Financial Literacy and Retirement Planning in Germany

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1 Financial Literacy and Retirement Planning in Germany Tabea Bucher-Koenen Joint work with Annamaria Lusardi NETSPAR Pension Workshop Zürich,

2 Financial Literacy around the World NETSPAR Theme Grant Financial Literacy: Evidence and Implications For Retirement Planning, Saving Behavior, and Financial Education Programs Aim of the Project: Compare financial literacy across countries using the same (or very similar) questions. Compare the effects of financial literacy on decision outcomes (focus on retirement planning/old age provision) across countries. Try to make the best comparison possible by explaining the data and the findings as well as the country specific context. Share Best Practice. Participants: Germany (Tabea Bucher-Koenen, Annamaria Lusardi) Italy (Elsa Fornero, Chiara Monticone) Netherlands (Rob Alessie, Annamaria Lusardi, Maarten van Rooji) New Zealand (Diane Crossan, David Feslier) Russia (Leora Klapper, Annamaria Lusardi) USA (Annamaria Lusardi, Olivia Mitchell)

3 Contents 1. Introduction 2. The data set: SAVE 3. Empirical Evidence 1. How financially literate are the respondents? 2. Who knows the least? 3. Does financial literacy matter for retirement planning? 4. Discussion and Conclusions

4 1. Introduction Increasing relevance of financial literacy: Pension system reforms Until 2001 monolithic pension system with strong state funded pillar (covers about 85% of the German work force and provides for about 90% of old age income) 2001 pension reform transformation to multi-pillar system: dramatic reduction of state pensions for future retirees, introduction of a state-subsidised but voluntary funded pillar More individual responsibility Increasing variety of financial products Financial crisis 2007/2008

5 2. Data German household panel on saving behavior Conducted by MEA since 2001 on a yearly basis Wave ,117 households of the random route panel Paper and pencil Respondents are selected randomly within the households

6 2. Data Contents: Socio-demographic characteristics Health Qualitative questions on savings, income and wealth Quantitative questions on income and wealth Psychological and social determinants of saving Financial Literacy: In 2007 and 2008: Three basic questions In 2009: Extended module (self-assessment, 11 quiz-like questions, 3 questions measuring cognitive abilities)

7 3.1 How much do the respondents know? Question 1 Understanding of Interest Rate (Numeracy) Suppose you had 100 in a savings account and the interest rate was 2% per year. After 5 years,how much do you think you would have in the account if you left the money to grow: more than 102, exactly 102, less than 102? do not know / refuse to answer

8 3.1 How much do the respondents know? Source: own calculation on the basis of SAVE 2009, N= 1,086; data is weighted

9 3.1 How much do the respondents know? Question 2 Understanding of Inflation Imagine that the interest rate on your savings account was 1% per year and inflation was 2% per year. After one year, would you be able to buy more than, exactly the same as, or less than today with the money in this account? do not know / refuse to answer

10 3.1 How much do the respondents know? Source: own calculation on the basis of SAVE 2009, N= 1,080; data is weighted

11 3.1 How much do the respondents know? Question 3 Understanding of Risk and Diversification Do you think that the following statement is true or false? Buying a single company stock usually provides a safer return than a stock mutual fund. do not know / refuse to answer

12 3.1 How much do the respondents know? Source: own calculation on the basis of SAVE 2009, N= 1,090; data is weighted

13 3.1 How much do the respondents know? Overall Performance In percent Correct answer to interest and inflation 72% All answers correct 53% No answer correct 10% At least one do not know/refuse 37% All do not know/ refuse 8% Source: own calculation on the basis of SAVE 2009, N= 1,059; data is weighted

14 3.1 How much do the respondents know? Spearman Rank Correlation (p-value) Interest 1 Interest Inflation Risk Inflation (0.000) Risk (0.000) (0.000) No. of correct answers (0.000) (0.000) (0.000) Source: own calculation on the basis of SAVE 2009, N= 1,059; data is weighted

15 3.2 Who knows the least?

16 3.2 Who knows the least?

17 3.2 Who knows the least?

18 3.2 Who knows the least?

19 3.3 Does financial literacy matter for retirement planning? Retirement planning Have you and your partner ever tried to find out, how much you would have to save today, to reach a certain standard of living at old age? Yes/No

20 3.3 Does financial literacy matter for retirement planning?

21 3.3 Does financial literacy matter for retirement planning? OLS Financial Literacy dummy 3 correct Men, partner, no. of children, age, education Income, employed, homemaker Retirement planning 0.08* (0.04) Yes No Retirement planning 0.06 (0.04) Yes Yes N R Source: SAVE 2009, OLS regression, Robust se in brackets, * significant at 10%; ** significant at 5%; *** significant at 1%

22 3.3 Does financial literacy matter for retirement planning? OLS Retirement planning Financial Literacy - index 0.05** (0.02) Men, partner, no. of children, age, education Income, employed, homemaker Yes No Retirement planning 0.04** (0.02) Yes Yes N R Source: SAVE 2009, OLS regression, Robust se in brackets, * significant at 10%; ** significant at 5%; *** significant at 1%

23 3.3 Does financial literacy matter for retirement planning? Problem: OLS estimate might be biased because individuals who want to plan for retirement gather information during the process IV estimation

24 3.3 Does financial literacy matter for retirement planning? 1. Financial education at a young age When you where a child, did you receive pocket money regularly? (answered on a scale from 0 to 10) 2. Peer effects (gathering information is costly, cost can be lowered by talking to neighbors) Variation at administrative district level in voting shares for certain parties in the national election in 2005 FDP libertarian party, strongly in favor of individual responsibility / higher stock market participation => high financial knowledge PDS/ Die Linke leftist party, strongly in favor of state responsibility / low stock market participation => low financial knowledge

25 3.3 Does financial literacy matter for retirement planning? First stage Financial Literacy Dummy Financial Literacy Dummy Financial Literacy Index Share FDP 2.6 (0.97)*** Share PDS/Linke (0.23)* Pocket money 0.01 (0.01)** Average regional income, population density, high school density 2.7 (0.97)*** (0.3)* 0.01 (0.01)** Yes 5.11 (1.96)*** (0.43)*** 0.02 (0.01)* Controls * Yes Yes Yes N F-value of excluded instruments (Prob >F) 8.46 (0.000) 7.58 (0.001) * Men, partner, no. of children, age, education, income, employed, homemaker (0.000) Source: SAVE 2009, Linear 2SLS Regression, Robust se in brackets, * significant at 10%; ** significant at 5%; *** significant at 1%

26 3.3 Does financial literacy matter for retirement planning? Second stage Retirement planning Financial Literacy Dummy 0.46 (0.18)** Retirement planning 0.38 (0.21)* Retirement planning Financial Literacy Index 0.18 (0.07)** Average regional income, population density, high school density Controls * Yes Yes Yes N Source: SAVE 2009, Linear 2SLS Regression, Clustered se in brackets, * significant at 10%; ** significant at 5%; *** significant at 1% Yes * Men, partner, no. of children, age, education, income, employed, homemaker

27 4. Discussion and Conclusions Financial literacy: 53% of the respondents can answer the three questions 37% report do not know at least once Level of financial literacy is lower among women, less educated and those living in east Germany Only about 25% plan for retirement. We find a positive and significant relation between financial literacy and retirement planning. IV estimation indicates that there is a positive and significant effect of financial literacy on retirement planning but more work is necessary.

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