Financial literacy should be a lifelong education because economic factors change over time, including the amount needed for retirement, says Wharton’s Olivia S. Mitchell. This episode is part of a series on “Financial Literacy.”


What Is Financial Literacy and Where Is It Now?

Dan Loney: Olivia Mitchell is professor of business economics and public policy as well as insurance and risk management here at the Wharton School. She’s also director of the Pension Research Council.

Olivia, you and I have talked about financial literacy for many years now, and the concept is one that a lot of people maybe don’t truly understand. From your perspective, what encompasses financial literacy?

Olivia S. Mitchell: Financial literacy is really a broad concept. But in particular, what we’ve been focused on is people’s ability to process economic information and to make informed decisions about things like saving, investment, and spending during retirement.

Loney: There has been a gap in financial literacy for many years now. With all the attention now that is starting to come forward, with the research that you and others have done, is it getting better?

Mitchell: I wish we could say things are getting better, and they may be a little bit at the margin. But we’ve been doing a number of studies of financial literacy across not only the U.S., but around the world, and there are still grave shortcomings in what people know and what people are able to do. I think there’s still much work to be done, as much as I hate to say it.

Loney: How important is research as a driver to open more doors around financial literacy?

Mitchell: I think the place to start is actually going back 20 years when a colleague of mine, Annamaria Lusardi, and I decided on a whim over dinner to discuss the possibility of surveying older people — people in their 50s and 60s — to find out how financially literate they were, and what impact that might have had on their saving, on their investment, and their retirement outcomes. To our shock and dismay, we found that people were sorely under informed. That one thing led to another, and now we’ve been doing financial literacy studies in over 80 countries, focusing on the young, the middle aged, retirees. There’s definitely much more that needs to be done for each of those groups.

Early Education in Financial Literacy

Loney: One of the areas we need to focus on is children and being able to incorporate financial literacy in their lives so that they are best prepared when they get through high school or college and get out to work. That seems to be one of the biggest challenges, although there are some states trying to do that right now.

Mitchell: In fact, around 21 states, and Pennsylvania is the most recent, have mandated that high schools provide financial education as a mandatory course. I think that’s very much to the good. Of course there’s still details, and the devil’s always in those details, about who’s teaching the class. Is that person capable and understanding of the subject? What kinds of topics will the high school kids be interested in? Because while they might not be interested right away in retirement planning, they probably need to know about credit cards, student loans, and all the other topics that they’re going to confront right away on leaving high school.

Loney: Many years ago, it used to be understanding a checking account and writing a check. Now, in this age of digital, we have so much at our fingertips through our smartphones and various apps.

Mitchell: And a lot of young folks make many bad mistakes. There was a case recently of one app, which had gamified investment in the stock market, and it also made it possible for people to borrow on margin. These are kids. A young man had accumulated $100,000 in debt and committed suicide as a result. You cannot only make big financial mistakes, you can make big personal, lifetime mistakes unless you’re better informed these days than we were back in our youth.

Loney: What are the greatest benefits to having that type of a framework in place when you think about individuals longer term?

Mitchell: The key issue with financial literacy is that it’s an ongoing process. I myself started the so-called Bank of Mom when my children were little. The Bank of Mom was nothing more than a spreadsheet, and they would get 25 cents allowance. If they wanted more money, they would have to do chores. We’d add up the positive side, and we’d add up how much they had to spend, and if they didn’t have enough, they couldn’t spend it.

This was a way to start edifying kids from a younger age about budgets. Later on, when it comes to high school, as I said, credit cards become paramount. My younger daughter, when she came to Wharton, was sent 20 credit cards in the first month and immediately got into financial trouble. We had to have a little session, cutting up the cards, and explaining interest, and so on. She’s done better since then, I’m happy to add.

Subsequently, when people get into the workforce, they’re making a number of choices like, what should I put into my 401(k), what should I invest the money in? Again, there’s multiple teachable moments.

Loney: The potential positive impact can be over a lifetime.

Mitchell: Absolutely right. The reality is that we see the young people that have been educated in financial literacy, they incur less debt, they save more, they plan more for retirement, they understand better what the options are for investment. Now what we’re seeing is people, when they hit retirement age, are doing a better job making sure they don’t run out of money in old age.

