less than half 29.7% 33.4% -3.7% * None 31.6% 4.7% 26.9% *** Invest n lfecycle fund 37.8% 28.2% 9.6% *** Take loan from retrement account 9.3% 8.7% 0.6% Retrement fundng Socal Securty 88.9% 69.8% 19.1% *** Penson plan payments 33.5% 73.6% -40.1% *** Savngs, nvestments, or retrement accounts 24.0% 37.8% -13.8% *** Dvdends or nterest ncome 11.6% 42.4% -30.8% *** Salary, wages, or self-emp. ncome 7.5% 42.6% -35.1% *** Rental ncome or sale of real estate 4.0% 14.9% -10.9% *** Reverse mortgage 1.6% 0.1% 1.5% *** Famly support 9.6% 1.4% 8.2% *** Change n response to current economc condtons 52.2% 35.2% 17.0% *** Real estate Homeowner 30.9% 86.7% -55.8% *** Other real estate ownershp 8.2% 39.0% -30.8% *** Have a mortgage among homeowners 44.3% 77.7% -33.4% *** Have a home equty loan among homeowners 12.1% 29.0% -16.9% *** Credt Number of credt cards *** Credt card balance 3,513 5,569-2,056 *** Have an auto loan 17.9% 45.3% -27.4% *** Declare bankruptcy n past two years 2.5% 1.2% 1.3% *** Insurance Have health nsurance 62.6% 95.8% -33.2% *** Have lfe nsurance 33.8% 83.4% -49.6% *** Have auto nsurance 70.8% 97.7% -26.9% *** Have homeowners or renters nsurance 36.1% 92.7% -56.6% *** Fnancal cost Mortgage nterest rate 7.3% 5.9% 1.4% *** Credt card nterest rate 12.7% 11.9% 0.8% *** Auto loan nterest rate 9.9% 6.1% 3.8% *** 127

8 128 Journal of Personal Fnance To gve an overvew of how the two ncome groups dffer n ther fnancal condton, Table 1 presents a varety of summary statstcs for the low-ncome (column 1) and hghncome (column 2) groups. The dfferences between the two groups are reported n the thrd column, and asterske used to ndcate whether these dfferences are sgnfcantly dfferent when performng a t-test. The varables n Table 1 are dvded nto three panels: fnancal lteracy and ablty, fnancal management results, and fnancal status. Panel A shows the results on fnancal lteracy and ablty. We construct a scaled fnancal lteracy score by addng up the number of correct answers for the fve fnancal lteracy questons and dvdng the total score by 5.21 The self-assessed fnancal knowledge and capablty scores are rescaled between 0 and 1 n the presentaton of our results. The results show that low-ncome earners, on average, have lower levels of fnancal knowledge than hgh-ncome earners. Ther self-assessed scores on fnancal knowledge and ablty are also lower than those for the hgh-ncome group. However, t s worth notng that for the low-ncome group, average self-assessed knowledge s qute a bt hgher than actual fnancal knowledge (0.59 vs. 0.49), whle that s not the case for the hgh-ncome group (0.73 vs. 0.75). Possbly, low-ncome consumers are not as aware of ther lack of fnancal knowledge, but we do not have suffcent data to test the hypothess at ths stage. It mght also be that, because low-ncome workers are less exposed to nvestments, ther percepton of fnancal knowledge s less affected by nvestment knowledge than the fnancal lteracy score s. Snce self-assessed knowledge may capture some aspects of fnancal knowledge more related to day-to-day 21 Those who answered don t know or prefer not to say to fnancal lteracy questons are coded as zeros. 128

9 matters, n the later analyss we wll use both self-assessed fnancal knowledge measures and the objectve fnancal lteracy scores. Panel B summarzes how ndvduals acheve personal fnancal plannng goals n terms of cash flow management, savngs and nvestments, retrement plannng, credt management, and nsurance plannng by ncome groups. It shows that low-ncome consumers acheve less than hghncome consumers. For example, under cash flow management there are fewer low-ncome earners settng up an emergency fund, and more of them are outspendng ther ncomes or overdrawng on ther checkng accounts. The dfferences between the two ncome groups are statstcally sgnfcant. However, t s worth notng that results here are smply summary statstcs wthout controllng for ndvduals characterstcs and fnancal exposures, such as wealth, educaton, etc. Thus, dfferences may reflect not only behavor but also economc crcumstances and fnancal needs. Panel C contrasts the current fnancal status of the lowand hgh-ncome groups. Low-ncome ndvduals have experenced an unexpected drop n ncome n the past year at a hgher rate than ther wealther counterparts. They have less access to checkng and savng accounts and have fewer nvestments both nsde and outsde ther retrement accounts. They allocate less to equtes n retrement accounts and rely more on socal securty and famly support as retrement fundng than hgh-ncome ndvduals do. More of the lowncome earners have changed ther wthdrawal amount or frequency from retrement accounts n response to the recent fnancal crss, whch reflects the fact that they are more vulnerable to economc shocks. In terms of real estate, fewer 129

