Elizabeth A Duke: The Federal Reserve System and individual financial
planning
Speech by Ms Elizabeth A Duke, Member of the Board of Governors of the Federal Reserve
System, at the 2011 Virginia Beach Financial Planning Day, Virginia Beach, Virginia,
22 October 2011.
* * *
Good morning. It is a pleasure to be here in my hometown of Virginia Beach and to
welcome all of you to Financial Planning Day. I am proud to see our city recognizes that
helping families plan for a more secure financial future is good for citizens and, at the same
time, it makes the economic base of the entire city stronger. I am also pleased, and more
than a little impressed, to see so many of you taking time out of your busy lives to focus on
this important topic. I hope you find, as I have, that the time you invest in this endeavor yields
a lifetime of personal and financial dividends. Knowledge is power, and I submit that financial
knowledge is also security.
Importance of financial planning to the Federal Reserve
You might wonder why a Federal Reserve Board Governor was invited to speak about
individual household financial planning. That's a fair question given that the Federal Reserve
System's structure was designed by Congress to give it a broad perspective on the U.S.
economy. Most of the Fed's actions are indeed focused on the whole economy. But the
relationship between your personal financial interests and the interests of the national
economy is more closely aligned than you might think. Let me explain.
There is, in fact, a direct relationship between household financial stability and the
stability of the U.S. economy. As building blocks of the economy, the financial health of each
household contributes to the financial health of the country as a whole. Thus, the Federal
Reserve has an inherent interest in the financial stability and strength of individual
households, whose spending, saving, and investing significantly impact economic growth.
Financially stable families also make the economy run more smoothly as these families face
less economic risk and have more economic mobility. Ultimately, financially secure
households are the backbone of a strong domestic economy.
Indeed, the condition of household finances is a key factor in the sluggish pace of
recovery that we are seeing today. In the run-up to the financial crisis, households became
increasingly over-leveraged, as the amount of debt from mortgages, credit cards, student
loans, and other liabilities outpaced income. Between 2001 and 2007, the household
debt-toincome ratio skyrocketed, increasing by more than it had in the prior 45 years.1 And both
household debt-to-income and household debt-to-assets ratios reached their highest points
since 1950.
Beginning in 2008, in the face of rising unemployment and falling home values,
households reduced spending and increased saving. Although many households have
suffered tremendous financial hardship, in the aggregate, U.S. consumers have moved from
a near-zero savings rate in 2005 to a savings rate that is currently running around 5 percent.
In addition, household debt levels have contracted notably: Mortgage debt and consumer
debt have declined 7 percent and 5 percent, respectively, since mid-2008. This decline partly
reflects the weakness in the economy: Tight underwriting standards have damped new loan
originations, and a sizeable amount of debt has been discharged through bankruptcies or
foreclosures. But households also appear to have a greater aversion to debt than in the past,
and a renewed interest in paying down debt more aggressively. Because of smaller debt
balances and lower interest rates, the share of aggregate household income devoted to debt
payments is at its lowest level since 1994. Going forward, as income and asset values
recover, these improvements in the aggregate household position should be felt by more and
more U.S. households.
The statistics may show that the consumer sector of our economy is improving, but I
know that financial instability remains a reality for many families and I am quite aware of the
difficult questions and painful decisions many of them face every day. Questions like: How
can I plan for my children's higher education, my own retirement, and even emergency
situations when I'm struggling with today's expenses? Yet, today, that type of planning is
even more important, as is gaining a basic understanding of savings, investing, and financing
options for these life events.
More and more often, Americans are finding they have to be active in ensuring their
financial security. But as they wade into financial decisionmaking, they are faced with more
complex decisions and numerous and complicated financial products from which to choose.
In fact, Federal Reserve Chairman Bernanke has said, "Buying a home, saving for retirement
or for children's education or even effectively managing the family budget now requires more
financial sophistication than ever before."2
He has also said that financially literate consumers "make the financial marketplace
work better, and they are better-informed citizens as well." To that end, the Federal Reserve
System has made financial literacy a top priority.
Well-informed, financially educated consumers are in a better position to improve their
economic security and well-being. In turn, these financially secure families are also better
able to contribute to thriving communities and thereby further foster community economic
development. And, as these communities thrive, the marketplace as a whole becomes more
effective and efficient.3 Clearly, life-long financial education and the ready availability of
decisionmaking tools and assistance are essential to this process.
