Friends, Family and Finances

In this post, I want to talk about how people become financially literate and from whom they learn about finances. In many of the surveys I have reviewed, including the ones I have designed, people report that they rely on family and friends for financial advice. In focus groups as well, people state that they learn from their family and friends. This is an important finding. I believe that people rely so much on friends and family because they want advice from people they trust and who have their best interests at heart. There are, however, limitations and drawbacks to relying solely on friends and family for financial advice.

One limitation of learning from our friends is that we tend to choose friends who are like us. So, if you are an artist, you are likely to be surrounded by people who know how to draw but do not necessarily know how to invest retirement savings. Furthermore, many financial matters are private. You may assume that your friend John is financially savvy, but you have probably not seen his 401(k) statement, and it is hard to tell from his house or car whether he is good at picking mutual funds. Nevertheless, he may be happy to offer you tons of financial advice.

Like friends, family members, parents in particular, are a popular source of financial advice, and many have argued that financial education does start at home. There are, nevertheless, drawbacks to advice from this source. First, not everybody has parents who are financially literate. Approximately half of the families in the United States do not invest in the stock market (at least when considering investment of private wealth). Thus, for many, it is not possible to learn about the stock market from parents. Second, parents—particularly older ones—lived in a very different economic environment than the one the current generation of working Americans are facing. Most parents of today’s young and middle aged adults had pensions that were defined benefit plans, experienced inflationary periods that decreased the burden of their debt, and hardly invested in the “global economy.” Financial markets have changed substantially from the time this generation of parents bought their homes, got their pensions, and invested their savings.

I do not mean to imply that we cannot learn from family and friends. One valuable lesson can be to avoid the mistakes that those around us have made, such as not preparing adequately for retirement, not having enough insurance, or having too much debt—mistakes that are proven to be all too common among many Americans today. But relying on such advice seems to me often too little and sometimes too late.

In my view, financial education belongs in schools. Finance and economics are sciences and should be taught as such. Moreover, people need to be financially literate before they engage in financial contracts and not after having learned how much financial mistakes can hurt. Finally, having financial education in schools offers a better chance that students whose parents do not work on Wall Street will be able to access financial knowledge.

There is an additional benefit: if everyone learns about finance in school, we can then talk to our friends about art, about history, about something other than our finances. One of the great benefits of obtaining financial savvy and know-how is that we are then able to devote ourselves to what really matters to us, without the distraction of financial worries.

The National Financial Literacy Challenge

From November 3 until November 26, 2008, high school students can participate in the National Financial Literacy Challenge. This online 35-question test measures financial knowledge and serves to document the state of financial literacy among participating high school students. Please help me spread the word about this test and encourage the school in your district to register to participate.

It is important that we measure financial literacy among high school students. These young people soon will or already are confronting financial decisions, such as taking out student loans to pay for college, managing credit cards, and saving or spending income from summer employment and allowances. Are young people well equipped to make these decisions? We do not know, and we need to find out! Several states have mandated financial education in high schools and there is a lot of discussion about whether financial literacy should be integrated into high school curricula. I particularly encourage the schools where financial literacy has been mandated or where courses on financial literacy are offered to participate in this test. All tests are imperfect to some degree, but we need some measurement of how much our students know and how well we are doing at teaching financial literacy.

And there are rewards for participating in this test (can you tell that economists devised it?). Students scoring in the top 25th percentile nationwide will earn a certificate of recognition from the U.S. Department of the Treasury. Students scoring exceptionally high will win a National Financial Literacy Challenge Award medal (hey, this would look good on a resumé). And there are monetary rewards too. The Charles Schwab Foundation will award a scholarship of $1,000 to up to 100 students who get a perfect score of 100%. In addition, the Foundation will award $1,000 to each of those students’ schools.

For more information or to register, please follow the link below:
http://flc.treas.gov/index.htm

Just to make you smile, I am including here a test that is part of the newspaper advertising copy for this challenge.

A bond is:
(a) a British spy
(b) glue
(c) a type of loan that pays interest