Amidst a growing societal discussion on racism, inequality, and social conflict, we need to focus on practical ways that we can address these issues. One of the challenges for disadvantaged people is that they lack access to the key tools for managing money and building wealth. Efforts aimed at increasing access to low-cost financial services are often referred to as increasing financial inclusion. Financial inclusion depends on both the availability of services and that people are educated as to their options. One of the many aspects of privilege is financial education. Wealthy parents teach their kids about how acquire and manage money. We need both better services for less-wealthy people and financial education so that people know how to navigate our complex financial system.
Poor people pay far more than their better-off counterparts for financial services, from banking to credit cards and mortgages. The prevalence of check-cashing services is one of the better-known examples. A mainstream bank does not charge clients when they cash checks. The very idea of such a charge would strike many Americans as absurd, but people without bank accounts (there are almost 10 million U.S. households that are unbanked) tend to pay a fee when they want to cash a check.
Poor people pay far too much when they want to borrow money. Because traditional banks don’t want their business, lower-income people may only have access to payday loans. These loans charge much higher interest rates than banks. Payday loans may charge $10 to $30 for a two-week loan of $100. If you need to extend the term of these short-term loans, you pay an additional rollover fee. The end result is that payday loans often charge effective annualized interest rates of hundreds of percent.
A less obvious area in which we need more financial inclusion is in tax-advantaged savings accounts for retirement, health expenses, and college savings. Because money in these accounts is essentially locked up, poorer people are less likely to be able to commit resources. Unless you have the discretionary income that you can afford to commit money for long periods of time, you don’t have access to the tax benefits of 401(k) plans, IRAs, HSAs, and 529 plans.
There is some good news regarding lower-cost financial services. Investing costs have fallen dramatically over the past twenty years. This occurred due to the inexorable forces of competition between financial services firms. The outcome has the potential to greatly improve financial inclusion with regard to investing. Consider just the recent move by many brokerages to stop charging commissions. Prior to this, paying five dollars per trade was considered low-cost. For someone who invests in $100 increments, however, that commission is five percent of your money. The fees charged by mutual funds and exchange traded funds (ETFs) have declined dramatically. The average annual management fee for U.S. investment funds is now 0.45%, as compared to 0.87% in 1999 (this is the asset-weighted average fee). This means that investors today are paying about half as much to fund managers as in 1999.
One of the most challenging hurdles in improving financial inclusion is education. Even when better alternatives are available, people can’t take advantage of them if they don’t know enough. Not surprisingly, poorer people tend to be less financially literate than wealthier people. This situation perpetuates inequality.
There is little question that much of social inequity is related to economic inequality. Lack of financial inclusion tends to increase inequality. The good news is that there are more and better financial alternatives for lower-income people than ever before. The challenge is that accessing these benefits requires a higher level of financial literacy than most Americans possess. We can improve financial inclusion with education, but improvements in tax incentives and economic policy should also play a role.