Financial institutions should care about their customers' financial health.
Financially healthy consumers aren’t just happier; they’re good for business and good for the long-term health of the economy.
When it comes to the financial health of American consumers, it’s hard to get shocked anymore—but this statistic really got me.
Nearly half of Americans spent more than we earned last year.
In a moment, we’ll sample the data and try to figure out where the disconnect is happening. We’ll see that promoting healthy finances among consumers isn’t just the right thing to do; it’s also good business, representing an incredible opportunity for the financial services industry.
But before we move on, it’s worth spending some time with that number. It means that nearly half of Americans are not putting pennies in the piggy bank. They’re not plowing money into their 401(k)s; they’re not getting the employer match. If they have investment accounts, they’re not building them up—they’re drawing them down
Nearly half of Americans don’t have an investment account. How did we get here?
Where does the money go?
A common misconception is that, rather than save or invest, Americans spend their disposable income on things like luxuries and entertainment.
Fortunately, we don’t have to guess where the money is going. In its Survey of Family Finances, the Pew Charitable Trusts found that American families spend just 8% of their income on entertainment, clothing, and services—an average of about $4,716 per year.
The real budget killers?
- Housing: 33% ($18,886)
- Transportation: 16% ($9,049)
- Healthcare: 8% ($4,612)
As you might expect, the way Americans spend has changed over time. For instance, the amount we spend on food has drastically decreased, from 43% of our income in 1900 to 13% in 2016. Ditto apparel, which fell from 14% to under 3%.
The opposite is true for housing, which climbed from 23% in 1900 to 33% in 2016 as a share of family budgets.
Another surprise: American consumer financial health may be poor, but it compares favorably with Europe in several key areas. For example, 21% of Americans admit to having no savings at all. That’s ominous, but it’s less than the number of Italians (25%), British (27%), Germans (29%), and Romanians (36%) who say the same thing.
"Nearly half of Americans are not putting pennies in the piggy bank. They’re not plowing money into their 401(k)s; they’re not getting the employer match. If they have investment accounts, they’re not building them up—they’re drawing them down."
There’s no easy diagnosis here. American consumer spending seems driven by necessity—a place to live, a healthy body, a way to get to work—rather than self-indulgence.
Undoubtedly, individual consumers’ making better financial decisions is part of the solution, but there are many other parts. A balanced approach to improving consumer financial health would necessarily involve coordinated action by consumers, fintechs, traditional financial institutions, and banks.
The legacy financial system doesn’t meet many people’s needs.
Too often, financial institutions win when consumers lose.
Bank overdraft fees are a case in point. According to a 2012 white paper by the Consumer Financial Protection Bureau, 27% of American checking account holders had been assessed at least one overdraft or not-sufficient-funds (NSF) fee during the previous year. The average amount paid by someone with at least one overdraft fee was $225.
Among this group, about a quarter were “heavy overdrafters,” meaning they had ten or more overdraft fees in the course of a year.
"27% of American checking account holders had been assessed at least one overdraft or not-sufficient-funds (NSF) fee during the previous year. The average amount paid by someone with at least one overdraft fee was $225."
For these and many other reasons, many people are turning towards alternatives to the traditional financial offerings. According to a recent study, just one in three millennials holds a credit card. Americans who remain in the traditional financial system aren’t particularly happy about it: only one in four believes that their bank is looking out for their financial well-being.
To say nothing of the more than 70 million Americans who are unbanked or underbanked. And the nearly 50 million Americans who are “credit invisible” or “unscorable.” Worse, these financial woes disproportionately affect minorities, young people, and communities of color.
This represents an opportunity for innovative financial institutions.
Americans aren’t in good financial shape. As a result, they under-participate in the financial system. When they do participate, their interactions often do not lead to better financial health—a vicious cycle.
It also represents a unique opportunity for the financial services sector to align incentives, so that banks win when consumers win, and consumers win when banks win. At very least, it’s an opportunity to build a system that isn’t quite so punitive toward people who struggle to make ends meet.
"In the study, consumers who believed their bank had their best interests at heart bought more products and invested more of their money."
For consumers, financial health is a way to achieve the things we want in life. It has been closely tied to all kinds of positive outcomes: things like mental and physical health; family stability; educational attainment; and social mobility.
It’s not just the right thing to do—a mounting body of evidence suggests that it’s also good for business. When financial institutions pay attention to consumer financial health, they unlock new markets, attract and retain new customers, and drive long-term revenue streams.
Individual consumers are the engine of the American economy; their spending drives two thirds of US gross domestic product (GDP). A recent rise in household debt has sparked concerns that consumers are overextended and—with less disposable income—won’t continue to buy things at their present rate.
