Are We a Nation of Financial Illiterates?

Let’s begin with two questions:

1. Do you consider yourself financially literate?

2. If so, how did you get that way?

And now, a third question:

3. How important is widespread financial literacy to the health of a modern society?

Before you answer the first question, take this little quiz, borrowed from the website of Annamaria Lusardi, a professor of economics at Dartmouth who knows and cares more about financial literacy than anyone else you’re likely to encounter:

1. Suppose you had $100 in a savings account and the interest rate was 2 percent per year. After 5 years, how much do you think you would have in the account if you left the money to grow?

a. More than $102
b. Exactly $102
c. Less than $102
d. Do not know

2. Imagine that the interest rate on your savings account was 1 percent per year and inflation was 2 percent per year. After 1 year, would you be able to buy more than, exactly the same as, or less than today with the money in this account?

a. More than today
b. Exactly the same as today
c. Less than today
d. Do not know

3. Do you think that the following statement is true or false? “Buying a single company stock usually provides a safer return than a stock mutual fund.”

a. True
b. False
c. Do not know

The correct answers are …

a., c., and b. I am guessing that the vast majority of this blog’s readers got all three answers correct. But there’s probably money to be made in betting the opposite way.

Those three questions are the ones that Lusardi, along with Olivia Mitchell of Penn, have been inserting in a variety of major U.S. surveys. In a new working paper titled “Financial Literacy: An Essential Tool for Informed Consumer Choice?” (abstract here, download here), Lusardi writes that among respondents age 50 and older, only half of them got the first two answers right and only one-third of them got all three answers right.

Because Lusardi, Mitchell, and many other economists focus on retirement behavior, it is pretty horrible news to learn that so many older people are ill-equipped in the basics of saving and investing. With most U.S. companies doing away with big employee pensions (see Roger Lowenstein‘s new book While America Aged), more and more people have to plan their own retirements. I share their concern but I also think that too much emphasis is put on retirement know-how. It’s not that saving for retirement isn’t important; but by the time you’ve woken up to the fact you have no idea what you’re doing for retirement, you’ve probably already bungled a lot of financial decisions. Which brings us to:

Question No. 2: If you are financially literate, how did you get that way?

I’d like to think I’m at least adequate in taking care of my family’s finances and everything that includes in the modern world: real-estate and insurance decisions, saving for college and retirement, investing and tax planning, etc. But it has been a bit of trial-by-error mixed with trial-by-fire — and to be honest, I was very fortunate to have an older brother who is smart, frugal, patient, and who worked for many years in finance. If it weren’t for him, I’d be in considerably sadder shape.

But here’s my point: I’m not exactly undereducated. I had 13 years of public schooling, 4 years of college, and another 2 years of graduate school — and after all that schooling, I don’t know if I learned enough to answer all three of Lusardi’s questions correctly. The subjects simply didn’t come up. Just as they apparently didn’t for the two-thirds of the older respondents to Lusardi’s questions.

The good news is that economics is being taught much more in high school now than it was 20 or 30 years ago. (While “economics” is of course not the same as “personal finance” or “financial literacy,” let’s for the time being pretend that most economics courses give students a rudimentary understanding of personal finance.) According to the National Assessment of Educational Progress (“The Nation’s Report Card”), 9 of 10 high-school students said they were exposed to some economics education, up from 1 in 4 in 1982. According to the National Council on Economic Education, 17 states now require students to take an econ course to graduate, up from 13 states in 1998.

So how’s it working? Not very well. According to the latest annual survey by the JumpStart Coalition for Personal Financial Literacy, “high school seniors correctly answered only 48.3 percent of the questions,” down from 52.4 percent a year earlier.

As Lusardi points out in her new paper, there is a vast — if perhaps unsurprising — split in the population: “Those with low education, women, African-Americans, and Hispanics display particularly low levels of literacy.”

Which brings us to Question No. 3: How important is widespread financial literacy to the health of a modern society?

Well, I would say very. So would Lusardi. When you have a society with a modern and fairly complex financial system, it’s probably not a good sign that more than half of the citizenry can’t handle even the basics: how a credit card actually works (I know some teenagers, e.g., who really think it’s “free money”); the beauty of compound interest and the ugliness of paying the minimum balance on a credit card; how to save and invest even when you don’t think you can; how to learn the amount of insurance you need, etc. Lusardi wonders whether people shouldn’t be required to get a license in order to take out a mortgage. That certainly would have dampened the subprime mess a bit, yes?

