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12 July 2018 Financial Analysts Journal Book Review

Household Finance (a review)

  1. Marc L. Ross, CFA
Household finance was once the investment and planning wallflower, but this is no longer the case. Stacked vertically, these three tomes, numbering about 1,000 pages each, could well serve as a footstool. And just as a footstool provides access to something otherwise out of reach, this extensive collection affords readers access to a rich chronology of developments in this field hitherto dispersed in academic journals.

Over the past 40 years, household finance has grown from a sleepy backwater into a complex and multifaceted discipline. Indeed, Michael Haliassos, the editor of Household Finance, notes that not until 2006 did this area of research receive its name from John Campbell, in his Presidential Address to the American Finance Association. Consider some of the rubrics under which the articles are subsumed: “Portfolio Models and the Stock Market Participation Puzzle,” “Portfolios of the Rich,” “Stock Trading Behavior and Age Effects,” and “Risk Aversion.” These labels are indicative of academia’s extensive ongoing effort to understand the individual investor’s proclivities and aversions, powered by several geopolitical developments around the world. Indeed, one may find affirmation of the professional and academic focus on this remit of the financial world in the increasing number of CFA® charterholders who specialize in private wealth management and who would, in consequence, benefit from the contents of this collection.

Developed nations’ increased longevity has strained social insurance schemes to the point that individual investors need to supplement their retirement income. In the United Kingdom, the Thatcher government’s privatization efforts encouraged greater household shareownership in the 1980s. To this, add companies’ ongoing shift away from defined benefit to defined contribution plans and tax incentives to open individual retirement accounts, particularly in the United States. The decades-long ascent of mutual funds, with their allure of professional management, has only fueled this trend.

In short, the burden of adequately provisioning for retirement has fallen on the individual investor’s shoulders. A more recent event with some less favorable consequences is the rise of financial innovation, particularly in mortgage finance, putting homeownership within reach of many who could not truly afford it. With wealth come risk and the individual’s need to understand its determinants. The global financial crisis of 2008–2009 taught investors hard lessons about the perils of debt.

The household balance sheet varies in complexity as a function of wealth and education, having come a long way from the basic menu of a bank account and a mortgage. The three volumes of Household Finance are organized thematically, affording the reader multiple perspectives on seminal issues in household finance and investing. These issues include asset allocation and location, risk aversion, stock trading behavior, underdiversification, financial literacy, financial advice, influences of culture and heredity on financial behavior, credit card behavior, and homeownership risk. Most of the pieces date from 2000 or later and thus address the increased number and complexity of financial decisions over the past 17 years. In addition, the writings consider household wealth from a global perspective.

The first part of the collection examines households’ equity and fixed-income participation rates around the globe. Relatively few households own individual securities, with those in Norway and Sweden being the exception. Differences in public policy, financial institutions, and cultural indicators explain these variations. The second part more closely examines the level of household participation in stock markets and how households process the choice between riskless and risky assets. Three studies in this section approach risk aversion from a behavioral and cognitive perspective. Financial advice receives extensive treatment, with perspectives on mis-selling, the advisory role of brokers, and the merits and demerits of regulation. Attention to these issues is appropriate, given the ongoing heated debate in the United States about fiduciary responsibilities of advisers in the context of Department of Labor rules.

The $1,368 price tag puts this collection beyond the reach of most individual investors but well within a library’s budget. It is an invaluable reference for researchers, economists, students of behavioral finance, private wealth managers, product managers, and public policymakers. Most individuals will not have time to read all three volumes in their entirety, nor is it necessary to do so. Collectively, they are a reference work to be accessed for particular areas of interest. Best suited to an academic or technical readership, the individual contributions demand rigorous study, for in many instances they use quantitative methods and statistical analysis to support the authors’ hypotheses.

Household Finance contains much for decision makers to consider. It represents a good start in an area deserving of more research. The increasing sophistication of new types of data comparable across countries, along with policymakers’ efforts to understand individual financial behavior better, will allow for greater cross-pollination with related disciplines, such as mathematics, psychology, and history. Hopefully, this interaction will shed more light on a burgeoning field of study.

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