10 130 Journal of Personal Fnance low-ncome consumers own ther homes or other real estate propertes. Low-ncome homeowners are less lkely to have a mortgage or a home equty loan. Low-ncome consumers have fewer credt cards wth lower card balances and are less lkely to have auto loans. Low-ncome earners are less lkely to be nsured, especally for lfe nsurance and homeowners or renters nsurance: 34% of them have lfe nsurance and 36% have homeowners or renters nsurance, whle the fgures for ther hgh-ncome counterparts are 83% and 93%, respectvely. Last, the results ndcate that low-ncome groups pay hgher nterest rates on mortgages, credt cards, and auto loans. Therefore, we conclude from the results n Panel C that lowncome ndvduals have less accumulated wealth through retrement and non-retrement savngs and real estate, they face hgher nterest rates for borrowng, are less lkely to have nsurance, and are more vulnerable to fnancal shocks. Knowng that low-ncome consumers have lower levels of fnancal knowledge and ablty, acheve fewer fnancal plannng goals and have less access to fnancal products, more assstance s needed to mprove ther fnancal stuaton. Professonal fnancal advce can be one soluton. In the remander of ths secton, we explore the prevalence of fnancal advce use among low- and hgh-ncome groups and ther atttudes towards such professonal servces. Fgure 1 shows the prevalence of fnancal advce among consumers. Frst, to gve an overvew of fnancal advce use, we fnd that 32% of respondents use savngs/nvestments advce, 19% tax advce, 35% nsurance advce, and 10% debt advce. Then, we nvestgate the use of dfferent types of fnancal advce by ncome group. The use of fnancal advce ncreases wth ncome, except for debt advce. 130

11 Fgure 1. Use of Fnancal Advce by Advce Types 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Tax advce Average: 19% <15 15~25 25~35 35~50 50~75 75~ ~ Income (n thousand dollars) 131

12 132 Journal of Personal Fnance 100% 80% 60% 40% 20% 0% 100% 80% 60% 40% 20% 0% 132

13 Although low-ncome people need more help to mprove ther personal fnancal plannng stuaton, we show that they are currently less lkely to use fnancal advce than hgh-ncome people to solve the problem. The skewed supply of professonal fnancal advce and products towards wealthy people and the less-favorable atttudes towards the ndustry among low-ncome communtes could explan why lowncome consumers use less fnancal advce to mprove ther fnancal stuaton. We collect data on Certfed Fnancal Planners (CFPs) and Certfed Publc Accountants (CPAs) wth a Personal Fnancal Specalst desgnaton, two major fnancal advce supplers. In Fgure 2, we show the average number of these supplers by quartle of average ncome n the zp code. The results clearly ndcate that CFPs and CPAs are located manly n the top-quartle neghborhoods.22 To examne the role of atttudes towards fnancal advsers, Fgure 3 comples the answers to the three percepton questons (trust fnancal professonals; fnancal professonals too expensve; hard to fnd the rght fnancal professonal) by ncome group. More low-ncome people beleve that t s hard to fnd the rght fnancal professonals and that advce s too expensve for them. Trust generally ncreases wth ncome, except at the tal ends of the dstrbuton. Overall, low-ncome consumers dsplay less favorable atttudes towards the fnancal advce ndustry. 22 Of course, ths s not to say that fnancal advsers work only for clents n ther zp code. The result, however, s reflectve of the skewed nature of supply n ths ndustry. 133

14 134 Journal of Personal Fnance Fgure 2. Supply of CFPs and CPAs by Income Quartle 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Frst ncome quartle Second ncome quartle Thrd ncome quartle Fouth ncome quartle CFP supply CPA supply Notes: Authors computaton. The zp code ncome data comes from the annual fle by IRS Statstcs of Income Dvson for tax year 2008 (avalable at Number of CFPs by zp code (total 7,521) was derved from the Fnancal Plannng Assocaton drectory Number of CPAs wth a Personal Fnancal Specalst desgnaton (total 4,688) by zp code was derved from the addresses n the Amercan Insttute of CPAs drectory 134

15 Fgure 3. Atttudes towards Fnancal Professonals Fnancal professonals too expensve <15 15~25 25~35 35~50 50~75 75~ ~ Income (n thousand

16 136 Journal of Personal Fnance Fgure 4. Ranks of Fnancal Advce Use by Income Group Low ncome 1. Insurance advce 24% 2. Savngs/nvestments advce 18% 3. Debt advce 10% 4. Tax advce 9% 0% 5% 10% 15% 20% 25% Hgh ncome 1. Savngs/nvestments advce 47% 2. Insurance advce 44% 3. Tax advce 31% 4. Debt advce 8% 0% 10% 20% 30% 40% 50% 136

