When planning for retirement, what would you trust in more: financial institutions such as mutual funds, or government programs such as Social Security or Medicare? The degree of your trust in either of those channels, guided by your level of financial literacy, will determine how you save and invest for retirement, according to a new research paper by experts at Wharton and elsewhere. The paper brings granular insights into how different types of trust shape retirement preparedness in the U.S., and the gaps that improved financial literacy could fill.

The paper, titled “Trust, Financial Literacy, and Financial Behaviors: Shaping Retirement Security,” is co-authored by Wharton business economics and public policy professor Olivia S. Mitchell, Maya Haren Rosen, a finance lecturer at the Hebrew University of Jerusalem, and Annamaria Lusardi, an economics professor at Stanford University.

The paper breaks fresh ground in retirement planning research with its sharp focus on trust in financial institutions and trust in government programs. “Our study’s domain-specific measures allow us to examine mechanisms directly tied to retirement saving behavior,” Mitchell said. The study also tracked metrics related to financial literacy, and how both trust and financial literacy vary by race and ethnicity.

According to the paper, “trust is broadly understood as the expectation that individuals, institutions, or systems will act fairly, reliably, and in alignment with established norms, especially under uncertainty.” Trust can promote investment and collaboration by reducing perceived risks in economic interactions, it added.

The researchers fielded a specially designed module in the 2020 Health and Retirement Study (HRS) of Americans aged 50 and above. Their sample size of 1,286 respondents represented a randomly selected 10% of the full HRS survey. The study measured trust in specific financial institutions including mutual funds, financial advisors, banks, and insurance companies, as well as trust in government programs such as Social Security, and Medicare and Medicaid.

Insights Into Trust and Retirement Security

“We found that, first of all, trust is multi-dimensional,” said Mitchell, who is also executive director of Wharton’s Pension Research Council. “The two areas we looked at — trust in financial institutions and trust in government programs — capture different behavioral mechanisms that the widely used ‘trust in people’ metric misses.”

A second insight from the study was that those two forms of trust have opposite associations with retirement security. Trust in financial institutions tends to encourage private saving and investment, while trust in government programs is associated with lower private retirement preparation, Mitchell explained. “So having more trust in government means you don’t save as much for yourself.”

The third insight from the study is that “trust and financial literacy independently shape retirement outcomes, and their effects differ substantially by racial and ethnic groups,” Mitchell stated. “The implication is policymakers should address both knowledge and institutional confidence, rather than either one alone.”

“If individuals expect Social Security and Medicare to provide a meaningful financial safety net in retirement, they will feel less need to accumulate additional retirement savings or invest in financial markets.”— Olivia S. Mitchell

The authors note that the new measures of trust related to the financial decisions adults confront provide “a more nuanced understanding of how trust shapes retirement behaviors.”

Here are the study’s key findings:

• People who trust financial institutions exhibit more financial behaviors conducive to retirement security, whereas those who trust government programs are less likely to save and invest for retirement.
• Specifically, a one-unit increase in people’s trust in financial institutions is associated with a 6% increase in the probability of having a retirement account, a 7.5% increase in the likelihood of holding stocks, and a 3.2% increase in household net wealth, or about $17,800.
• In contrast, a one-unit increase trust in government programs is linked to a 4% and 6% lower likelihood of having a retirement account and holding stocks, respectively, and a 1.6% reduction in household wealth, or about $8,900. “These findings indicate a crowding-out effect: People who trust public programs more feel less compelled to save privately,” note the authors.
• Substantial heterogeneity is evident by race and ethnicity. Compared to white people, Black and Hispanic people exhibit lower trust in people, trust in financial institutions, and financial literacy, yet they report greater trust in government programs.
• Trust in financial institutions is strongly related to outcomes for white people, whereas trust in government programs is stronger for minorities.

Reading the Findings

What explains the trust in government programs, given the rising concern over the solvency of the Social Security Trust Fund and threats to Medicare funding? The evidence from the study “measures trust, not expectations about future benefit levels or program solvency,” Mitchell said as she explained how one could interpret the findings.

“Our results do not imply that people blindly trust government programs or believe Social Security alone will fully cover their retirement,” Mitchell continued. “Rather, they suggest that people with greater confidence in Social Security and Medicare may perceive less need for saving. This confidence can coexist with awareness that future benefits may change if people believe the government will continue to provide a meaningful retirement safety net.”

Such confidence in government programs is also consistent with the crowding-out effect the research uncovered, Mitchell noted. “If individuals expect Social Security and Medicare to provide a meaningful financial safety net in retirement, they will feel less need to accumulate additional retirement savings or invest in financial markets,” she said. “This does not imply that they expect these programs to meet all their retirement needs, but only that they have greater confidence in public support, and this reduces the perceived necessity of private preparation.”

Boosting Financial Literacy

The paper notes that while trust in public programs can promote confidence in the broader system, the findings also suggest that “it could have a detrimental effect on personal financial decisions, by reducing private incentives to save.” The authors see an opportunity for future researchers to guide policymakers on how they might enhance trust in these programs, while at the same time emphasizing their limitations, so as to encourage greater personal saving and participation in financial markets.

“There’s a responsibility on parents and teachers to start educating children in financial literacy very young.”— Olivia S. Mitchell

One way to narrow the gap between expectations and outcomes is to acquire the requisite financial literacy to save and invest wisely. “Individuals who are more financially literate may find it easier to evaluate financial products and therefore rely less on trust alone, while having greater trust in financial institutions can increase willingness to act on financial knowledge or to seek out advice,” the paper points out.

Mitchell noted that financial literacy programs should be complemented by efforts to build confidence in financial institutions. “Education helps people understand the products, but consumers are unlikely to act on that knowledge if they don’t trust the institutions offering those products,” she said.

“Policymakers and financial providers can strengthen trust if they can inspire greater transparency, provide stronger consumer protections, deliver high quality financial advice, and provide clear communication about both the benefits and the limitations of public retirement programs,” she continued. “Trust and financial literacy operate independently, which is why improving retirement preparedness requires addressing both knowledge and institutional confidence simultaneously.”

Employers also provide financial education, guiding their workers on saving and investment, especially for retirement, she added. Already, 39 U.S. states now require personal finance courses for high school graduation, according to the Council for Economic Education; Mitchell wants that mandate to be extended to all 50 states.

Over 20 years ago, Mitchell and her co-author Lusardi designed what they describe as “the Big Three” financial literacy questions that everyone should master, namely compound interest, inflation, and risk diversification. Specifically, as it relates to retirement security, the authors identified three types of financial behavior: having a retirement account; holding stocks in retirement or other accounts; and making an effort to grow total net household wealth, which includes financial and real estate assets, net of debt.

Begin Financial Education Early

For decades, Mitchell has advocated that financial education should begin in grade school. “As soon as children can learn to count, they need to understand and be taught about money, about budgeting, about the value of their time, and about the value of investments,” she said. “There’s a household responsibility and a responsibility on the part of teachers to start educating children in financial literacy very young.”

Mitchell had walked that talk in her own household. Years ago, she set up an imaginary “Bank of Mom” for her two young daughters. If they wanted to buy something beyond what they saved with their weekly 25-cent allowance, the Bank of Mom would pay them a bit of money for doing chores around the house, like washing the car or watering the plants; they could also save that money in the Bank of Mom. “Today, both are very financially savvy, I’m proud to say,” Mitchell said of her daughters, who now have their own children.