Twenty-five states now require high school students to take a personal finance course before graduating, yet financial literacy remains low in the United States. About half of American adults cannot correctly answer three multiple-choice questions designed to test basic money knowledge.

Wharton economist Olivia S. Mitchell, who came up with those questions with Dr. Annamaria Lusardi at Stanford, wants to change that. As a professor in the Department of Business Economics and Public Policy, Mitchell has spent her career studying spending and saving. She said a major reason why Americans aren’t saving nearly enough for a comfortable retirement is that they fail to budget. They spend too much money on overdraft fees, credit card interest, and luxury items.

Low financial literacy costs Americans an estimated $390 billion a year, Mitchell said, and people with poor budgeting skills are seven times more likely to spend over 20 hours a week dealing with personal finance issues.

“Moreover, if you don’t save when you’re young, you forego all the beauty of interest compounding that will make you a happier retiree,” she said in an interview with Wharton Business Daily. (Listen to the podcast.)

Important Financial Literacy Lessons for Every Age

Parents can play a critical role in teaching their children how to be smart with money, and there are lessons to be learned at every age. Mitchell offered this advice:

  • Ages 3 to 5: Start explaining the concepts of money. Show them bills and coins and how to make change, both physically and digitally.
  • Ages 6 to 9: Introduce the idea of doing tasks to earn extra money. Have a physical or virtual piggy bank or savings jar to reinforce the difference between spending and saving. Explain that time and money are finite resources, so choices have to be made.
  • Ages 10 to 13: Start teaching them how to comparison shop and save for bigger purchases, such as a bicycle or a gaming console. Open a savings account for them, which helps them understand the role of banks.
  • Ages 14 to 18: Teach them how to budget, track their expenses, and live within their means. If teens take a part-time job, explain paychecks and taxes. It’s also important at this stage to explain credit, the benefits of good credit, and the risks of debt.

“It’s not that all debt is wrong or evil, but debt needs to be taken on with understanding and strategically.”— Olivia S. Mitchell

Mitchell, who serves as executive director of the Pension Research Council, said parents should lead by example and really talk to their kids about money. Involve children in household decisions around money, such as where to go shopping and ways the family is trying to save. When her own daughters were young, Mitchell played Monopoly to introduce financial concepts such as managing risk. Later, she helped them sell Girl Scout cookies, set up a lemonade stand, and hold a car wash.

“I always tried to talk to my children about living within their means. Don’t spend it all. Try to spend less than you can,” she said. “It’s also important to teach them that time is a scarce resource. If you waste it, that’s going to have a negative effect on not only your spending, but what you’re able to do later.”

Mitchell also encouraged parents to help children think through the difference between needs and wants, so they become more mindful about their purchases.

“It’s not that all debt is wrong or evil, but debt needs to be taken on with understanding and strategically,” she said.