More Depressing News on America's Financial Literacy (or Lack Thereof)

(Digital Vision)

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:

Americans’ Financial Capability

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:

Financial Literacy around the World: An Overview

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.


Eric M. Jones

85% of people are above average.

Mike B

Depending on the distribution of data that isn't at altogether unlikely. All it takes is one extreme outlier to make everyone above average :-) Perhaps you meant to say 85% of people are above median.


I believe that this is one of the fundamental reasons for the state of our economy. Not only do the people of our country not understand how to "do the math", the politicians, our would-be leaders, can't either. Some can, but they seem to be in the minority and they are yelling into the wind.


I'm fairly conservative in my thinking and political affiliation and I always thought that more financial education was required. While I still believe so, the last few years have shown me that a large percentage of the population likely don't have the mental and cognitive ability to learn enough to help themselves. Unfortunately, I have concluded that we do indeed need to protect people from themselves more than we do today.


OK, so what are the reasons for this? Insufficient experience and/or intelligence? Environment? Competing interests? Character? Something else?

Enter your name

Competing interests, I think. It's much more fun to buy the cool new T-shirts for the kids than to tell them for the ten thousandth time that we can't afford that. I know a poor (barely working class) single mother who made exactly that mistake: three pricey T-shirts at $30 a pop, followed by a session with a credit counselor who actually told her that her kids *deserved* pricey T-shirts, and that her problem was that she needed to get a second job. (For the first time in her financial life, the mom was right: she should have said no, if we buy those T-shirts, then we won't be able to pay the electric bill.)

Also, when you're poor, you're trying to buy status symbols. It's all well and good for Steve Jobs to wear turtlenecks and blue jeans; everybody knows he's got millions, so he gets no benefit from flaunting it. But if you're barely making it, then one status symbol -- whether it's clothes, car, electronics, or whatever -- buys you a lot more of the shallow respect that we call status than a week's worth of groceries in the cabinet, or $100 tucked away in your sock drawer in case of an emergency.



Financial products differ from "primary rewards" like food, shelter, sex, etc., in that they are a level removed from our visceral understanding of goods and services. While most financial mechanisms make simple rational sense (e.g. interest payments compensate for time), the more complex ones are several steps from clear monetary exchange (credit default swaps help hedge against the necessary risk for economic expansion.) Retirement is a future primary reward, but can we expect everyone to orient their consumption towards the future? How do we encourage that behavior? I remember when interest provided an incentive to save.

caleb b

My experience with my friends mirrors this finding. Exactly one friend I know saves; he’s 26 and has all his money in cash and gold coins…seriously. Everyone else is leveraged to the hilt or still lives with their parents. Yeah, we’re doomed.


In other news... people who create, buy, sell, insure, and/or bundle financial products don't appear to have any 'financial literacy' either. This also would appear to leave our economy exposed to shocks.

Oh wait, that's not news, that's the opposite...

Joshua Northey

As you guys love to point out it is all about incentives. Unfortunately the incentives are all wrong in this case.

People who participate in the mass culture are bombarded by advertisements attempting to get them to spend as much money as possible. Business has gotten incredibly good at using innate psychological biases to get people to make purchases. It also has little interest in correcting this deficit.

The average person goes into debt to buy a lot of consumer products that have a marginal, and worse yet, temporary impact on their utility. Then their finances are so poor that they end up with lower net utility. The circuitry we run on was designed for an environment where life expectancy was 30 not 80.

When you put aside $5000, you don't tell your friends about it. And the rewards of being consistently financially responsible are often realized years into the future.

Meanwhile if you take that $5,000 and take a loan for $15,000 and buy a fancy no car/boat/garage/whatever...

You get an immediate shot of:
The increase in utility for the item (until it wears off when you become used to it in two weeks)
A short time where your friends will treating you as though you are successful.
You yourself feel successful (until you start missing payments 6 months from now).
Mates possibly mistakenly thinking you are successful.

Financial Literacy should be the #3 thing we are teaching in schools. Reading>Numeracy>Financial Literacy.
Civics, History, Science, it is all less important to someone's lifetime well being than being responsible with resources. And we do not teach it at all! I know I got through 20+ years of schooling without one single second spent on financial literacy.

Especially in an era when such a large % of the population will be a solo or joint head of household at some point, the current practice is just unconscionable.



Nevermind we constantly have 'economists' on the TV telling us that if we spent more of our disposable income (what disposable income?), we wouldn't be in this recession...

