Jay Ritter, the Cordell Professor of Finance at the University of Florida, sends some thoughts along in response to a piece about financial literary in this week’s Economist that features Nudge. Even professors of finance need a nudge sometimes!
1) I remember in 1990 or so telling a fellow finance professor that I didn’t really know how to do the lease vs. buy decision for an auto purchase. (Once I started teaching leasing, I figured this out.) He admitted that he didn’t know either.
2) And I remember how my first wife, with an MBA from Michigan, didn’t understand the basics of how to minimize interest payments on credit cards (pay off one in its entirety each month, and charge current purchases to that card, so that we didn’t have to pay interest immediately on each new purchase).
3) Last October I advised my brother, a successful small businessman, on taking out a mortgage. He didn’t realize that the implicit interest rate that he would be paying was over 33 percent per year on the monthly cash payment saving if he took out an interest-only mortgage. I was able to figure this out quickly, but I knew it had to be a high number because of the adverse selection problem that exists with the consumers who are taking out interest-only mortgages. His mortgage broker probably couldn’t have figured this out, even if she had the correct incentives to do so.