And we haven’t even touched upon the most basic macroeconomic issues like supply and demand, etc. Can you imagine how different the shrill news coverage of rising gas prices would be if the public (and the media) cared even just a little bit about how the economy actually works?

A lot of behavioral economics, including the good ideas in Nudge, is about cleverly correcting harmful human tendencies — but many of these tendencies need correction only because so many people are so undereducated in such matters.

I am all in favor of a well-rounded education, but seriously: what good is it if high-school students learn about Flaubert, biology, and trigonometry if they don’t learn how to take care of their money? One bright side to the increasingly dark economic news these days is that more and more people will learn (albeit the hard way) Rule No. 1: Do not buy what you cannot afford.

So what’s to be done? I turned to Lusardi with a few questions; her answers are well worth reading. I’d also be interested in hearing your ideas in the comments.

Q: How does U.S. financial literacy compare to other developed nations?

A: This is a difficult question to answer because, as you may know from my work, almost no (national) survey has (or had) information to measure financial literacy. Moreover, we do not have a consistent set of literacy questions across countries. However, judging from some work I have been doing comparing the U.S. with the Netherlands and Italy and the O.E.C.D. Report on Improving Financial Literacy, I can say that other developing nations face the same problem of widespread financial illiteracy. If anything, financial illiteracy in other countries is worse than in the United States.

Q: Was there ever a time when financial literacy was better taught in U.S. schools? (I believe that “home economics,” back when it was born, included some home-finance component, didn’t it?)

A: Some type of consumer education has been present from the early years (1930’s and 1940’s). Between 1957 and 1985, 29 states adopted legislation mandating some form of “consumer” education in secondary schools. Fourteen states specifically required coverage of topics relevant to household financial decision making, from budgeting and credit management to balancing checkbooks. Yet, if you read the results from the JumpStart Coalition Survey of Personal Financial Literacy, financial knowledge is very low in high school and not improving.

Because of this evidence, some have argued against teaching financial literacy in high school (and against financial literacy education in general). In my judgment, this is premature. In fact, this evidence can be interpreted as showing that we need to improve the way in which we teach financial literacy in school.

Q: I would argue that teaching kids biology, trigonometry, and literature may be less useful than teaching basic financial literacy; what are the barriers to doing so, and who is trying hardest to make this happen?

A: I do not think that literature and mathematics are less useful in the lives of people than financial literacy. In my view, financial literacy should not replace these courses (in fact, some financial literacy can be integrated into mathematics), but should be added into the curriculum with the same high standing. As students study Faulkner or Steinbeck, Madame Curie or Louis Pasteur, they can also study Milton Friedman. In my view, as I will explain more below, we need to stay away from things like how to balance a checkbook and teach about the workings of the economy. We do not teach how to bake a cake in high school. It would be useful to know how to cook (please see statistics about obesity), it would add to the lives of people, and moms are now working full time and have stopped teaching that, but these practical matters should stay out of schools.

Among the barriers about teaching financial literacy in school are 1) lack of resources and financial support (and we need well trained teachers); 2) the fragmentation of the legislation (most of the decisions about curricula are done at the state and local level); and 3) the lack of consensus about what to teach (many institutions, including banks, are devising high school curricula and there is a wide spectrum of curricula out there).

Both the National Endowment for Financial Education (N.E.F.E.) and the National Council of Economic Education (N.C.E.E.) are doing good work to raise awareness and introduce financial education in school.

Q: If you were president of the U.S. for a day (or longer), what are 5 pieces of financial literacy that you’d try to have taught to everyone?

A: If I were president for a day, I would like the following topics taught in high school:

1. Basics of how markets work. Things like: it is the law of demand and supply that determines prices in competitive markets, and the interest rate is the price of money.

2. Time value of money and the working of interest compounding: Because so many payments in finance happen at different points in time, one needs to know how to compare payments. Discounting is at the basis of asset pricing. What is the price of bonds? It is the present value of its payments. Interest compounding is a fundamental concept and it requires a little bit of math. It is critically important to understand interest compounding to be able to fully appreciate the importance of starting to save young and how to borrow and handle debt.

3. The concept of risk and the working of risk diversification and insurance: A lot of the decisions about saving and investing have to do with how to handle risk.

4. Basic accounting: To know the net values one needs to subtract assets and liabilities, and that it makes a big difference between whether we choose market prices versus book prices.