Enter your name

The numbers here don't really surprise me:

News flash! Half the population isn't saving for retirement or college education, because they're still struggling to pay the rent, put food on the table, or buy clothes!

Extra, extra! People in the bottom half of the economy won't be paying their kids' college tuition or dorm fees!

Read all about it! Kids working their way through college are using their income to pay tuition today, not to fund a retirement that is 50 years away!

Breaking news! People who count themselves lucky to hold onto a dead-end minimum-wage job figure they'll be working until the day they die!

Personally, I'd be happy to see us phase in a small, mandatory, wage-based tax for retirement savings -- with the money put into a personal, inheritable, tax-advantaged account like an IRA, and with zero "spend Mommy's retirement on the kids' college tuition" or "wager Daddy's retirement on the housing market" options -- but I don't see any possibility of a less-coercive method resulting in reasonably universal retirement savings.



Yet it seems that a large fraction of those who are now struggling would, not so long ago, spend money on oversized vehicles, RVs, power toys, designer-label clothes (the ones made in the same factories and to the same pattern as the generic, but priced 3X higher because they have the designer's name embroidered on them), pricey cell phone contracts for adults & kids, 60" plasma TVs with hundreds of channels of premium cable... While those few of us who spent on none of those things, but saved & invested instead, are doing quite well.

Maybe the secret is to lose a job in the middle of a recession, or become temporarily disabled, or suffer some similar hit to one's earning capacity at a fairly young age, so that you learn that the good times can be swept away in a few moments, and the unprepared will struggle to deal with the consequences.

Miley Cyrax

But Jaaaaames, Americans are entitled to designer clothes, garish jewelry, SUVs with rims, big-screen HD TVs, and iPhones and iPads, even if they're already living on taxpayers' money via welfare, project housing, or food stamps.

But for real, you nailed it: "While those few of us who spent on none of those things, but saved & invested instead, are doing quite well."


A possible cause is the moral hazard created by the social safety nets -- existing and implied.

For example, I know folks who do not take as much interest in their retirement arrangements because they figure they will make-due on Social Security.

I know folks who weren't very careful with their mortgage terms because they figure if things went south, there'd be a way out.

Mike B

There is nothing wrong with that. One major problem with China is that because it has no social safety net the population has very high saving rates. If it weren't for the West buying all their stuff China would be suffering from severe economic stagnation. People need to find the proper mix of consumption and savings least we fall victim to the Paradox of Thrift ( ). As much as people hate being told what to do, the Government has a critical role in getting people into the savings/consumption sweet spot. Social Security allows older workers to take risks like starting a business or at least not have to freak out, start hoarding all their cash subsisting on a diet of canned soup.


But what exactly is wrong with economic stagnation? It seems better than the squirrel-cage economy, in which everyone is working frantically to keep up the payments on all the consumer bling they had to have but can't enjoy because they're too busy working frantically...


One cause is almost certainly the poor state of our public education system. Most students finish high school with only a passing acquaintance with basic economic theories (such as the laws of supply and demand), and without the math skills needed to effectively evaluate the myriad financial options that confront them as adults (or heck, even as 18-year-olds). Many districts do not even teach economics any more, and virtually all allow students to graduate with woefully substandard math skills.

For example, one of the biggest financial decisions a person has to make in their lives is where to go to college and how to pay for it, yet most 18-year-olds don't have the skills needed to do a basic cost-benefit analysis of the various options confronting them. They cannot calculate the net present value of a stream of interest payments (the basic calculation used to help determine whether or not to take on debt for a purchase), and therefore often find themselves in over their heads in terms of debt before they even reach their mid-twenties.

I taught HS social studies (including economics) for several years at a school district in the heart of Silicon Valley that is considered to be on of the top 100 districts in the country, and even then I was astounded by how poor many students' math and reasoning skills were.

Financial illiteracy is the effect...poor math and reasoning skills the two major causes.


Mike Fladlien

I taught a record keeping class with 67 students, 9-12. One of my main goals was to teach simple interest. The lesson was taught 5 times, approximately 4.5 hours with 100 problems assigned. Yesterday I gave the final and only 25% of the students could correctly calculate the answer. I could be a horrible teacher, but the results are not encouraging. Students don't understand the concepts of financial literacy, don't care, or see the relevance. It should be noted at over 50% of our student population is on free and reduced meals.