Americans confront a wide array of products in today’s financial marketplace. There are credit and debit cards, bank and brokerage products, saving and investment options, insurance policies and pension plans, not to mention IRAs and 401(k)s. Choosing the right options and managing them well requires economic savvy. Yet a great many Americans — especially those over 50 —know precious little about money matters, according to research about financial illiteracy
that my colleagues and I have conducted.
This financial illiteracy has serious consequences. It affects how well Americans save and plan for their retirement, and how they fare after they retire.
Grade of C for Financial Knowledge
A landmark study about money, interest rates and personal finance in 2005 sought to determine, among other things, an average financial literacy grade for American adults. It gave them a C. White adults scored higher than their black and Hispanic peers, and women tested lower than men.
More recently, in a 2011 study of people over 50
who are not yet retired, only half of those surveyed could correctly answer two simple questions about compound interest and inflation. Only one-third of the respondents gave correct answers to both of those questions and a third question about risk diversification.
Moreover, and rather worryingly, people tend to be much more confident in their financial acumen than their knowledge warrants.
Men Suffer Most From Overconfidence
Although surveys have shown that men are more likely than women to know the financial facts of life, they are often overconfident: Men tend to say they are "very confident" about their answers even when those answers are incorrect. By contrast, women are more likely to indicate that they don’t know an answer, which suggests that they may be more teachable.
Additional research has shown that widespread financial illiteracy isn't a benign affliction: It causes people to make grave mistakes, often in more than one area of their finances.
For instance, people who don’t understand interest are more likely to end up with excessive amounts of debt and to pay more in mortgage interest than necessary. They're also more likely to overspend — and less likely to pay credit card bills in full and accumulate adequate money for retirement.
Financial illiteracy helps explain why so many Americans have high levels of debt and little or no retirement savings.
The Cost to the Country
The problem is especially acute in a weak economy, with families losing their homes and livelihoods. Moreover, when people make poor financial decisions, the costs are often passed on to others, as it means higher spending by the government. For this reason, financial illiteracy is a broad social problem that harms not only vulnerable individuals, but every rung of the workforce.
This means investing in financial literacy can have a high payoff.
In our research, we compared the financial savvy and saving paths of two groups — adults who attended high school in the handful of states that mandated financial education classes and those who didn’t. What we found was promising: Exposure to these classes improved the students’ subsequent financial knowledge and ability to make financial plans, particularly in states that devoted above-average financing to their schools.
Growing numbers of companies now offer their employees seminars that explain the importance of saving for retirement. That’s helpful, though it’s difficult to measure the impact of such seminars, since the workers who attend them may already be among the better savers.
In the end, financial illiteracy isn't a simple problem to address, nor will there be a one-size-fits-all solution. But such efforts as offering financial-education classes to adults at local colleges and workplace seminars on retirement planning are clearly worthwhile. Not only will they help protect the country from future financial catastrophes, but they will also help the most vulnerable among us: low-paid workers, the least educated, women and the poor.
The research reported in this article was supported in part by grants from the Social Security Administration, financed by the Michigan Retirement Research Center and the Financial Literacy Center. Support was also received from the Pension Research Council and Boettner Center for Pensions and Retirement Research at the Wharton School. The findings and conclusions presented here are solely those of the author and do not represent the views of the Michigan Retirement Research Center or Financial Literacy Center, any agency of the federal government or the Wharton School.