This process also makes clear why the City of Virginia Beach and the Federal Reserve
share an interest in your economic well-being. So let me now set the stage for the day with
some basic financial planning suggestions and information about Federal Reserve resources
that you might use as you develop and implement your own financial plans.
Create a personal financial plan
Your attendance here today shows that you already recognize the importance of the
first recommendation I will offer: Create a personal financial plan. Having a financial plan or
strategy will help you to achieve your financial goals and increase your likelihood of being
financially healthy in the long run. I stress that you are wise to make your financial decisions
with an eye toward achieving long-term goals. This will help you become more financially
secure and satisfied. Living in the moment puts you at greater financial risk and leaves you
with a more limited selection of financial products.
The Federal Reserve Bank of Dallas offers a popular financial planning publication,
Building Wealth. In it, individuals and families seeking help to develop a plan for building
personal wealth will find an overview of personal asset-building strategies that includes
setting financial goals, budgeting, saving and investing, managing debt, and understanding
credit reports and credit scores. The Dallas Fed makes Building Wealth available online in
both English and Spanish, and has created an interactive version of the publication, making it
usable as a personal finance education resource for schools, nonprofit community
organizations, and financial services providers.4
Another valuable online resource is the Federal Reserve Bank of San Francisco's
Guide to Financial Literacy. This free publication explains what level of financial education is
appropriate for a variety of age groups, offers guidance for consumers making key financial
decisions at different stages of life, and includes a compendium of financial education
resources that address these needs.5
Saving is important
As you develop a financial plan, I offer my second recommendation: Saving is
important, and you're going to need to increase your savings to manage your financial lives
successfully. American families rely on savings and investments to achieve a secure
retirement, save for their children's education, buy homes, start businesses, manage
financial emergencies, and pass on wealth and opportunities to the next generation. This not
only makes financial sense, but there's a growing body of evidence that families with savings
and assets generally do better in life than those without in terms of social, behavioral,
educational, and economic outcomes.
I am aware that during tough economic times, saving is a challenge for people at all
stages of life. Starting salaries for recent college graduates have declined, which means that
young Americans who are employed have fewer resources for saving and investing than
previous generations. On the other end of the spectrum, many older workers are delaying
retirement because they have insufficient assets to fund their retirement. Even more troubling
is research showing that many consumers who should be saving for retirement have been
forced to take hardship withdrawals from their 401(k) plans. According to an analysis by
Vanguard, hardship withdrawals increased by 49 percent between 2005 and 2010.6
The increasing use of retirement savings for other purposes is particularly problematic
now that employers have increasingly shifted the responsibility for saving for retirement
toward individual employees. Having a secure retirement is a high priority and a significant
long-term goal for many Americans, so it is especially important that they have an
understanding of the level of resources they will need in retirement and the investment
options available to them.
Despite these recent trends, most people have the ability to save if they plan
accordingly. One way to establish and maintain regular savings is through automation. Think
about your own 401(k). At one point, perhaps when you were hired, you made one decision
to save, and the rest was done for you - automatic payroll deductions, investments,
statements, etc. Automatic payroll deductions can also be established to build general
savings, savings for college, and other critical pre-retirement assets. Experiments with
automatic savings programs like "Auto401(k)s", the "Save More Tomorrow" concept, and
"AutoSave" have generated encouraging results.
In addition to tax-advantaged and automatic savings programs, there are a number of
targeted savings initiatives that can help families save. For example, low-income residents of
Virginia are eligible to participate in the Virginia Individual Development Accounts (VIDA)
Program, which matches $2 for every $1 saved in a VIDA account. Like other individual
development accounts (IDA), this program encourages low-income individuals to save for
specific needs by matching the contributions of the account holder. In the case of VIDA, the
combined savings can be used for the purchase of a first home, to start a business, or to
finance higher education.
Similar in concept to the IDA, a new child development account (CDA) is being piloted
for a small number of third and fourth graders in Alexandria, Virginia that can be used later in
life to further the child's education, to purchase a home, or to capitalize a small business.
Under the Child$ave program, contributions to the account can be made from any private
source with businesses encouraged to establish accounts bearing their name, such as,
"Jonathan Swift, a Safeway Scholar". And this type of initiative is popping up all over the
country. In San Francisco, the "Kindergarten to College" initiative sets up college savings
accounts for all of the city's kindergartners. In Oklahoma, the "SEED for Oklahoma Kids"
experiment establishes an account at the birth of a child and "seeds" each account with
$1,000. On an annual basis, eligible families can earn matching funds for their contributions
to a parallel account they open within the state's tax-advantaged College Savings Plan.