5. Rights and responsibilities of consumers and institutions. People need to know there is a Federal Deposit Insurance Corporation, bank deposits are safe (up to $100,000), and there is no need to line up to withdraw deposits; they should know who does and does not have fiduciary duties and what it means to use a financial advisor (you cannot sue them if the stock market plummets).

These are rigorous topics, there exists a lot of first rate academic research on them, and they deserve a seat in high schools. In other words, yes to financial literacy and without apology!

If I were president for another day, I would also do the following:

1. Have federal, rather than state and local policies, about financial education: Why should Nevada have a different curriculum than New Jersey; Does interest compounding work differently in New Jersey?

2. Make the financial industry stay out of the process of devising curricula and financial education in general. It is a problem of incentives (they do not face the right incentives). This is a job for non-for-profits and academics and it is critically important to have independent players.

3. I would make sure teachers are equipped to teach and resources are allocated appropriately (at least get the same money as other topics). Having the gym teacher do financial literacy education defies the purpose of having financial education in schools.

[Note: I discussed this topic on the public-radio program The Takeaway.]


Forrest

I'd teach them a philosophy of money before dealing with the nuts and bolts. Which would be intended to teach them a way of thinking about money which would make them want to save and invest. Chiefly--

The main goal of TV advertisers is to teach you a gigantic lie-- that the world is a friendly place which is to be trusted.

The world is in fact not to be trusted, and savings and investments are castles, moats and bulwarks.

Money works differently at different levels.

If you try it and practice it, you can learn to control your lifestyle, be just as happy short-term spending far less, and be more happy long-term by becoming the owner of companies.

artdogs

@agitator:

LOL! Yes, the Messiah will cure all! Just ask the Europeans and everybody that's been brainwashed to put those Obama '08 bumper stickers on their cars.

Yes, friends, agitator is right: Obama Messiah will cure all. Fear not!

Dave Shafer

Is it surprising that people can't do 7th grade math? No. Do people need to be able to do math to "get" personal finance? Mostly. Is the real problem behavioral? Yes. Now the real issue is the third question and that word safety. You see Wall Street and its army of mutual fund salesment use that word like a its some religious totem. The real question is what does that "safety" cost you. In the case of mutual funds, it costs you a decent retirement unless you have a defined benefit pension to lean on. Look up the Dalbar Inc. studies to find out what the real rate of return for folks in mutual funds is. Now put that rate of return into your calculator. Then add in at least 1 year of no inputs to your mutual fund for life (layoffs, sickness, extraordinary expenses, etc.). Then add in a 2.8% inflation rate. Now you see that the real risk of investing in mutual funds (and that diversification) is a poor retirement. No automatic, safe, pay yourself first, slow, or any other adjective, type of investment scheme will get you there. Only becoming an intelligent investor and applying what you learn will work. For the rest, there is only social security!

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mully

Seriously... if an adult cant answer all three questions correctly then they must be something seriously wrong with the educational system.

And the correct answer to A is that you will have 110,40 dollars after five years (100*1,02^5)

Alex

There is no national curriculum, nothing mandated by the federal government.

Education is a state matters. Control over the licensure of teachers, the design of content frameworks or curricula, graduation requirements, the designing and funding of standardized tests. All of that is a state matter.

(NCLB is a revolutionary law becuase it expanded the federal role in education, but it is still quite small. NLCB mandates tests and consequences for the tests for schools, but it does not dictate the content of the tests. It leaves to each state to come up with its own tests.)

(Sen. Bird got mandatory coverage of the constitution on one day year, but the form and content of that coverage is left to states, districts and schools.)

"Why should Nevada have a different curriculum than New Jersey; Does interest compounding work differently in New Jersey?" asked Dr/Ms. Lusardi. But is that any differnet than Shakespeare? Is that any different then algebra? Is that any different than spelling?

What does it say that this expert in financial literacy knows so little about how our education system works?

Or our Constitution. The president does not have the power to dictate curriculum. The president certainly does not have the power to dictate how local districts spend their budgets or staff their classes. Regardless of the need or the sensibility of the arrangement, education is a state and local matter in this country.

Perhaps understanding the most basic finances of k-12 school funding would explain this. Where does the does the money come from?
Federal Gov: 6-8%
State Level: 40-50%
Local Level: 40-50%
And the power, in this case, about matches the money.

