The evolution of personal finance

The ways that people earn money, spend, borrow, and invest are all changing quickly. We are experiencing the greatest changes in personal finance since the start of the industrial revolution. To thrive in the new economy, people need to know far more and be disciplined and proactive in managing their finances. In this post, I explore the ways in which personal finance has changed and continues to evolve.

The Past

The industrial revolution resulted in people flocking to cities to work in factories and other centralized enterprises. Workers became accustomed to receiving regular paychecks. Over time, companies added additional benefits such as healthcare and pension plans. Household finances became more stable and predictable. Prior to industrialization, regular paychecks and structured benefit plans were the exception rather than the norm. The 20th century saw the large-scale introduction of employer-sponsored health insurance and retirement plans. The first employer-provided health insurance plan was created in 1929. The first company-provided pension plans started in late 1800’s. Traditional pension coverage peaked around 1980, at 46% of private sector workers.

In tandem with workers receiving regular paychecks as a result of industrialization, availability of consumer credit skyrocketed. The first credit reporting agency was founded in 1899. Following World War II, demand for consumer credit accelerated dramatically. The introduction of credit cards (starting in 1950) expanded the use of discretionary borrowing further still. In 1970, only 16% of U.S. households had credit cards. By 2004, this had increased to 71%.

During this heyday of traditional, steady employment, most people didn’t need to understand much about personal finance beyond balancing a checkbook each month.

The Present

Today, traditional pension plans have largely disappeared. Only 15% of private sector workers have traditional pension plans (as compared to 46% in 1980). Most workers have 401(k) plans and IRAs, self-directed savings and investment plans, rather than traditional pensions. Each person needs to figure out how much to save in these plans, as well as how to invest their savings. Traditional pensions made things really easy with formulas for how much retirement income you would receive, given years of service and highest-paying years. People with self-directed plans need to use calculators to estimate how much retirement income they can expect, given assumptions about future savings and investment performance.

A declining fraction of workers have employer-provided health insurance. In 2008, 56% of private sector employers offered some form of health insurance. In 2017, this had dropped to 47%. In addition, the out-of-pocket costs for covered workers have grown rapidly, far faster than inflation.

Americans’ debt loads have grown steadily relative to income. Median household income in 2017 was $61,000 and median household debt was $137,000. Over the past fifteen years, the fastest-growing form of debt has been for higher education and Americans now owe more in educational debt than for any other form of borrowing besides mortgages.

The daunting reality for many families is that they need to plan and make financial choices that they are not equipped for. As a result, we are seeing many people approaching retirement with low levels of savings compared to estimates of what they will need to be able to maintain their lifestyles in retirement.

The Future

In 21st century America, financial literacy is vital. The 20th century provided vast access to credit, but closed with shrinking access to traditional retirement plans and health insurance. In combination with diminishing job tenure and an increasing percentage of workers employed as contractors or freelancers, current trends mean that each household must operate as a financial microcosm. Individuals and families need to be keenly aware of how much they are spending, saving, and borrowing, along with the implications of each of these elements of household finance. It is crucial for households to maintain higher levels of liquid assets in anticipation of the unpredictability of the labor market, as well as building more traditional emergency savings.

The good news is that current policy and modern technology make it possible for people to manage their finances more efficiently and effectively than has ever been possible before. The costs associated with investing have been declining for decades. It is possible to build a diversified asset portfolio at far lower cost than a decade or two ago. The average expense ratios of stock and bond mutual funds have fallen by 43% in the last 20 years. This is a substantial benefit for people saving for retirement, to pay for college, or anything else. In addition, retirement plans for the self-employed have improved dramatically, to the point that self-employed people have access to retirement vehicles that may be as good as even the best corporate plans. To take advantage of these benefits, however, financial literacy is required.

Along with financial literacy, however, managing one’s financial life requires an awareness of the incredible influence of consumerism, convincing people that they always need more. In the first decade of the 21st century, we have seen this play out most dramatically as millions of young people are sold expensive college educations that they cannot afford. The future of personal finance must incorporate an increased thoughtfulness with regard to consumption and the long-term consequences of what we buy today. Consumer credit allows people to mire themselves in levels of debt that preclude many other future choices.

In a nutshell, the future of personal finance requires three elements. People need to be educated, proactive, and intentional with regard to their finances. Modern society provides little guidance and limited protection and there are substantial interests that facilitate and promote ever-increasing consumption and debt. The tools and information are available, but we need a major shift in the ways that people deal with income, borrowing, consumption, and investing.