Read the article, answer the questions:

1) Define savings and wealth. What is necessary to turn income into wealth.

2) What is "The life cycle theory of consumption and savings"? Discuss and draw figure 3 (label the figure).

3) What is the relationship between education and income? Discuss and support your discussion with the evidence (data/stats presented - see table on page 3).

4) Describe how the following 3 financial habits contribute to well educated families' ability to build wealth over time: liquid assets, diversification, and low debt to relative assets.

5) Explain why the relationship between education and income might not be as simple as it first appears (see box on top of page 4)

PAGE ONE Economics Education, Income, and Wealth Scott A. Wolla, Ph.D., Senior Econor ssica Sullivan, Economic Education Intern GLOSSARY Asset: A resource with economic value that an in the past hundred years, much higher than the average during that the expectation that it will provide future time span and probably higher than for much of American history - Janet Yellen, Federal Reserve Chair ! apital gains: A profit from sum of the original prin Americans have among the highest living standards in the world and have enjoyed rising living standards for decades. Median household income in In a credit report used to indicate a person's the United States in 2015 was $56,516, up from $49,276 in 2010.? However gains in household income have not been evenly distributed across all elinquency rate: The number of loans that since the 1970s, peaking in 20133 (Figure 1). A 2015 Gallup poll found that total number of loans. 63 percent of Americans feel that the distribution of U.S. money and we is unfair. " While many factors contribute to income and wealth inequality, citions under which one party (a person of itution) promises to pay another party the role of education is a key piece of the puzzle. cash at some point in the another party nancial investment: Placing money in a sav U.s. come In he Inequality a Rising Trend assets, such as stocks, bonds, of mutual fi with the imention of making a financ dial matters and applying that knowled aman capital: The knowledge and skils that ence, and training come: The payment people receive for pro- urces in the marketplace tended to cover a borrower's expenses until is or her nest perday May also be calleda rycheck advance or a payday advance. NOTE: The Gini coefficient (also known as the Gini ratio or index] is a con y ul settleng a good , services, un friarkid a scale from 0 to 1: The higher the number. the higher the level of inequality. 2013. In 2015 the, Gini coefficient was 0.479. SOURCE: FRED", Federal Reserve Bank of St. Louis, A 2016: https/fred.stlouisfed.org/graph/70-Zhu. LLOZ Nuenuer Federal Reserve Bank of St. Louis | research stlouisfed.org PAGE ONE Economics" U.S. Personal Saving Rate Over 50 Years A Model of Saving and Spending: The Life Cycle Theory of nsumption and Saving NOTE: The horizontal line indicates the average saving rate over the period. 016: http:/fred.sklosisfed.org/graph/g-bozk." ure 3), people tend to borrow to purchase homes, cars or an education when the ig pay down debt The Basics antilikeand gaming years, and finally spend to When people earn income, they use that income to do money during retirement. Within this pattern of planned three things: pay taxes, buy goods and services (consume), and save. Saving is not spending on current consumption borrowing and saving, the hump-shaped pattern of or taxes and involves giving up some current consu ( the horizontal line) across the lifecycle. Thus saving tion for future consumption. The accumulation of mo to build wealth-is essential for a higher quality of life set aside for future spending and consumption is known during retirement. s savings. Americans don't save as much as those i other industrialized nations. The U.S. personal saving Two similar terms must be differentiated here: Income is rate has dropped substantially over the past 50 years the payment people receive for providing resources in the marketplace. For example, people often receive pay- checks twice a month. You may have heard people dis- son, German house- cuss the flow of income. Saving involves setting some of holds saved 16.7 percent, on average, in 2015.6 the flow orincome aside to increase weaning, wealth is the turning the flow of income into a stock of wealth regime Wealth, also called net worth, is the total value of a per saving money. There are several options for saving, son's assets, such as liquid assets (cash or something you cars, minus any liabilities (money owed; debt). Saving to cial investment. People invest in financial assets with build wealth is an important part of financial planning. the aim of "making money"-they hope to earn interest and debt is not necessarily a bad thing. Because income dividends, profits, and/or capital gains in the future. debt) allows people to have things now and pay for them Education and Income over time. In economic terms, this alled smoothing The relationship between education and income is consumption. income men telephone creamOF strong- Education is onen referred to as an investment use the life cycle theory of consumption and saving to similar reasons people invest in ancial assets, including explain this phenomenon. As shown in the model (Fig- to make money. In general, those with more education PAGE ONE Economics' Federal Reserve Bank of St. Louis | research.stlouisfed.org 3 Family Financial Outcomes Based on Education Education* Percentage of Median wealth Wealth-to-income Millionaires to sign school diploma $22.520 2596 Advanced degree $273,488 5116,265 5689,100 NOTE: "Based on the exduration level of a family headed by some of income. For example. the ratio for families without a high school degree was 143, which means that, on average, for every $1 of income there was $1.43 of OURCE Bothara, Ray: Emmons. Willum R. and North Began The Du phics of Wealthe He Today's Economy." Essay No. 2: Education and Wealth, Federal Reserve Bank of St. Louis, May 2015. pp. 4. 