Measuring Financial Literacy Welfare Through the Lens of a Lifecycle Model

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In this paper, John Karl Scholz and Ananth Seshadri focus on a behavioral norm that leads to financial security, specifically, saving enough during working years to maintain pre-retirement living standards during retirement. We use an augmented lifecycle model to predict optimal wealth accumulation levels for a variety of populations.

The authors then use data from the Health and Retirement Study to calculate deviations between these targets and observed wealth holdings; these calculated deviations provide a wellgrounded measure of the degree to which households are preparing for retirement. Results indicate that, in 2008, 36 percent of retired Americans born before 1954 had saved less than their optimal targets. Economically disadvantaged households were significantly more likely than others to be undersaving, and therefore are natural targets for efforts to improve financial capabilities. Finally, we examine current popular savings advice and begin to develop rule-of-thumb guidance that more closely matches the results of the full-fledged dynamic optimization problem.