by Ruth Steinhardt
Business school professor Annamaria Lusardi, the Denit Trust Distinguished Scholar in Economics and Accountancy, is one of the foremost researchers in the field of financial literacy, and the academic director of GW’s Global Financial Literacy Excellence Center. Dr. Lusardi sat down with GW Magazine to discuss the state of financial literacy (it’s not good, people) and how Colonials can help.
What is “financial literacy?” Why use that term?
I like the phrase “financial literacy” because in today’s world an understanding of basic financial concepts is equivalent to the ability to read and write. During the industrial revolution, people increasingly needed to be literate in order to participate in society; in the modern economy people need to understand simple financial ideas. And fortunately people are beginning to recognize that it is a basic skill.
Broadly speaking, what does your research say about the current state of financial literacy in the United States?
The level of financial literacy is critically low, especially if we consider what is at stake. From age 17, when we decide whether to go to college, we start making big decisions. Then people have to make decisions about pensions, how much to save, and how to invest their retirement. We also have broad access to credit, so we can rack up huge debts.
But the research suggests that we don’t actually have the skills to make those decisions. Only a third of Americans can correctly answer our [three simplest] questions about the most basic concepts at the heart of financial decision-making. We are not asking if people know asset pricing or complex things like that. We don’t even ask people to do the calculations.
The first question is about interest: If you put $100 in a savings account with an interest rate of 2 percent per year, would you have more than $100 after five years? Less than $100? Exactly $100? Then we have a question about inflation, and finally a question about risk diversification. That’s why we say the knowledge is critically low, because these are three quite elementary questions.
Why aren’t people financially literate, and when and how should they be taught to be?
Financial literacy is not learned by osmosis; it’s not “general knowledge.” It’s a specific skill, and we need to start teaching it as early as possible. The way it’s done now, we have basically one semester-long course in high school—and not all states have even that much. I can’t think of any single subject that is learned in one semester at the end of high school. We don’t learn math or history or English this way, because that’s not how an important topic is learned.
We don’t teach literature so that you can write War and Peace. We teach it so that you can appreciate books. We want people to be financially literate not because we expect them to be Warren Buffett, but so that they can compute the complexity of the decisions they will have to make, ask for advice if they need to, and take proper action.
Are there groups that are made particularly vulnerable by a lack of financial literacy?
Actually, there are three. We see a lack of knowledge at both ends of the age spectrum: The young are vulnerable because they have no experience. But while the young know little and acknowledge they know little, the elderly also know little but they think they know the most. That makes them an ideal object for scams.
Interestingly, around the world we also find that women have been left behind as market economies develop. Across the countries where we have used our questions, they answer in the same way: they say that they do not know the answer. This is critically important, because we have a group that not only doesn’t know but it admits it doesn’t know. And I think that makes women an amazing group and an amazing target for financial education. Especially because in many households, it’s the woman who makes the domestic decisions—planning for a child’s education, taking care of aging parents. So teaching a woman to be financially literate will help her and help her take better care of her family.
What can GW alumni do to improve the state of financial literacy?
They can be proactive ambassadors for financial literacy. A GW alumnus could ask the school district where they live to add financial literacy in the curriculum. Or they could ask the business community of which they are part to support the training of the teachers in that district. We can break this cycle where the young are not equipped to live in society.
We can also educate adults. We can push for workplace financial education, and if not in the workplace, then in the places where people go to learn: libraries and museums.
It’s not just about personal finances. This stuff has implications for society, as we saw in the financial crisis. If a substantial number of people make mistakes, taxpayers will be asked to pay for that. So we need to be as informed as possible. And there’s nothing magical about it! There’s not even anything particularly difficult about it. The fact that we are making such a drama out of this topic has been to the detriment of everybody.