A decline in consumer spending was one of the contributing causes of the Great Depression, and many fear that, in modern days, it could lead to an economic slowdown. Why aren’t we paying more attention to this problem?
Disciplined innovators are taking steps in the right direction.
As it turns out, some people are paying attention. People like David Hijirida.
“My heart is with the consumer,” says Hijirida. “When I left the banking industry, it was partly because I was tired of the way banks were treating customers. Simple’s mission, vision, and values address that exact frustration.”
Hijirida is the CEO at Simple, a Portland-based fintech company. On their app, you can quickly set up a checking account with a debit card, automate saving toward specific goals, and discover how much money you can safely afford to spend at any given moment.
“$500 in savings may not seem like a lot, but it can prevent a traffic ticket from becoming a lost driver’s license, and a lost driver’s license from becoming an inability to work.”
Simple began by aligning their incentives with customers, and it has worked out well for them. From a company of two, they’ve grown to a team of 300. After several years of robust growth, they were acquired by BBVA Compass in 2014 for $117 million. At the same time, they have helped thousands of their customers save toward their goals, plan for retirement, and improve their financial health.
Simple was an early actor in this space, but they’re hardly alone. Qapital is a banking app that adds an investing feature, recommending a portfolio strategy based on your individual timeline. EARN is a tech-enabled nonprofit that incentivizes saving among low- and middle-income families.
“$500 in savings may not seem like a lot, but it can prevent a traffic ticket from becoming a lost driver’s license, and a lost driver’s license from becoming an inability to work,” says EARN CEO Leigh Phillips.
We’re not talking about a lot here: to encourage healthy financial habits, EARN will match up to $20 in monthly savings, per family. But it makes a real difference. Over 70% of the people who join the program haven’t saved anything in the previous 6 months. After they join, 80% of them continue their newfound monthly savings habit.
How to measure consumer financial health.
Financially healthy consumers are good for business and good for the economy. Meeting their needs represent an enormous opportunity for newcomers and established players alike. But how can financial services providers determine whether their products are contributing to consumer financial health? How can we wrap our heads around the day-to-day goals and challenges that customers are facing?
The answer is to measure consumer financial health—and weave those metrics into the fabric of our businesses.
"Credit scores were created in the 1950s as a way to assess the likelihood that a given person would repay a loan. Today there are used for all kinds of things they were never intended for."
Today, the only metrics related to consumer financial health that most companies pay attention to are FICO scores. The problem with credit scores is that they only indirectly take consumer financial health into account. They were created in the 1950s as a way to assess the likelihood that a given person would repay a loan. Today there are used for all kinds of things they were never intended for: as a way to screen candidates for jobs, housins, and even utilities.
An easy example of how credit scores and financial health aren’t necessarily correlated: you can have a great credit score without saving a cent toward retirement. On the flip side, you can have a terrible credit score while spending less than you earn and maintaining a sustainable debt load.
Financial services providers can do better. Indeed, customers deserve better. Imagine a set of metrics that were truly grounded in consumer financial health—metrics that might also be used to help predict whether they could repay a loan.
In its 2016 report “Eight Ways to Measure Financial Health,” the Center for Financial Services Innovation (CFSI) has done just that. The authors divide financial health into four broad categories—Spend, Plan, Save, Borrow—and name two key indicators within each category.
Take the “Plan” category. 1) Do you have appropriate insurance? 2) Are you planning ahead for future expenses? Your answers to these questions will determine whether you are healthy, unhealthy, or at risk.
Taken together, your eight answers yield your CFSI Financial Health Score. The score is still being refined as a business tool, but ultimately, its creators hope that it will be used in the same way as a credit score, i.e., businesses will use it to quickly diagnose, track—and ultimately improve—the financial health of their customers.
It’s time to build consumer financial health into the fabric of our businesses.
It’s still early days, but several companies have already distinguished themselves for incorporating consumer financial health metrics into their business models.
That list includes newcomers like Petal and LendingClub, as well as established players like KeyBank and Regions, all of whom have started using CFSI’s scoring toolkit to measure the financial health of their retail consumers.
"The CFSI Financial Health Score is still being refined, but ultimately, its creators hope that it will be used in the same way as a credit score."
This work couldn’t be more timely. 57% of Americans—more than 138 million people—lack financial health, and it’s having a real impact on their lives. They may find themselves unable to cope with an unexpected illness or struggling to afford college tuition for their children.
Incorporating financial health indicators into regular business practices won’t always be easy. In many instances, it will require concerted action by all members of the financial services ecosystem. But we owe it to ourselves, and to our customers, to do better. Financially healthy consumers aren’t just happier and more fulfilled; they’re good for business and good for the long-term health of the economy.
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