Financing Low Income Communities

2. New Savings for Old Innovations: Asset Building for the Less Affluent

CHAPTERTWO NewSavingsfromOldInnovations: AssetBuildingfortheLessAffluent DanielSchneiderandPeterTufano “[Weshould]focusonthe100millionwhoareinvestorsandnottrytocover‘pre-investors’ who should focus on saving.” —Financial services executive, private discussion with author, 2004 ALTHOUGH the rich and poor both have the need and the desire to build financial assets to enable them to meet important life goals, there is a false dichotomy that is captured in the epigraph. Taken from an exchange with a successful financial services executive, it signifies the perception that the rich invest, but the masses at best only save. What differentiates the wealthbuilding activities of the rich and the rest of society to justify this semantic distinction? Is it because the less affluent tend to save in banks and the rich invest in mutual funds and hedge funds or because the less affluent tend to buy low-risk products and the rich buy higher risk products? If so, then would a rich person’s holdings in bank products or money market mutual funds not constitute part of his or her investing strategy? Is planning for short-horizon goals just saving and long-horizon goals investing? Trying to differentiate saving and investment based on institutional features seems to be an impossible task. Thisisbecause,inthefinancialsystem,adizzyingnumberoftermsdescribe the same function and seemingly different products and institutions often 14 FinancingLow-IncomeCommunities serve identical needs. To see past these institutional definitions, the functional approach to defining the financial system (Crane et al. 1995) suggests that activities can be decomposed into the set of core functions they perform. Saving (or investing) addresses two such functions: moving money across either time or space and risk management. In either activity, the saverinvestor moves money across time because she reduces her consumption today to consume more tomorrow, perhaps when it is necessary to fund a child’s education or to retire. By saving or investing, she engages in risk management to protect herself from various risks (such as unemployment or poor health) or to diversify her investments. Along these dimensions, saving by the poor and investing by the rich are identical. These functions (moving money across time and space and managing risk) are timeless and common to all people. In part, this likely explains why some prefer to use the broader term asset building, though even this ignores important risk-management motives for saving. Adopting a functional approach to understanding the problems of helping less affluent families to save leads us to consider a broad range of institutions and possible solutions. Supporting saving for the less affluent is not a banking problem or a mutual fund problem; it is not merely about time deposits or about stocks and bonds. Rather, it is a generic problem that can best be understood in terms of simple root causes: diseconomies of small scale and poor information flows. It is a problem whose solution is likely to be found in many different institutions and products. Adopting a functional approach might mistakenly seem to suggest a naiveté about institutional details or an ignorance of the differences between saving by the more and less affluent. To the contrary, we recognize that though the need to save may be common to rich and poor, their specific preferences— and the institutions that vie to serve them—are not alike. As we will discuss, government policies encourage asset building among the more and less affluent , financial service firms have distinct preferences about which families they choose to serve, and these families may have different risk tolerances that lead to different goals and practices. Regardless of risk profile, saving appears to have important benefits for families. Michael Sherraden (1991) hypothesized that the ownership of assets would result in certain economic, social, and political benefits. It is important to note that he attributes these effects not to the high income associated with asset holding but rather to the ownership of those assets. Table 2.1, adapted from Sherraden (1991), and Deborah Page-Adams and her colleagues (2001), summarizes these findings. The positive effects Sherraden discussed have been documented in a number of studies. Assets in the form of homeownership have been shown to increase residential stability, lead to higher levels of property maintenance, increase social and political participation, and produce greater marital sta- NewSavingsfromOldInnovations 15 bility. Home ownership is also correlated with higher levels of family health. Assets have been shown to lead to greater economic security and to decreases in domestic violence (Page-Adams et al. 2001). Assets and homeownership benefit children through better educational...