5. 9, and 13: (media Fles/PDFadHFS/esaysHES.Essay-2:2015-Education earn higher incomes (see the table). The higher income Unempl to as the "college wage premium " Research shows that FRED this premium has grown over time.' In addition for the more skils people have, the more employ core a lower average une than those with less education (Figure 4). Education and Wealth The relationship between education and wealth is also strong. Of course, e gner income makes saving easier, and saving is necessary to build wealth. Those with lower incomes have a flatter (non-humped) income NOTE in November 2016. the overall US. unemployment rate was 46 percent pattern, which make saving and paying down debt Was 2.3 percent, while that for those with less than a high school diploma was It those with more education also tend to make financial decisions that contribute to building 73 percent wealth. It is important to realize, however, that anyone can follow the financial behaviors that well-educated families tend to practice, such as these: 3) Keep debt low relative to assets. Those with low Have some liquid assets. Liquid assets can help debt relative to assets pay lower interest rates. Those with high debt relative to assets pay higher interest out having to sell assets or accumulate debt. Liquid rates, which can make it difficult to save. And, over assets include savings accounts, stocks, and bonds. longer periods, both savings and debt are suscepti- ble to the effects of compound interest-which 2) Diversity. To diversify means to invest in various financial instruments to reduce risk. In addition to means that savings (or debt) can grow at exponen tial rates over time." tangible assets such as houses and cars, those with higher levels of education also tend to hold a great- It is important to rea owever, that the relationship nesses, which tend to provide higher returns (but also more risk of loss). income and more wealth. Factors such as natural ability PAGE ONE Economics* Federal Reserve Bank of St. Louis | research.stlouisfed.org 4 Correlation Is Not Causation ever , are not ready to say that education alone is the cause of higher income (and wealth), in fact, you might have heard the phrase, "correlation does not imply causation." What does this mean? Well, just ce cream sales. They tend to increase when the rate of sunburn also increases, Does increased ice cream consumption, then, cause an increase in the sunburn rate? Not likely. In fact, a third factor months, when more people tend to be outdoors and thus more likely to get a sunburn. Likewise, while at least some of the college wage ation, other factors, such as the following, are surely gig isnowledge and skills acquired Natural ability: Those with high intellectual ability are more likely to complete college, and that ability contributes to success in the job market as well Assortive mating ("like marries like"k Highly educ double the wage premium and increase household any other highly educated Inheritance: People with more education are more likely to have parents with accumulated wealth Better health and longer lifespan pile with more education tend to be healthier, which benefits from social sconfer (increasing lifetime earnings) and live longer (collecting more lifetime Separate Thrivers from Strugglers in Today's Econom ryan. "The Demographics of Wealth: How Age, Education and Race and family background also impact both income and Conclusion wealth and are not caused by having more education (see the boxed insert). Income and wealth inequality have been on the rise in the United States for decades. Research indicates that The Role of Financial Literacy the level of education is strongly refered to both income shows that up to half of wealth inequality may tend to have more liquid assets to withstand financial many people do not have the skills or ability to manage storms, diversity their savings (investments), and main- their money effectively. As a result, they are more likely behaviors are effective strategies for building income transaction costs and fees and ientiapay higher tied to financial decisionmaking, it is likely that financial ing options." High-cost borrowing includes the use of literacy can play a key role in reducing wealth inequality art to own stores is currently any new shops an over time . igh school students to take a course in economics and nly ly states require a course in personal finance." dents in states with financial education t scoresmergen delinquency rates and out financial education requirements 15