Befuddled by debt? You're not alone
Americans are 'financially illiterate' and caught up in a web of debt. Poor savings don't help, according to two new studies.
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NEW YORK (CNNMoney.com) -- Americans don't understand debt, which may be one reason that they have too much of it, according to a survey released Tuesday.
The survey presented 1,000 people with a hypothetical scenario about credit card debt and asked them to compute how long it would take to pay it off. Only 35.9% of the 1,000 respondents could figure out how many years it would take for the amount they owe on their credit cards to double. A full 18.2% did not know how to respond and 31.9% of those surveyed over-estimated the timeframe.
The survey by Harvard Business School and Dartmouth College professors and TNS asked respondents to assess their debt levels. Those who said they felt they were carrying too much debt were found to be "wildly wrong" when it came to using compound interest to calculate how long it would take to pay off that debt.
Of those polled, 26% said they consider the debt they are carrying to be unmanageable, while 61% said their debt level was "just right."
Americans don't realize they're unaware of some of the complexities of personal finance - like compound interest - said Bob Neuhaus, the executive vice president and the head of the financial services sector in the U.S. for TNS. "If financial literacy was higher, you would see more caution in the use of consumer debt. It would not eliminate the problem, but it would mitigate [it]."
The survey draws attention to a large problem without an easy solution. "Even those with a college degree don't have an understanding of the basic finance ideas," said Annamaria Lusardi, Professor of Economics at Dartmouth College.
However, there are smaller, more manageable steps that can make a difference. Harvard Business School Professor Peter Tufano, a self-proclaimed believer in financial education, does not see credit as inherently bad, but he said that debt services are much more complicated now than they were a generation ago. He said credit card companies could help by creating more consumer friendly credit contracts that plainly spell out the terms, and bills that itemize outstanding debt so consumers can grasp the reality of how they spend money and how long it will take to pay.
A lack of savings could be compounding the consumer debt problem. Another nationwide survey of 1,000 Americans released Monday by the American Savings Educational Council (ASEC) and America Saves found that a mere 53% of Americans have adequate savings with only 28% saving the recommended 10% of their annual income.
Three-quarters of Americans surveyed said that they spend less than their income and save the difference, which may provide enough for an emergency unexpected expense, but only a little over 50% have enough savings to provide for a comfortable standard of living in retirement.
However, those who make more money are able to sock away more for a rainy day, according to the savings survey. Ninety-percent of the high-income group (those earning at least $75,000 annually) say they have adequate savings, but only 48% of the low-income group (those earning below $35,000 annually) can say the same. And 81% of the high-income group report saving at least 5% of their income, compared with 34% of the low-income group.
Regardless of income or level of financial literacy, there is one unifying lesson: have a plan. "Having a financial plan increases savings and financial stability," said Stephen Brobeck, executive director of Consumer Federation of America.