There is some evidence that financial knowledge is the result of regular saving, rather
than the source. So these types of programs offer children and adults the opportunity to
manage their own account, thereby fostering financial education while encouraging saving.
Create an emergency fund
My third recommendation is to create an emergency fund in addition to your
longerterm savings and investments. These frightening statistics demonstrate why: Nearly half of
all Americans consider themselves financially fragile, meaning that they would "probably"
(22.2 percent) or "certainly" (27.9 percent) be unable to come up with $2,000 in 30 days to
cope with a financial emergency.7 Similarly, almost half of all Americans report having trouble
making ends meet.8 Almost half of all households surveyed in the 2009 Survey of Consumer
Finances had less than $3,000 in liquid savings, and 20 percent had less than $3,000 in
broader savings.9 Finally, in a recent survey on the effects of unemployment and the
recession, 70 percent of workers reported withdrawing funds saved in college and retirement
accounts for present day needs, likely leading to a significant loss of wealth in future years.10
These circumstances emphasize the importance of unrestricted savings, or savings
that can be used for emergencies or precautionary purposes. Cobbling together even a
minimum amount of emergency savings can have a significant impact, especially among
lower-income households. In fact, the Consumer Federation of America found that
lowincome families with $500 in emergency savings had better financial outcomes than
moderate-income families with lower savings. In addition, recent research found that
households that are "liquid-asset poor" are two to three times more likely than those with
liquid assets to experience "material hardship" after a job loss, health emergency, death in
the family, or other adverse event.11
Clearly, emergency savings are important for households at every income level. For
some, a tax refund or tax credit is a possible source of emergency funds. The Federal
Reserve Bank of St. Louis has a user-friendly publication titled, You've Earned It! What the
Earned Income Tax Credit Can Do for You.12 This booklet explains how the Earned Income
Tax Credit (EITC) works and who qualifies for the credit. Millions of low-income, working
Americans are unaware that they are eligible for thousands of dollars in tax credits.
Receiving a windfall such as the EITC is the perfect opportunity to establish savings that
would be available for unexpected expenses. And thanks to the IRS form 8888, which has
been around just a couple of years now, you can send your EITC refund directly and
automatically to up to three different accounts.
Manage your debt
My final suggestion is to manage your debt. Loans are an excellent way to use future
income to pay for an important purchase today, such as a car, an education, or a home. But
before taking out a loan - a student loan, for example - you should ask yourself three
questions.
First, does the value of the purchase justify the payments you will have to make?
Education is one of the best investments you can make, but think about whether the extra
earnings from a particular course of study will enable you to earn enough to make loan
payments in the future. Furthermore, when preparing to manage student debt, consider the
full breadth of expenses - room and board, books and supplies, etc. - that you will incur to
determine the total amount you will need to borrow. According to the American Council on
Education, half of all graduates in 2004 used credit cards for school expenses.13 You want to
avoid having to do that.
The second question is closely related: Will you be able to make the payments on the
loan even if everything doesn't go as you plan or if payments are higher in the future?
Consider the highest payment you will potentially face rather than just the initial payment.
And finally, ask yourself if you have found the best loan for you. Ask lenders questions,
read the information they give you, and make sure you know everything about the terms of
your loan. And shop around for the best deal.
In addition to thinking carefully about the initial loan decision, it is important to
periodically re-evaluate your debt position. Sometimes the best way to invest your new
savings is to pay down high-cost debt. Another way to save money is to refinance your
mortgage into lower interest rates. Through the government's "Home Affordable Refinance
Program", borrowers with mortgages through Fannie Mae or Freddie Mac can refinance their
loans even if they owe more than the home's current value. Interest rates and mortgage
underwriting are changing continually so I urge you to investigate this option on a regular
basis. If you are unable to refinance your debt due to credit problems or if you are struggling
to make payments, I encourage you to work with a non-profit housing counselor or debt
counselor to identify possible solutions.
Conclusion
It has been my pleasure to share my thoughts with you on this important topic. As you
plan for your financial future, please keep in mind that planning is a process. You have taken
the important first step in this process simply by being here to learn more about tools and
resources available to help you and your family. But putting those tools to use is not
necessarily easy. I know from first-hand experience that understanding the basics of nutrition
doesn't make it any easier to stay on a diet. But I also know from experience that making a
plan and sticking to it brings real success whether in the form of a healthier lifestyle or in the
form of a more secure financial future.
And as I said at the outset, as we all work to improve our individual financial stability,
we will ultimately build a stronger economy. I wish you all great success.