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Jamie

I am financially literate thanks to my parents, who early on taught me that credit cards are for convenience, not for financing things, and should be paid off in full every month. They taught me that only big ticket items such as homes, vehicles, and education should be financed. They have subscribed me and my husband to Kiplinger's Personal Finance magazine for the last three years. As a result, we save like crazy and max out our IRAs and 401ks.

Sadly, not everyone has parents like mine.

T-Bone

In addition to teaching economics, I think job search, application, and interview skills should be practiced as well. So many more people are working jobs for only a few years rather than a lifetime. So practicing job skills makes students become comfortable with the process, giving them more power to voluntarily choose their path rather than being at the mercy of the market.

Students should also learn about the outlook (prospects) for different careers so that more students choose to pursue careers that are projected to have a shortage of qualified applicants or jobs that will meet their expectations in terms of pay, benefits, workload, job function. The Bureau of Labor Statistics already provides this information for many occupations.

I think this goes hand in hand with economics, since career planning is a large part of economic decisions.

Mark

1. Suppose you had $100 in a savings account and the interest rate was 2 percent per year. After 5 years, how much do you think you would have in the account if you left the money to grow?

a. More than $102
b. Exactly $102
c. Less than $102
d. Do not know

Good luck finding a savings account that does not charge you a fee for having less than a minimum balance with only 100 dollars in the account.
At my last two banks you would have had the fees take you all the way down to $0 dollars left with only 100 dollars in savings.

Kathleen Lisson

I am financially literate and I learned the value of saving money and paying off all credit card balances from my father. He paid off our mortgage early and we celebrated when we finally 'owned' the house.

Your article echoes the most important lesson - do not buy what you cannot afford.

Kathleen Lisson

Xaq Fixx

I am 26, a college dropout and easily got all 3 questions correct. The closest thing we had to an economics or financial class at my high school was a "business math" class, but it was a near remedial class for people that couldn't get past Algebra I (lower than geometry, Trig, and Calc.) In the Boy Scouts, however, Personal Finance Merit badge is required to qualify for the Eagle Rank. I have studied economics on my own, focusing primarily on Austrian Economics, but have read some Friedman, obviously Freakonomics, Bastiat's "The Law" and have become friends with several economist and Economics professors. I record a podcast for a non profit group and have had the opportunity to interview some interesting people including Milton Friedman's Grandson, Patri Friedman. I have several more interviews scheduled with GMU's Dr. Peter Leeson, Loyola's Dr. Walter Block, SJSU's Dr. Colleen Haight & Dr. Ryan Operea, and the Beacon Hill Institute's Dr. Benjamin Powell. Even if the education isn't compulsory, as it would be in public schools, the information is valuable and out there. It is the responsibility of the individual to seek it out for his/her self.

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Martin

I agree that financial literacy should be taught in schools (and I would argue at the expense of teaching fictional literature), but I don't think a class in accounting would be of much benefit. Students will not learn much from knowing the difference between operating and net income.

The skills that are important are basic supply and demand, the time value of money, and basic investing. I would suggest a year long (or two semester) sequence could ad these skills.

Further, I went to high school in a district that requires that "economics" be taught in high school. So in our government class, used 3 weeks to attempt to explain supply/demand and the stock market. And I'm convinced the teacher to this day does not understand those principles. That is probably why financial education has not had a positive impact yet.

November

When I was young (late teens/ early 20s) I had a boyfriend whom I had to teach how to write a check. Later (mid 20s - we were still friends) I had a financial crisis which required me to use a "speedy tax refund" place. I mentioned to him the incredulous 300% APR, to which he responded, "that doesn't make sense, won't you just owe them money."
Until now, it hadn't occured to me to blame a faltering school system (he went to a private, prep-school btw) I assumed this was the result of very lazy parenting. My son, 7, already understands about credit card interest, etc. I think we have a personal responsibility for educating our children & I actively seek out any knowlege he needs that I don't currently have, so that I can pass it on.
Also - busy/ working mom is not an excuse. I am a single mother with a hectic full time job and a full/ active life taboot. I know I'm coming off as
elitist now, but I really believe this is important. No excuses - educate your children. (not you guys - obviously) :)~

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math wiz/artista

Dear Johan;

you have made an assumption- math has nothing to do with art or with life experience. Suggestion- go read 12th night once more and try to answer the big question-- why 12 nights- not 11 or 13. If you answer the question- then you get the math.

We seem to forget our number "roots' or don't quite well understand them enough.

