The case for improving financial literacy

The mixed evidence on the effectiveness of financial education programs has led some to question whether it is worth trying to improve financial literacy. In fact, it is not clear there is even a choice. As it was impossible to live and operate efficiently in the past without being literate, i.e., knowing how to read and write, so it is very hard to live and operate efficiently today without being financially literate. Given the complexity of current financial instruments and the financial decisions required in everyday life, from comparing credit card offerings, to choosing methods of payments, to deciding how much to save, where to invest, and how to get the best loan, individuals need to know how to read and write financially.

Note that, as with reading and writing, the objective of a policy for financial literacy should be basic knowledge. While it may not be feasible to transform financially illiterate people into sophisticated investors, it may be possible to teach them a few principles about the basics of saving and investing. Moreover, as illiteracy was not eradicated with a handful of lessons or in a matter of months, so financially illiteracy cannot be eradicated with a few seminars or one benefit fair.

Set in this framework, it is clear that some standards for financial literacy are needed. What do people need to know? What should be the pillars of financial literacy programs? Setting these standards will be the backbone of devising financial education programs. There are obvious benefits of having one institution that presides over or establishes those standards, and the Treasury Department seems an obvious candidate for this role.

Technology makes it possible to use interactive methods to teach. Thus, “students of financial literacy” do not necessarily have to attend classes at school, but can learn from courses on-line (or from CDs or DVDs) from their home. Courses can also be customized and tailored to the different needs and levels of financial knowledge. Moreover, as the evidence on the effectiveness of the stock market game in high schools seems to suggest, it may be important to find ways to make courses engaging and to stimulate interest in acquiring financial literacy.

Baby Boomer Retirement Security: The Importance of Financial Literacy

They say that pyramids are a bad thing, but I like this one. Today, it was announced that my paper with Olivia Mitchell, "Baby Boomer retirement security: The roles of planning, financial literacy, and housing wealth," was awarded the Fidelity Research Institute Pyramid Prize for academic work on improving lifelong financial well-being.

Here's an overview of the paper:

With the first wave of 76 million Baby Boomers on the cusp of retirement, the authors sought to understand how financially prepared this large and influential cohort is for the next phase of their lives. Using the Health and Retirement Study for their analysis1, Lusardi and Mitchell explore the links between financial literacy, planning and retirement savings adequacy. They conclude that individuals who plan for retirement (planners) arrive close to retirement with much higher wealth levels and display higher financial literacy than non-planners. Their analysis shows that planning can actually jump-start the retirement savings process and that even a small amount of planning can go a long way towards boosting wealth holdings. Their estimates suggest that those who plan accumulate nearly 20% more in net worth versus those who don't plan for retirement.

Lusardi and Mitchell further conclude that from a policy standpoint, for financial literacy initiatives to be effective in complimenting legislation like the Pension Protection Act of 2006 which was intended to enhance overall retirement savings, that a one-size-fits-all approach is unlikely to do much to build retirement wealth. They contend that instead, targeted efforts will be needed and will be most useful if focused to particular subgroups in the economy that are most at risk of not preparing adequately for their retirement.

For the great majority of working Americans, their biggest and most complex financial goal will be preparing for retirement and this comprehensive research helps to advance our understanding of the connection from financial literacy to planning activity and from planning activity to wealth accumulation. These findings highlight the need to develop and integrate creative approaches to improving financial literacy for Americans to complement the development of other innovative initiatives such as auto enrollment, auto increases, and appropriate default investment options to improve the financial security of current and future retirees.

And here's a link to the paper.