17 Before leavng ths secton, we further explore the demand compostons of fnancal advce among low- and hgh-ncome clents. Fgure 4 ranks the prevalence of each type of fnancal advce among the two ncome groups separately. We fnd that low- and hgh-ncome ndvduals have very dfferent demand compostons of fnancal advce. Insurance advce s the one that low-ncome consumers demand most (24%), followed by savngs/nvestments (18%), debt (10%) and tax (9%) advce. For ther part, hgh-ncome consumers use savngs/nvestments advce most (47%), followed by nsurance (44%), tax (31%) and debt (8%) advce. For polcymakers, fnancal planners and educators to better fll the gap and serve the low-ncome communty, there s a need to understand that group's specal fnancal needs and exposures. For example, the low-ncome group needs nsurance advce more than savngs/nvestments advce. Ths makes sense gven that they do not have as many assets to nvest and are more exposed to economc nsecurty. Determnants of fnancal advce adopton In the prevous secton, we found that the prevalence of usng fnancal advce vares among ncome groups. In ths secton, we use dscrmnant analyss to explore the factors affectng consumers decson to use fnancal advce and how these factors nfluence low- and hgh- ncome ndvduals dfferently. There s a rch lterature on who seeks fnancal advce. The characterstcs that have been found to affect ndvduals fnancal advce-seekng behavor can be grouped nto four categores: demographc, socoeconomc, psychosocal and fnancal lteracy and capablty. In the frst category - 137

18 138 Journal of Personal Fnance demographc factors - older marred females are found to be more lkely to use fnancal advce (Bluethgen, Gnschel, Hackethal, & Müller, 2008; Fnke, Huston, & Wnchester, 2011; Gerhardt & Hackethal, 2009; Hackethal, Halassos, & Jappell, 2012; Hung & Yoong, 2010; Joo & Grable, 2001). As for the socoeconomc characterstcs, educaton, homeownershp, wealth and workng status also affect fnancal advce-seekng behavor sgnfcantly (Bluethgen et al., 2008; Collns, 2010; Elmerck, Montalto, & Fox, 2002; Fnke et al., 2011; Grable & Joo, 1999; Gerhardt & Hackethal, 2009; Hackethal et al., 2012; Haslem, 2010; Grable & Joo, 2001). Effects of psychosocal factors and fnancal lteracy are relatvely new topcs n the lterature. Rsk tolerance, fnancal behavors, atttudes towards retrement, fnancal stress and levels of fnancal satsfacton are found to affect fnancal advce adopton sgnfcantly (Grable & Joo, 1999 and 2001; Bluethgen et al., 2008; Gerhardt & Hackethal, 2009; Joo & Grable, 2001). Fnke et al. (2011) shows that people wth lower self-reported fnancal knowledge are more lkely to pay for fnancal advce, and Collns (2010) fnds that hgher fnancal lteracy ncreases the use of fnancal advce. We extend ths lterature by ncorporatng all these factors nto one model and studyng how they work together to affect ndvduals decson to pursue professonal fnancal advce. Namely, we perform a dscrmnant analyss based on the followng regresson: Advce 1 X Advce where s a dummy varable ndcatng whether ndvdual uses advce. Snce Elmerck et al. (2002) pont out that regresson results vary by categores of advce, we run four regressons for savngs/nvestments, tax, nsurance and debt 138

19 X advce separately. ncludes demographc characterstcs such as gender, age, martal status, and race; t also has socoeconomc characterstcs comprsng educaton, homeownershp, busness ownershp, ncome level, nvestment amount outsde retrement accounts, workng status and experencng an unexpected ncome drop n past year. X Addtonally, psychosocal factors are ncorporated n, ncludng beng wllng to take nvestment rsk, beng satsfed wth current fnancal condton, and atttudes towards fnancal professonals (trust fnancal professonals, beleve fnancal professonals are too expensve, and fnd t hard to fnd rght X fnancal professonals). Last, consders the followng fnancal lteracy and capablty varables: fnancal lteracy score, self-assessed fnancal knowledge, good at dealng wth day-to-day fnancal matters, good at math, and keeps up wth economc fnancal news.23 We also control for other fnancal exposures and regonal factors n the regresson.24 We use dscrmnant analyss nstead of tradtonal Probt regresson because ths approach can statstcally test the relatve mportance of ndependent varables when explanng the decson to use fnancal advce. As mentoned by Har, Anderson, Tatham and Black (1995), dscrmnant analyss can be used to determne whch of the ndependent varables accounts the most for the dfferences n the average score 23 Satsfed wth current fnancal condton, atttudes towards fnancal professonals, fnancal lteracy and capablty levels are scaled to a 0-1 range. 24 Fnancal exposure controls nclude dummy varables ndcatng f the ndvdual clams t s dffcult to pay blls, overdraws on checkng account, has a defned-contrbuton plan, has been nvolved n foreclosure process n past two years, declared bankruptcy n past two years, has hgh-cost loans, and has health, homeowners or renters, lfe and auto nsurance. 139

20 140 Journal of Personal Fnance profles of two or more groups. Magntudes of coeffcents from dscrmnant regressons can show the relatve explanatory power of each ndependent varable. Grable and Joo (1999) follow the same strategy to nvestgate the most mportant factors affectng ndvduals decson to seek professonal fnancal help. 140