Loney: In your research, you’ve talked about financial literacy being an investment in human capital. Explain that a little bit.

Mitchell: We see financial literacy much like other kinds of education. It takes time to learn financial concepts and to apply them, and sometimes it takes money so that you can hire someone or take a course or what have you. These are the two components that are involved in investing in that college. Moreover, that knowledge can depreciate if you don’t use it over time. There are always new financial products on the market, adjustable-rate mortgages, and so forth, so that the knowledge base needs to be continually built throughout life.

It is definitely an educational process. Many employers are now offering financial literacy training at the workplace. Why? Because they understand that their workers are suffering financial stress due to debt. The debt folks are calling them up at work and hassling them for not paying their credit cards or what have you. This is something that really is in everybody’s best interest, to have a more productive and better-informed workforce.

Loney: There are probably many instances of missed opportunities. You were mentioning before about retirement savings, but maybe some people don’t have a secure retirement because they don’t have the understanding.

Mitchell: Indeed, most employers that have 401(k) plans or their equivalent in the nonprofit sector will pick what they call a default savings rate. That is, if the worker has no clue what to do, then the company will say, “All right, we’re going to have a default savings rate of 5% of your income.” The reality in this day and age is 5% is probably not enough. It probably ought to be at least three times that.

It’s nice to have some guided advice from the employer, but if that savings target is too low, then the employee needs to have additional information to be able to say, “I might want to save a little more if I can, when I can. I might want to save enough to get the full match rate from the employer.” When I negotiated with my kids. I told them they had to save 25% of their paychecks when they started working, and we settled on 18%, which I felt was a huge success.

Loney: When you’re talking about kids, what they can potentially save in their early time out in the workforce, when they don’t have a husband or a wife or a significant other, when they don’t have children — that’s the time to really get things started so that you can have that great base as you move forward.

Mitchell: It’s particularly a challenge now that 50 million Americans have student loans. Many of them, in fact, are continuing to have to repay those loans through retirement. A total of 6% of Social Security recipients are still having their Social Security checks garnished for student loans. If you can set people’s feet on the right path early on, don’t get them involved in pay day loans, or only paying the minimum on the credit card, or buy now, pay later is a very popular phenomenon. All those things reflect a misunderstanding of financial literacy, about the consequence of not saving enough and living within your means.

Long-term Benefits of Financial Literacy and Why It’s Important

Loney: You’ve also done some research looking at the difference that having financial literacy education can have long term.

Mitchell: Absolutely. For example, if you don’t understand interest rates, and heaven knows that’s been in the news a lot lately, they won’t refinance their loans when interest rates go down, or they pay too much for borrowing, or they fail to insure themselves against living a very long time. If you’re going to retire at 60 and live to 100, and mark my words, a lot of us will, that’s a whole long time to try to live on your savings if you haven’t concentrated on it properly early in life.

Loney: Is this something that plays out in many countries around the world as well?

Mitchell: Absolutely. To date, about 80 countries have now set up national programs around financial literacy. Finland is interesting. Finland has launched a new national strategy for becoming the country with the highest financial literacy in the world by 2030. I wish we in this country would follow that shining example. But we are seeing progress, especially at the state level, and many employers are doing their part now to help people do a better job saving for retirement, investing, and by the way, not taking out their entire nest egg when they hit retirement, but rather helping retirees eke out their money over their lifetimes.

Loney: What do you think are the most important components that either young adults or parents trying to help their children need to think about with financial literacy?

Mitchell: I don’t know how it was in your family. In my family, finances were not discussed publicly. People’s incomes were always very private, and folks didn’t really talk about things like how much the rent was. I think there’s more we can do to be more transparent. For example, helping kids set budgets so that they understand how much something costs and how much work it takes to save, to be able to pay those costs.

I worked through high school. I worked in college. Increasingly, the work experience is something that a lot of kids don’t have. And parents understandably protect their kids from working too much, or not getting their schoolwork done. But I find that just living in the work world early on is a really good way to start explaining and understanding how costly it is to live, how careful one has to be, and ultimately, the value of saving.