It’s no secret that many Americans are financially illiterate — unable to understand basic principles of money management, including how to save, invest and manage their money. To address this situation, Wharton, Dartmouth and the Rand Corporation have established the new Financial Literacy Center, which will develop “educational materials and programs that help foster saving and retirement strategies over the life cycle.” Annamaria Lusardi, an economics professor at Dartmouth, will lead the new Center with Olivia S. Mitchell, professor of insurance and risk management at Wharton. They will be assisted by researchers from a variety of organizations. Lusardi — along with Michelle Greene, deputy assistant secretary for financial education and financial access at the U.S. Treasury Department — spoke with Knowledge at Wharton about the need for financial literacy training and tools, the reasons why Americans tend to be ignorant when it comes to money matters, and why it’s especially important to teach smart spending and savings habits at a young age.
Knowledge at Wharton: Annamaria Lusardi and Michelle Greene, thanks for joining us. Annamaria, let me start with you. What specifically are Americans most ignorant about when it comes to managing their money? And just how bad is the situation?
Annamaria Lusardi: According to a new financial capability survey, we found that financial illiteracy is widespread — meaning that a lot of Americans don’t know the basic concepts of economics and finance. But it goes beyond financial knowledge. What we also found is that people are not particularly good even in their everyday management. For example, a [certain number] of people overdraw their checking accounts, are late in credit card payments and pay a lot of credit card fees. [Especially] alarming is that many people don’t hold a buffer stock of savings, meaning they are vulnerable to the many shocks that can happen to them.
Knowledge at Wharton: Michelle, would you concur with that? Is there any one area you feel that consumers are most ignorant about?
Michelle Greene: I would agree with Annamaria that there is widespread need for better financial education, and some of it is on very fundamental basic concepts — the idea of compound interest and that, if you borrow money, you will pay back more [than the amount of the loan]; if you save money, you will get back more. Just having an understanding of those concepts can really change behavior. So making sure that people grasp those key [ideas] and understand how their behavior influences their financial futures is what we would like to focus on.
Knowledge at Wharton: Do you think the financial crisis has made Americans more skeptical of the business community and the kind of financial advice they get from others? Has it made them realize more than ever that they must take control of their own finances?
Greene: I think if we can see a silver lining in the financial crisis, it is that there is a renewed sense of people feeling they need to understand their own finances. They need to have better behaviors, think more about the future, think more about savings. So we look at this as a moment for financial education and for financial capability. People are focused on it in a way they never have been before. We have a chance here to really change behavior and change people’s lives.
Lusardi: It is definitely a teachable moment, and that’s why it is so important to be proactive. I also think that the other thing the crisis has taught us [concerns] the costs of making financial mistakes. This is something we were not so acutely aware of, but we now see that these costs can have dramatic consequences. It is important to take that into account even when we think of financial education. A lot of people are skeptical of financial education and say it is expensive. But I think the financial crisis has taught us that it is expensive not to do financial education.
Knowledge at Wharton: What do you think is the biggest impediment to Americans learning about money management? It seems to me it might be lack of time. It might be a feeling that they really don’t have that much control over their money or certainly not over the economy. Maybe it is just fatigue from looking at all the options out there — including all the new financial terms they feel they need to know in order to make wise decisions.
Lusardi: All of the things you have mentioned are important. I think that financial decisions per se are complicated, and are made more complex by the complexity of the financial markets. We have to take that into account because we need to find ways, first of all, to simplify information. And we need to find a way for people to be able to [access] good sources of information. Time is definitely important. That is why we need to find a way to provide information when it is needed. We need to use the times when people are making decisions, for example, as teachable moments to simplify those decisions and provide information.
An example is when people are filing taxes or when people are first hired [at new jobs]. We have shifted onto the individual the responsibility to make financial decisions. But it is very important to understand that these are difficult decisions and to find ways to provide helping tools. One tool is financial literacy…. We need to make improvements and equip people with the tools that are necessary for making good financial decisions.
Greene: I think part of the answer also has to be starting young. We need to get this into our schools. Students are getting credit card offers before they are old enough to drive or vote. We must make sure that they have the knowledge that they need to protect their financial futures and make good decisions from a very young age.
Knowledge at Wharton: Just following up on that, Michelle, we did a recent podcast with Linda Katz, founder of the Children’s Literacy Initiative. She described the U.S. education system as “dire” in that it leaves an increasing number of children without adequate reading and writing skills. You are addressing a different, but not unrelated, problem, which is about adding financial literacy to high school curricula because it is at that point that people need to start learning about interest rates and mortgages — including why you shouldn’t take out a mortgage that you can’t afford. But how can you introduce financial literacy into high schools when the teachers themselves often don’t know enough about this topic to pass on the knowledge to their students?