21 Table 2. Dscrmnant Analyss of Respondent Factors Usng Standardzed Coeffcents (1) All ncome groups (2) Low-ncome (3) Hgh-ncome Panel A. Savngs/Investments Advce Investment amount outsde Investment amount outsde Fnancal professonals too retrement accounts retrement accounts expensve Fnancal professonals too Fnancal professonals too Investment amount outsde expensve expensve retrement accounts 0.44 Trust fnancal professonals 0.29 Drop n ncome 0.25 Trust fnancal professonals 0.40 Drop n ncome 0.17 Trust fnancal professonals 0.23 Educaton 0.17 Educaton 0.16 Have defned-contrbuton plan 0.21 Female 0.15 N. 18,813 3,522 6,068 Panel B. Tax Advce Investment amount outsde retrement accounts Fnancal professonals too expensve 0.34 Age Investment amount outsde retrement accounts Busness owner 0.32 Busness owner 0.33 Fnancal professonals too expensve Busness owner 0.34 Investment amount outsde retrement accounts Income 0.27 Drop n ncome 0.23 Trust fnancal professonals 0.31 Trust fnancal professonals 0.21 Fnancal professonals too expensve Income 0.20 N. 18,792 3,520 6,

22 Panel C. Insurance Advce Have lfe nsurance 0.29 Have hgh cost loan 0.44 Fnancal professonals too expensve Busness owner 0.27 Have lfe nsurance 0.30 Trust fnancal professonals 0.34 Fnancal professonals too expensve Busness owner 0.29 Have lfe nsurance 0.28 Have hgh cost loan 0.24 Have homeowner nsurance 0.22 Drop n ncome 0.27 Drop n ncome 0.23 Have auto nsurance 0.22 Age N. 18,815 3,519 6,068 Panel D. Debt Advce Declare bankruptcy n past two Declare bankruptcy n past two Declare bankruptcy n past two years years years Overdraw checkng account Overdraw checkng account Have hgh cost loan Satsfed wth current fnancal condton 0.25 Have hgh cost loan Overdraw checkng account Have hgh cost loan Involved n foreclosure process n past 2 years Dffcult to pay blls Educaton Dffcult to pay blls Satsfed wth current fnancal condton N. 18,819 3,517 6, Notes: The table shows the ndependent varables wth the top fve dscrmnant standardzed coeffcents n each regresson. The full sample contans 28,146 observatons, out of whch 7,013 are classfed n the low-ncome group and 7,779 n the hgh-ncome group. The numbers of observatons n ths table are smaller because of mssng observatons for some of the questons. 142

23 Column (1) n Table 2 presents the top fve canoncal dscrmnant coeffcents n each regresson, whch reflect the varables relatve sgnfcance n contrbutng to the dscrmnant functon. We fnd that the factors explanng the most varance n advce-seekng behavor among all ncome level respondents vary by type of fnancal advce. For example, wealth (nvestment amount outsde retrement accounts) and belevng that fnancal professonals are too expensve are the top two factors affectng consumers use of savngs/nvestments and tax advce. Havng lfe nsurance and runnng a busness are the top two determnants for nsuranceadvce adopton. The two factors contrbutng the most to the use of debt advce are declared bankruptcy n past two years and overdraw checkng account. In addton, factors that are shown to have sgnfcant effects and that have been the focus of much of the prevous lterature such as gender and homeownershp, do not affect the use of fnancal advce so sgnfcantly after controllng for other factors. Factors such as trust n fnancal professonals and belevng that fnancal advce s too expensve, not studed much n the prevous lterature, play very mportant roles n fnancal advceadopton decsons. For example, trust n fnancal professonals s among the top fve factors affectng savngs/nvestments and tax-advce adopton. Lachance and Tang (2012) study the relatonshp between fnancal advce and trust and conclude the same. Next, we explore how these factors affect low- and hgh-ncome consumers decsons to use fnancal advce dfferently. We run the four regressons among low- and hghncome ndvduals and show the results n columns (2) and (3) separately. We fnd that even for the same type of advce, low- 143

24 144 Journal of Personal Fnance and hgh-ncome consumers concerns are dfferent. For example, for savngs/nvestments, tax and nsurance advce, belevng that fnancal professonals are too expensve s the top concern among hgh-ncome consumers. However, lowncome consumers put other factors such as wealth, age, and havng hgh-cost loans ahead of expense when consderng usng such advce. For example, n low-ncome consumers decsons to adopt savngs/nvestments advce, nvestment outsde retrement accounts wth the standardzed coeffcent of 0.58 plays a more mportant role than belevng that fnancal professonals are too expensve wth a coeffcent of Whle t s commonly assumed that cost s the man concern when consumers decde whether to seek fnancal advce, our results ndcate that ths s only the case for hgh-ncome consumers. Effects of fnancal advce The effects of professonal fnancal advce on ndvduals fnancal matters have been a very mportant topc n the lterature snce any postve effects that exst can justfy the expense of seekng professonal advce. To fnd an effcent way to mprove socety s overall personal fnancal condton and fnancal lteracy level, t s necessary to know f and how fnancal professonals, as one potental soluton, can help mprove consumers fnancal well-beng. However, so far the lterature has been lmted n two ways. Frst, most studes focus only on the effects of nvestment advce on portfolo performance (Hackethal et al., 2012; Bluethgen et al., 2008; Jansen, Fscher, & Hackethal, 2008; Gerhardt & Hackethal, 2009) or credt management (Staten, Ellehausen, & Lundqust, 2003; Hrad & Zorn, 2001). Investment and credt advce s only a subset of professonal fnancal advce offered n today's 144

