We’ve all had that moment – you look in your bank account and there isn’t nearly as much money in there as you thought, and pay day is still an alarming amount of time away. However, our research with King’s College London suggests that people’s misperceptions about their personal finances go way beyond the occasional ill-advised spending spree. We are routinely underestimating the costs of big life events like having children and retiring – something that could seriously affect our ability to prepare for them and, in turn, affect what we have in our back pockets each month.
While we know our little darlings are expensive, we massively underestimate the cost of raising a family; the average guess at what it costs to raise a child to the age of 21 is £50,000. The actual cost has been calculated as being four times this much. This isn’t inexperience either; the average guess among those with children at home is £40,000, suggesting that the Bank of Mum and Dad will need a hefty overdraft facility.
What’s strange about our underestimation here is that we assume certain costs associated with raising a child, like childcare, are more than they actually are: people think that the average cost for 25 hours of nursery care for a child under two is £200 per week, when the actual figure is nearly half that.
Fast forwarding through to later life, we also hugely underestimate what we need to put into a pension. People think they only need to save £124,000 in a private pension in order to get a total income of £25,000 a year in retirement (the average among current pensioners), assuming they also claim the full state pension. Pension calculators, however, suggest that the true figure is more than twice this, at over £300,000. With such a shortfall between what we assume we need to pay in and what is actually required, parents may have to hope that their costly children start to pay back what was spent on them sooner, rather than later.
People also hold a number of misperceptions about what is going on in society and the economy more broadly. For instance, the public think that there are many more people in the UK earning high salaries than there actually are; the public think that 10% of the UK earn more than £150,000 a year when in reality just 1% do. But we fail to comprehend the contribution that this small proportion of the population make to the overall tax take; when asked what percentage of income tax paid comes from this 1%, on average we think they pay in 10% of all income tax, when in fact, this 1% contribute 28%.
On top of this, many of us are confused about what has happened to the economy and, in particular, the national deficit and debt since 2010; 42% correctly identify that the deficit has decreased, but 32% think it has increased and 26% don’t know. Half of us (47%) correctly identify that the government debt has gone up, but 28% think it has decreased and 25% don’t know. Our accuracy on this is, as you might expect, related to our political attachment. Conservative voters are more likely to believe that both the deficit and the debt have gone down (64% and 45% respectively). In contrast, only 35% of Labour voters think the deficit has reduced and only 22% that the national debt has gone down. Perhaps our confusion isn’t that surprising – when the Prime Minister is taken to task by the Chair of the UK Statistics Authority for confusing the debt and the deficit, what hope is there for the rest of us? Our misperceptions here matter; as Britain headed to the polls on May 7th, the number one factor influencing how people voted was the economy – yet many lacked a clear understanding of what was actually happening to it.
Of course, we get some things right; when it comes to both the average full time salary and the average house price we’re pretty much spot on – perhaps a feature of media reporting on both these issues. But when it comes to many important financial issues, we’re not really on the money at all!