I’ve written on the woeful state of Americans’ financial literacy a few times in the past. There is probably no academic researcher more attuned to the problem than Annamaria Lusardi of Dartmouth. This week’s NBER e-mail blast describing the latest crop of economics working papers includes nine papers; of those, four are written or co-written by Lusardi on this topic.
Among the highlights (or, I should say, lowlights); the bolding is mine:
This paper examines Americans’ financial capability, using data from a new survey. Financial capability is measured in terms of how well people make ends meet, plan ahead, choose and manage financial products, and possess the skills and knowledge to make financial decisions. The findings reported in this work paint a troubling picture of the state of financial capability in the United States.
The majority of Americans do not plan for predictable events such as retirement or children’s college education. Most importantly, people do not make provisions for unexpected events and emergencies, leaving themselves and the economy exposed to shocks. To understand financial capability, it is important to look not only at assets but also at debt and debt management, as an increasingly large portion of the population carry debt. In managing debt, Americans engage in behaviors that can generate large expenses, such as sizable interest payments and fees. Moreover, more than one in five Americans has used alternative (and often costly) borrowing methods (payday loans, advances on tax refunds, pawn shops, etc.) in the past five years.
The most worrisome finding is that many people do not seem well informed and knowledgeable about their terms of borrowing; a sizable group does not know the terms of their mortgages or the interest rates they pay on their loans. Finally, the majority of Americans lack basic numeracy and knowledge of fundamental economic principles such as the workings of inflation, risk diversification, and the relationship between asset prices and interest rates.
As bad as Americans are, we aren’t alone:
by Annamaria Lusardi, Olivia S. Mitchell
In an increasingly risky and globalized marketplace, people must be able to make well-informed financial decisions. Yet new international research demonstrates that financial illiteracy is widespread when financial markets are well developed as in Germany, the Netherlands, Sweden, Japan, Italy, New Zealand, and the United States, or when they are changing rapidly as in Russia. Further, across these countries, we show that the older population believes itself well informed, even though it is actually less well informed than average.
Other common patterns are also evident: women are less financially literate than men and are aware of this shortfall. More educated people are more informed, yet education is far from a perfect proxy for literacy. There are also ethnic/racial and regional differences: city-dwellers in Russia are better informed than their rural counterparts, while in the U.S., African Americans and Hispanics are relatively less financially literate than others.
Moreover, the more financially knowledgeable are also those most likely to plan for retirement. In fact, answering one additional financial question correctly is associated with a 3-4 percentage point higher chance of planning for retirement in countries as diverse as Germany, the U.S., Japan, and Sweden; in the Netherlands, it boosts planning by 10 percentage points.
Finally, using instrumental variables, we show that these estimates probably underestimate the effects of financial literacy on retirement planning. In sum, around the world, financial literacy is critical to retirement security.