The fine folks over at ideas42 recently did a three-part series called Three Myths About the Underbanked and connected to a recent white paper called Reimagining Financial Inclusion. I highly recommend that you head over there and read part one, part two, and part three.
Because there are so many misperceptions of how finances work for low income households, and because this issue is so important to how we think about poverty and addressing poverty, I’m going to offer a single summary post of their findings.
In Bridges Out of Poverty, Ruby Payne reiterates a common myth about poverty:
One of the hidden rules of poverty is that any extra money is shared. Middle class puts a great deal of emphasis on being self-sufficient. In poverty, the clear understanding is that one will never get ahead, so when extra money is available, it is either shared or quickly spent.((Ruby Payne, Phillip DeVol, and Terie Dreussi-Smith, Bridges Out of Poverty: Strategies for Professionals and Communities, Kindle Edition (Highlands: Aha! Process Inc, 2009), Kindle Locations 387-388))
Payne and her coauthors are deeply concerned with ‘poverty culture’. The implication isn’t simply that low income families fail to save, but that low income households lack the desire for save (even if it’s for good reasons, like the lived experience of “never get[ting] ahead.”
But the problem isn’t that low income households don’t want to save. As the folks at ideas42 point out, “83% of Americans worry about their savings, suggesting a large majority of consumers do want to save even if they aren’t able to at the moment.” Moreover, low income households ‘save for sooner’, meaning that they expect to use their savings in less than a year (and often less than six months).
None of this indicates that low income households don’t want to save. In fact, those households are saving, if only for the short term. Instead, it indicates that low income households lack the resources to build substantial savings over the long term.
One of the first proposals to addressing poverty is often to address financial literacy. We often assume that low income households live in poverty, in part, because they don’t know how to manage their money. But in fact, people who are low income tend to be more knowledgeable about what things cost and where their money is going. They even use creative strategies – like freezing a credit card in a glass of water or using envelope budgeting – to manage their finances.
Among the highlights:
Low income households are more likely to know the cost of goods than their high income peers. Whether it’s the starting taxi fare in their city or the price of a beer, low income people are more likely to know the price. They’re also more likely to change their willingness to buy the product based on where they encounter it.
Low income households are more likely to know where their money goes than their high income peers. In part because a higher percentage of income is spent on certain things – rent can eat up a lot of a low income household’s budget, for example – low income people tend to know where every dollar goes. They don’t wonder where their money went… they know.
We often think that only wealthy households pay for financial services: portfolio managers, financial advisors, and so on. But low income households pay an astonishing amount of money for financial services each year. In 2014, they paid an aggregate $34 billion in fees and interest. Much of that was for using services that other people access for free and as a penalty for having unsteady income.
Low income households pay for basic services. This includes services that many people can access for free, like check cashing and money transfers. While these fees aren’t necessarily high – Walmart charges $3 for checks up to and including $1,000 – the point remains that low income households have to pay in order to access basic services.
Low income households pay penalties for unsteady income. Many low income households have volatile and unpredictable income streams, must juggle bill payments, and have little or no access to credit. This means that low income households are more likely to pay overdraft fees, NSF fees, late fees, and other penalties simply for not having enough money at a given point in time.
The folks at ideas42 estimate that low income households pay an average of $1,100 a year on basic financial services. For a family of four living at the Federal Poverty Level (an income of $24,300), that’s about 4.5% of their income!
How we imagine problems affects how we choose to solve them. If we believe that low income households don’t want to save, we’ll work to educate them on the importance of saving and instill that desire. If we believe that they don’t understand finances, we’ll encourage them to take financial literacy classes. If we believe that they aren’t using – or paying for – financial services, we’ll encourage them to use those services.
The problem, of course, is that if we don’t understand the problems, we’ll apply the wrong solutions. And one of the biggest challenges facing us when we try to address poverty is that we tend to base our approaches on myths rather than facts.
The question facing us is not ‘how do we change the attitudes of low income households (e.g. how do we teach them the importance of saving)?’ It’s ‘how do we create financial products that serve low income households effectively?’ In other words: how do we help people who want to save, actually save? How do we help people use their financial knowledge and reduce financial burdens? How do we provide access to affordable credit and restructure fees to account for unsteady income? And so on.
But the first step to addressing poverty is overcoming the myths that we cling to and getting our facts straight.