25 market. In addton, fnancal advce not only affects ndvduals portfolo performance or credt management n a drect way, but can also affect consumers behavor and fnancal lteracy level, whch potentally have a bgger mpact on consumers fnancal well-beng. In the current professonals era of fnancal servces, fnancal advsors do more than just suggest fnancal products or manage portfolos for ther clents, they work wth the clents. Durng the process, the educaton and coachng functon can do more than just fx the current fnancal problem for whch the clent s seekng help (Warschauer, 2002). Very few studes have looked at the effects of professonal advce on clents behavor and fnancal lteracy level. Second, reverse causalty and selecton caused by unobserved characterstcs can lead to based estmatons of causal effects of fnancal advce on ndvdual fnancal behavor usng lnear regressons. Lyons (2005) concludes that, whle the general consensus from the lterature s that fnancal educaton postvely affects fnancal outcomes, t s mportant to acknowledge that the fndngs are far from conclusve, especally wth respect to the drecton of causaton. Well-desgned experments can be a soluton to ths problem. For example, to rule out the problem of reverse causalty and selecton bas, Hung and Yoong (2010) desgns and mplements a hypothetcal choce experment to study the effect of fnancal advce on defned-contrbuton plan holders fnancal behavor. However, the queston that can be explored by one experment s very lmted. Currently, no such experment allows us to nvestgate the effects of fnancal advce on consumers fnancal behavor from a broad perspectve. 145

26 146 Journal of Personal Fnance Another possble soluton s to use nstrument varables. Hackethal et al. (2012) employ ths strategy to study the mpact of advce on advsed accounts performance n Germany, and Yoong (2010) uses nstrument varables to examne the effect of fnancal lteracy on stock partcpaton. However, very lttle has been done to study the effect of fnancal advce on ndvduals fnancal behavor n the Unted States due to the lmtatons of the data and unavalablty of qualfed nstrument varables. The NFCS dataset offers new varables that can be used as nstruments, and we consder the followng sx canddates: trust n fnancal professonals, belevng that fnancal advce s too expensve, fndng t hard to fnd the rght professonal, havng defned contrbuton plans, and number of CFPs and CPAs n the zp code. These varables are expected to have effects on ndvduals decson to use fnancal advce but not on ther fnancal lteracy and behavor drectly. To select the preferred nstrument set for each regresson, we follow Yoong s (2010) crtera by checkng the relevance, weakness and exogenety of the nstrument varables. In partcular, we use Anderson canoncal correlatons test, a lkelhood-rato test of whether the excluded nstruments are correlated wth the endogenous regressors to check for relevance. The null hypothess needs to be rejected to meet the relevance requrement. We test for weakness by usng the Cragg-Donald Fstatstcs from the frst-stage regresson, whch must be hgher than the Stock-Yogo crtcal values to pass the test. We also check for exogenety wth the Sargan-Hansen test of over-dentfyng restrcton, whch tests the jont null hypothess that the addtonal nstrument s uncorrelated wth the error term and the excluded nstruments are correctly excluded from the estmated equaton. We need to fal the null to pass the exogenety test. 146

27 We explore the effects of professonal fnancal advce on ndvduals fnancal matters n three areas: fnancal lteracy (both self-assessed and objectvely measured); negatve behavors (ncludng spendng more than one's ncome over the past year, usng hgh-cost loans,25 overdrawng on checkng accounts, and beng charged credt card penaltes),26 and postve behavors (ncludng tryng to fgure out how much to save to retre, settng up emergency funds, and revewng nsurance coverage). We mplement the nstrument varable approach by runnng the followng two-stage least squares regressons for each type of advce (savngs/nvestments, tax, nsurance, and debt): Advce 1 1Instrument 2 X Effect Advce X Advce In equaton (2), the frst-stage regresson, s a dummy varable ndcatng f ndvdual uses the relevant Instrument type of advce. denotes the nstrument varable X used for each type of fnancal advce. Control varables n (2) and (3) nclude gender, age, race, educaton, ncome, and workng status. In addton, scaled fnancal lteracy scores are Effect used to test effects on postve and negatve behavors. 25 Hgh-cost loans nclude auto ttle loans, short-term payday loans, refund antcpaton loans, loans from pawn shops, and usng rent-to-own stores. 26 One s consdered to have been charged credt card penaltes f he or she was assessed a fee for late payment or an over-the-lmt fee for exceedng the credt lne. 147