Greene: I would say that you have to start younger than high school. Some of the very basic concepts [are] about needs versus wants — about deferred gratification, about [learning] that saving for later can help you get something more later. I think you really need to start building on those concepts much earlier than high school. High school is a time when you can start getting into some of the topics that you mentioned, which people will need as they enter their own adult lives and start taking responsibility for their own finances. The teacher issue is a huge one, and I think teacher training has to be a part of the solution. Ideally, in the long term, it would be terrific if we could get more of this training into teachers colleges so that teachers feel more comfortable [with the subject] and can [teach it to their students].
Lusardi: I also want to say one of the other reasons why it is so important to have financial education in schools is because we need to educate people before they make financial decisions — not after. I also think it is about equality of opportunity. In our work, we found that the very small group of students who can be deemed financially literate are disproportionately white male students from college educated families. But not everybody comes from a family that can teach financial literacy to them and not everybody comes from a family where they can get the right lesson. It is very important that everybody have access to financial education; otherwise people are already starting … on an unequal footing. In this current society, if we don’t give everybody this tool, we are going to create inequality right from the beginning.
Knowledge at Wharton: Is it true that women and girls are more ignorant, less financially literate than men and boys?
Lusardi: It is so true. This is, to me, one of the topics that makes me very passionate about this field. We have found wide gender differences in financial literacy in every survey we have looked at. It is not only [with regards to] older women; it also [applies] to younger, modern women, and it is not just in the U.S.; I have seen it in every survey across the world. So there is a true gender difference. Women seem to know less than men, [which is] problematic because we see that women have very different needs than men. There is certainly a strong need for them to be making important financial decisions. Also, we know that they are the ones taking care of children. They are the ones making financial decisions often for the [whole] family. So it is really important to provide women the tools for making good financial decisions.
Greene: Actually, to that point, one of the groups that I sit on as a treasury representative is The White House Council on Women and Girls. This is an interagency council with all of the agencies at the federal government. One of its areas of focus is economic empowerment and financial literacy for women and girls — for this very reason, because it is so critical.
Knowledge at Wharton: Is the level of financial illiteracy the same in the U.S. as it is in other developed countries? Or are Americans more literate or less literate than their counterparts?
Lusardi: It depends what you are looking at, whether you are looking at, for example, level of numeracy or at a more sophisticated concept like, do people know about diversification? Do they know about the difference between stocks and bonds and so on? We have done several international comparisons and, I have to say, the sad news is that financial illiteracy is widespread in other countries as well. Often other countries fare even worse than the U.S. One of the reasons is that in the U.S., half of the population participates in the stock market. So maybe some of the family has acquired some experience in these concepts via participation in the stock market and perhaps via defined contribution pension plans. In other countries, the family does not participate as much in the financial market and so, consequently, their knowledge of the more sophisticated concepts is lacking. That is why in other countries — not just in developed ones — there have been many initiatives to promote financial literacy. Even the developing countries are really focusing now on financial literacy programs.
Knowledge at Wharton: There have been attempts recently to better inform people about financial literacy, including teaching them how to manage their 401(k)s. This doesn’t seem to work particularly well. So I am wondering how your Center and these efforts that you are undertaking are different, and why you think they will succeed when a lot of other efforts haven’t made much progress?
Lusardi: What we are really about is evaluating programs in addition to designing programs. We think it is very important to know what works and to devote resources to [that]. Because we are now shifting the responsibility [for managing money] on to people [themselves], I don’t think it is a question of, ‘Should we do or not do financial education?’ but rather, ‘Which effective financial education program can we do?’ That’s why it is so important to [conduct] academic research on this topic and evaluate the programs that exist because we need to be able to devote resources efficiently.
But I also think that one way to be effective is to first listen to the needs and the desires of the population. So the approach has to be from the bottom up and has to start with listening to the concerns and the needs of people. That’s why in our Center we have taken a multi-disciplinary approach. We work with psychologists, marketing [people] and sociologists, and also do a lot of empirical work … both quantitative and qualitative, which includes focus groups. Our job is to listen to people. If we are listening effectively, we might be able to design an effective program. But to understand whether these programs are effective or not, we need to do rigorous evaluation.
Greene: I think that point is well taken. In the government, we are absolutely focused on basing our policies on research [into] what works and making sure that what we are doing is effective. Related to your point, there is increasing disclosure and information. People [must] have clear, straightforward information with which to make their decisions. For example, there is the Schumer box [summarizing the costs of a credit card] on your new credit card bill, which shows what happens if you only pay the minimum, how long it takes to pay it off, how much you have to pay if you want to pay it off more quickly. I think information like that can be very useful in helping consumers make better choices.
Knowledge at Wharton: Before we end, I would just like to say to anyone listening: Annamaria, I love your blog. It is very informative and very humorous. I will put a link in this podcast so other people can enjoy it as well. Thank you both for coming.