Gary

I feel like my primary education touched on these areas quite well. We had a mandatory Home Ec class where you learned to balance a checkbook and the like. We had a competitive stock market game in which students had model portfolios and played stock pickers, I also to AP economucs, and a slew of business classes, among them business law, and business analysis. It gave me a distinct advantage in college against my peers. Surely some of the "waste of time" classes I took as an undergrad could have been put to better use. I am no brighter for having read Twelfth Night, but if I understand compound interest, I'm in good shape.

KevinM

"Among the barriers about teaching financial literacy in school are "

Financial literacy includes concepts that often contradict the political ideology of the teachers, their union, and the government that funds them.

Johan

The financial illiteracy of the masses is the source of riches for the few... Why do you think only 10% of the world population is wealthy? (rhetorical question) It is because only 10% of the population understand finance well enough. The reasons for this are numerouse. The reason focused on in this article is the poor financial education in school. This truely is a problem; the only one that can be solved. The bigger problem, as some have already hinted at, is that people differ in their interests... Some people enjoy literature, some art and so forth. In highschool these differences are very clearly visible. You can not change the interests of teenagers so you can not improve their financial knowledge. The teens that find economics and finance interesting will learn it, the rest will not. It would be far better to require all 21 year olds to take a finance course. Most of them would already see the advantages of such a course. Of coarse, the course would have to be paid for by the government... that would be my suggestion. Oh, and so you can decide for yourself if my advice is credible or not I should provide some information about myself... I have just turned 22, have graduated from University a year ago having studied Management and Economics, and now work as an equity analyst/asset manager at a brokerage. I am currently preparing for the level 1 CFA exam.

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doug

a) save 10-15% of income.
b) don't spend more than you bring home.
c) live within your means.

Who did Phil Gramm say was whinning?

Anne

1) ish. I did major in business and take lots of courses, but I was never very good at crunching the complex numbers. I do know enough to understand the importance of compound interest, which lead me to convincing quite a few friends to start saving accounts/retirement accounts early...

2) parents and school (high school and college)

3) insanely important!

I wonder for those that didn't learn about this information in high school, did you go to public or private (college prep/private) schools? My bf and I talk about this often, how he (college prep) didn't know how basics of finance until he went to college and spoke with his parents about it. I, on the other hand, at my public school, had to take a general business class. Everyone needed to take this class to graduate. Course topics (and tests questions!) included balancing a checkbook, following a stock throughout the semester and how buying a new car is the worst thing you can do. It wasn't nearly as intense as my business courses in college, but set me up so that i knew the basics of finances when i did get a checking account, etc. Actually, the first place i heard not to get a credit card in college was in that class! I wonder if high schools that expect their kids to enter the work force (public) teach this more readily then those that expect them to go to higher education (prep/private)?

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DT

When I was in elementary school (I'm 26 now), we had a class on financial literacy. I remember having to compute simple and compound interest. I also remember learning how to write a check. In college, I taught that highly refined skill to several other women in my dorm.

In my senior year at Barnard there was a program to help us transition to the outside world. This included (optional) classes in financial literacy, as well as helpful information on subjects like renters' insurance and how to buy a decent wine for $10. I think the program was new my year but it's been expanded since. Barnard did a lot of great things for me, but this one is pretty high on the list.

For the record, I have an automatic savings plan, an investment account, and an IRA. And I'm in graduate school.

math wizard

If you are asking about the cause of financial illiteracy- again- one more "no logical brainer"- we still have not mastered mathematics in a way that we understand it. so how can teachers teach math to our kids- there are those with parents who teach them and those with parents who cannot or don't. My daughter would not let me and her dad couldn't- she still asks me how much is 8 times 20. And why- Her 3rd grade math teach of a progressive bent believed that it did not matter whether you got the question right or wrong- what mattered was the process i.e., as if getting the math right on building a bridge does not matter- she left that school and is still have difficulty understanding what her teachers are talking about in math. And she understood the concept of limits at age 4.

Limits are important when it comes to finances. But we don't seem to have a sense of them. Not the financial geniuses who have sold homes to people who cannot afford them long term or the people who bought them.

Now as to the question of how to teach mathematics. For all you teachers out there--Notice the word is plural--hint, hint-- this reallly matters when you are teaching and learning math. I know- I taught in a public school and grades when up in 8 months by more that 1/4. And I have the records to show it. notice the word taught-

No more for now- back to work.

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