28 148 Journal of Personal Fnance n the second-stage regresson (3) nclude ndvdual s selfassessed and objectvely measured fnancal lteracy scores, ndcators of each of the negatve and postve behavors n the nne regressons, respectvely. To explore the causal effect of Effect fnancal advce on, we use the nstrumented varable Advce estmated from the frst-stage regresson. Table 3 shows the results among all ncome level respondents. All the regressons pass the relevance, weakdentfcaton, and exogenety tests.27 All four types of fnancal advce are assocated wth greater self-assessed knowledge. However, advce does not mprove the objectve measure of fnancal lteracy. No sgnfcant effect s found for savngs/nvestments or tax advce, and nsurance and debt advce are assocated wth lower fnancal lteracy scores.28 In most cases, all types of advce help clents mprove postve behavors, but only savngs/nvestments and tax advce help avod negatve behavors. For example, clents takng nsurance 27 We use Anderson canoncal correlatons LM statstcs to test for the relevance of nstrument varables, Cragg-Donald Wald F-statstcs for weakness test and Sargan-Hansen statstcs are for exogenety test. χ 2 (2) P- value for Anderson canoncal correlatons LM statstcs needs to be lower than the sgnfcance level to meet the relevance requrement. Cragg-Donald Wald F-statstc must be hgher than the Stock-Yogo crtcal values to pass the weakness test and χ 2 (1) P-value for Sargan-Hansen statstcs should be hgher than the sgnfcance level to pass exogenety tests. Regressons of debt advce on have emergency fund pass the weak dentfcaton test at the 15% level nstead of the 10% level, as n other regressons. 28 Fnancal lteracy scores from the fve questons are ttled to nvestment knowledge, whch may not truly reflect the nfluence of nsurance/debt advce on clents fnancal knowledge related to nsurance and debt matters, whle self-assessed fnancal knowledge measures may capture some aspects of fnancal knowledge related to nsurance and debt ssues. Such dsconnect between the two fnancal knowledge measures may explan the postve effects of nsurance/debt advce on self-assessed fnancal knowledge, but negatve effects on fnancal lteracy scores. 148

29 Table 3. Effects of Fnancal Advce on Fnancal Lteracy and Behavor among All Income Groups Fnancal Negatve behavor Postve behavor lteracy Selfassessed Lteracy score Spend > ncome Hgh cost loan Overdr. from checkng Credt card penalty Calculate retre amt. Emergency fund Revew nsurance Savngs/nvestments advce *** *** *** *** *** *** *** *** N. 24,587 24,913 24,326 24,608 22,938 18,854 24,105 26,774 23,117 Instrument varables tests Anderson canon. corr. LM Cragg-Donald Wald F χ 2 (1) P-value Tax advce *** *** *** *** *** *** *** *** N. 24,549 24,876 24,302 24,578 22,914 18,798 24,069 24,164 23,083 Instrument varables tests Anderson canon. corr. LM Cragg-Donald Wald F χ 2 (1) P-value Insurance advce

30 150 Journal of Personal Fnance *** *** *** *** ** *** *** *** N. 25,782 26,133 25,493 25,805 24,019 19,619 25,291 24,203 24,201 Instrument varables tests Anderson canon. corr. LM Cragg-Donald Wald F χ 2 (1) P-value Debt advce *** *** ** *** *** *** *** N. 25,785 26,141 25,502 25,811 24,033 19,622 25,293 24,201 24,199 Instrument varables tests Anderson canon. corr. LM Cragg-Donald Wald F χ 2 (1) P-value Notes: The table shows coeffcents of fnancal advce on fnancal lteracy, negatve and postve fnancal behavors n the second-stage regresson. Control varables not shown n the table n the second-stage regresson nclude gender, age, race, educaton, ncome and workng status. In addton, scaled fnancal lteracy scores are used as control varables to test effects on postve and negatve behavors. Anderson canoncal correlatons LM statstcs are used to test for the relevance of nstrument varables; Cragg-Donald Wald F statstcs are for weakness test and Sargan-Hansen statstcs are for exogenety test. The sampl ncludes all the respondents who have complete set of nformaton for the regresson. *** ndcates statstcal sgnfcance at the 1% level, ** at the 5% level and * at the 10% level. 150

31 advce wll pursue more postve behavors, but they are also more lkely to spend more than ncome, overdraw from checkng accounts and get credt card penaltes. Therefore, we conclude from Table 3 that there are some postve effects from takng advce, but t depends on the type of advce. Savngs/nvestments and tax advce serves better to correct clents behavor and promote postve behavor than does nsurance and debt advce. The reason for such a phenomenon s worth nvestgatng n further study. One explanaton could be that savngs/nvestments and tax advce s more lkely to be provded n a comprehensve plan,29 wth fnancal advsors workng wth clents to defne the problem and work through the process. Insurance and debt advce, however, focuses more on solvng one specfc problem and referrng products, whch decreases the probablty that advsors wll help clents mprove ther overall fnancal behavor. In addton, none of the advce helps to mprove clents' fnancal lteracy, although t does make them perceve that they know more. Thus, our results ndcate that, currently, professonal fnancal advsors are not an effectve channel to mprove consumers fnancal lteracy. Next, we examne whether our prevous results are dfferent for the low-ncome group. To do so, we modfy the regressons n (2) and (3) as follows: Advce 1 1Instrument 2 X. Effect Advce Advce Low X 3 29 We fnd that those who use savngs/nvestments or tax advce are more lkely to use savngs/nvestments, tax and nsurance advce together than those who use nsurance or debt advce. 151

32 152 Journal of Personal Fnance The frst-stage estmaton (4) s the same as n (2), but Low Advce n the second stage, we nclude a new varable, whch s the nstrumented nteracton between the low-ncome dummy and use of fnancal advce to test the addtonal effect of Advce on Effect among low-ncome consumers. As Low Advce there s one more endogenous varable n the second stage, we need a new nstrument. By followng Wooldrdge (2010), we create a new nstrument varable by nteractng the low-ncome dummy wth the estmated value of frst stage. Advce n the Table 4 shows the effects of fnancal advce on fnancal lteracy and behavor and the addtonal effects among low-ncome consumers. All the regressons pass the three dentfcaton tests on nstrument varables.30 As for fnancal lteracy, low-ncome consumers are more lkely to beleve that ther fnancal knowledge level s mproved after recevng savngs/nvestments, nsurance, and debt advce, but ther objectve fnancal lteracy level s not sgnfcantly hgher than hgh-ncome clents after recevng the advce. Fnancal advce helps low-ncome clents more by avodng most negatve behavors and mprovng some postve behavors to a greater extent than the hgh-ncome clents. For example, recevng savngs/nvestments advce lowers the chance to overdraw from checkng accounts among all ncome-level respondents wth a coeffcent of -0.81, and t helps the low-ncome ones 30 Regressons of debt advce on have emergency fund pass the weak dentfcaton test at the 15% level nstead of the 10% level, as n other regressons. 152

33 more wth a coeffcent of ( =-1.27). Consderng the lmted access to fnancal advce n lowncome communtes, low-ncome consumers lower fnancal lteracy level and ther worse fnancal condton, t s expected that, wth the same nput, the margnal beneft of fnancal advce to low-ncome consumers wll be hgher than t would be to hgher-ncome groups. However, as we dscussed n the ntroducton, the current professonal fnancal servce ndustry s skewed towards hgh-end consumers, manly due to the compensaton system. To mprove the overall fnancal capablty level of the socety, polcymakers, fnancal counselors, planners, and educators should fnd ways to promote more fnancal advce to low-ncome groups, as we have shown that the margnal beneft from provdng such a servce s hgher for low-ncome clents. Concluson Usng a unque rch dataset from the NFCS, the paper frst compares the fnancal condton of low- and hgh-ncome consumers. We fnd that low-ncome ndvduals have less fnancal knowledge and ablty, acheve fewer fnancal plannng goals, and have less access to fnancal servces and products. Meanwhle, they are not usng as much fnancal advce as wealther ndvduals as a channel to solve the problem. The skewed supply of professonal fnancal advce and products towards wealthy people and the less-favorable atttudes towards fnancal professonals among low-ncome communtes could explan ths. We provde nsghts to those who want to advocate fnancal advce servces to low-ncome communtes by showng that the unque demand compostons among low- 153

34 154 Journal of Personal Fnance ncome clents, and ther varous consderatons, dffer from those of hgh-ncome consumers when seekng fnancal advce. We fnd that low-ncome earners demand nsurance advce most, followed by savngs/nvestments advce, debt advce and tax advce, whch s qute dfferent from the demand compostons of hgh-ncome clents. Dscrmnant analyss shows that the top concern among low-ncome consumers seekng fnancal advce s not cost as among hghncome consumers; rather, for low-ncome consumers, factors such as wealth, age and havng hgh-cost loans appear of greater concern. Therefore, fnancal advce provders should focus on dfferent sets of fnancal servces and pay attenton to the unque consderatons among low-ncome consumers to serve them better and attract more potental clents. Usng an nstrument varable strategy to solve the problem of reverse causalty and selecton, we fnd that savngs/nvestments and tax advce mproves clents postve behavors and corrects ther negatve behavors. In addton, low-ncome consumers fnancal behavor s mproved more than that of hgh-ncome ones. Such fndngs mght help justfy the cost of subsdzng fnancal advce for low-ncome households wth key stakeholders such as polcymakers, fnancal planners and educators. In addton, our analyss ndcates that fnancal advce has postve effects on clents fnancal behavor, whch could potentally beneft the clents n the long term. The fnancal stuaton wthn the low-ncome communty has ganed a lot of attenton as we learn more about ncreases n ncome and wealth gaps. As a group of consumers who need more resources to mprove ther fnancal well-beng and who represent a large potental market to fnancal advce 154

35 supplers, low-ncome consumers advce-seekng behavor has not yet been studed extensvely. Today s fnancal advce ndustry s more focused on wealthy clents, and the lterature on advce-seekng behavor s based towards hgher-ncome ndvduals. Ths paper contrbutes to the lterature by showng that fnancal exposures and advce-seekng consderatons among low-ncome ndvduals dffer from those of ther hgher-ncome counterparts. We also show that professonal fnancal advce has a larger postve effect on the low-ncome group. However, we recognze that more research s needed to better understand the fnancal behavor of low-ncome consumers n order to serve them better. Appendx Fnancal Lteracy Questons: The NFCS ncludes fve standard questons on fnancal lteracy developed by Lusard and Mtchell (2009): Compound nterest queston. Suppose you had $100 n a savngs account and the nterest rate was 2% per year. After 5 years, how much do you thnk you would have n the account f you left the money to grow? 1) more than $102, 2) exactly $102, 3) less than $102, 4) don t know, and 5) prefer not to say. Inflaton queston. Imagne that the nterest rate on your savngs account was 1% per year and nflaton was 2% per year. After 1 year, how much would you be able to buy wth the money n ths account? 1) more than today, 2) exactly the same, 3) less than today, 4) don t know, and 5) prefer not to say. 155

36 156 Journal of Personal Fnance Bond queston. If nterest rates rse, what wll typcally happen to bond prces? 1) they wll rse, 2) they wll fall, 3) they wll stay the same, 4) there s no relatonshp between bond prces and the nterest rate, 5) don t know, and 6) prefer not to say. Mortgage queston. A 15-year mortgage typcally requres hgher monthly payments than a 30-year mortgage, but the total nterest pad over the lfe of the loan wll be less. 1) true, 2) false, 3) don t know, and 4) prefer not to say. Dversfcaton queston. Buyng a sngle company s stock usually provdes a safer return than a stock mutual fund. 1) true, 2) false, 3) don t know, and 4) prefer not to say. Self-Assessed Fnancal Knowledge Queston: On a scale from 1 to 7, where 1 means very low and 7 means very hgh, how would you assess your overall fnancal knowledge? Self-Assessed Ablty Questons: How strongly do you agree or dsagree wth the followng statements? Please gve your answer on a scale of 1 to 7, where 1 = Strongly Dsagree, 7 = Strongly Agree, and 4 = Nether Agree nor Dsagree. You can use any number from 1 to 7. 1) I am good at dealng wth day-to-day fnancal matters, such as checkng accounts, credt and debt cards, and trackng expenses 2) I am pretty good at math 3) I regularly keep up wth economc and fnancal news 156

37 References Bluethgen, R., Gnschel, A., Hackethal, A., & Müller, A. (2008). Fnancal advce and ndvdual nvestors portfolos. Journal of Fnancal Transformaton, 23, Collns, M. (2010). A revew of fnancal advce models and the take-up of fnancal advce. Center for Fnancal Securty Workng Paper Elmerck, S. A., Montalto, C. P., & Fox, J. J. (2002). Use of fnancal planners by U.S. households. Fnancal Servces Revew, 11, Fnke, M. S., Huston, S. J., & Wnchester, D. D. (2011). Fnancal advce: Who pays? Journal of Fnancal Counselng and Plannng, 22, Gerhardt, R., & Hackethal, A. (2009). The nfluence of fnancal advsors on household portfolos: A study on prvate nvestors swtchng to fnancal advce. Workng Paper. Retreved August 15, 2012, from Grable, J. E., & Joo, S. H. (1999). Fnancal help-seekng behavor: Theory and mplcatons. Fnancal Counselng and Plannng, 10, Grable, J. E., & Joo, S. H. (2001). A further examnaton of fnancal helpseekng behavor. Fnancal Counselng and Plannng, 12(1), Hackethal, A., Halassos, M., & Jappell, T. (2012). Fnancal advsors: A case of babystter? Journal of Bankng & Fnance, 36 (2), Har, J. F. Jr., Anderson, R., Tatham, R., & Black, W. (1995). Multvarate data analyss wth readngs (4th ed.). Englewood Clffs, NJ: Prentce Hall. Haslem, J. A. (2010). The new realty of fnancal advsors and nvestors. The Journal of Investng, 19, Hrad, A., & Zorn, P. M. (2001). A lttle knowledge s a good thng: Emprcal evdence of the effectveness of pre-purchase homeownershp counselng. Low-Income Homeownershp Workng Paper Seres, LIHO Cambrdge, MA: Jont Center for Housng Studes, Harvard Unversty. Retreved August 15, 2012, from df. Hung, A., & Yoong, J. (2010). Askng for help: Survey and expermental evdence on fnancal advce and behavor change. RAND Workng Paper Seres WR Jansen, C., Fscher, R., & Hackethal, A. (2008). The nfluence of fnancal advce on the asset allocaton of ndvdual nvestors. EFA 2008 Athens Meetngs Paper. Joo, S. H., & Grable, J. E. (2001). Factors assocated wth seekng and usng professonal retrement-plannng help. Famly and Consumer Scences Research Journal, 30, Lachance, M., & Tang, N. (2012). Fnancal advce and trust. Fnancal Servces Revew, forthcomng. 157