Friday, May 28, 2010

Improving Our Financial IQs: Why Managing Money Should Be a Lifetime Skill

At the Wharton conference that I described in my previous blog, I sat down with Michelle Greene for an interview with Knowledge@Wharton. The link to the interview is provided below, but in this blog I wanted to discuss a few topics that have come up many times in this and other discussions.

In case you do not know Michelle, she is the Deputy Assistant Secretary for Financial Education and Financial Access at the U.S. Treasury Department. The title may look long, and it is for a good reason: she heads the office at Treasury which is in charge of financial literacy and financial education. One of the issues that office has to deal with is that many Americans are unbanked or underbanked and do not participate in traditional financial markets, hence the attention to financial access in addition to financial literacy.

Many people have asked me why financial literacy is so low and why we appear to be getting worse in terms of financial knowledge. In my view, it is not the case that financial knowledge has worsened, rather that the world has changed. Individuals have been put in charge of decisions that were—in the past—the responsibility of employers or the government (such as determining how much to put aside for retirement and how to manage pension wealth). Individuals have to make these decisions while facing much more complex financial markets. For example, ETFs, REITS, and 403(b)s were not in vogue twenty years ago and yet, while the acronyms are not exactly appealing, they have become part of what an average worker has to deal with in their financial planning. In the past, a CFO with an MBA in finance was making decisions about how to allocate investments in order that the company be able to pay a pension to the firms' employees; now workers John and Jane Doe are in charge of making these decisions. This means that every single worker now has to spend time and effort in collecting information and searching for the best conditions.

Given these changes, it may be obvious why the office that Michelle Greene heads is so important: we need to equip people with the tools to make financial decisions and increase financial knowledge if we are asking them to be in charge of their financial well-being after retirement. But, it is not enough to put them in charge. These are difficult decisions—even for a CFO with adequate training—and we cannot expect the average worker to navigate the financial markets if he/she does not know the difference between a bond and a stock or what an annuity is.

As Michelle stated in the interview, if there is a silver lining to the financial crisis, it is that there is a renewed sense among people that they need to understand their own finances. They need to engage in better behaviors and think more about the future. The financial crisis has also taught us the cost of financial mistakes. While we have not yet witnessed what may happen if workers with defined contribution pensions accumulate too little for retirement or make bad decisions on how to draw down the money from their retirement accounts, we have seen that choosing the wrong mortgage can end with the sheriff at the door and the furniture for sale on the lawn.

Michelle also spoke of the importance of starting to learn and to save when young and the need for inserting financial education into our schools. In my view, this is critically important as people need to have a basis on which to build their financial knowledge. Schools cannot teach every concept that will be of importance for making financial decisions in the future. But they can make people appreciate the importance of financial knowledge and the need to build on it over time. I am often asked what we should teach in high school to improve financial knowledge and my short answer is that we should teach people to be curious and to be interested in financial literacy. We do not teach literature expecting students to write the next War and Peace but rather to appreciate a good book. Similarly, we should teach financial literacy so that students appreciate the need to be informed before making financial decisions.

I want to end by saying that I am extremely proud of the work that Michelle is doing. Her work can and is having an impact on the lives of people, on the decisions that John and Jane Doe have to face—decisions that are part of a very different system than the one encountered by previous generations. There is a lot at stake here, and I hope that people will realize that inside the gray and imposing Treasury building alongside the White House, there is an office devoted to improving financial literacy and financial access.


Sanjay Thacker, Mumbai, India said...

Annamaria, i am happy to hear of this initiative to create financial literacy. I have lived in USA, Canada and India, and do perceive that financial literacy is low in the average populace. People do not understand the various kinds of financial instruments, the risk profile of investments, the concept of consistent and longterm investing through SIPs, the concept of compounding returns over the longterm to build for retirement, etc. Also, people have extraordinarily high expectations of returns but very low expectations of losses when investing in markets! It is a very good cause you and Michelle at the Treasury Dept. are pursuing. Wish Godspeed to you both! Sanjay, Mumbai, India.

G.A. Jimenez said...

Dr. Lusardi,

Please let me begin by commending you for your efforts to promote financial education. Like you, I believe the lack of financial literacy among the vast majority of people is an issue that requires urgent attention. How many families in our society have lost homes and life savings due to ill-informed decisions? I also agree with your prescription that the financial education process should begin at an early age. Basic financial concepts such as tradeoffs, time-value of money, and opportunity cost provide a valuable analytical framework which can improve decision making and engender a healthy dose of skepticism. In my own advocacy, which I currently realize via my blog,, I attempt to present financial concepts in an accessible fashion by commenting on recent news items and encouraging readers to draw their own conclusions. Any feedback you may have would be greatly appreciated.


G.A. Jimenez

Robert A. Chambers said...

Educating the Youth: A Long Term Solution to the Financial Crisis

By Robert A. Chambers

In reference to the original post, I agree that society’s growth has shifted the responsibility of financial literacy from the intellectual elite to the general public. Economics and Finance were traditionally areas of study strictly for business majors or students who got stuck with an undesirable elective. Currently, those students are today’s “movers” of our grand capitalist system. The problem is, too many others are ignorant of the facts regarding personal financial prudence and stability.

My career experiences as a Client Financial Analyst for Citibank N.A., an educator for the New York City Department of Education, and an adjunct professor at Pace University have afforded me some unique experiences in the discipline of Finance Education. I have seen irresponsible financial behavior firsthand, and recognize that the necessary change starts in our schools.

As a CFA, I saw this ignorance manifest itself in some of my clients. I would often conduct various financial transactions for my clients as well as offer advice. For example, when a client contacted me to process an auto loan, I wanted to know if they were homeowners. If they were, I would then check to see how much equity they had available in their home, for two very important reasons. First, the interest rates on an equity loan are lower. Second, there is a tax benefit on home equity loan payments. Although this is legal and financially sound, only a small percentage of my clients--- specifically those that were financially literate--- would jump at the opportunity to get a cheaper rate and make a portion of their car payment a tax write-off.

Not only was I disappointed in my clients who insisted that I process an auto loan regardless of their equity, I was also disappointed in the attitudes of those clients, specifically those that were less educated and worked extremely hard to purchase their home. I encountered various rebuttals. “It is sacrilegious to use your home equity for anything other than an emergency!” “You are scamming me into losing my house!” “It is none of your business how much equity I have. Just process my application for an auto loan!”

Financial irresponsibility does not first appear in adulthood. As a middle school and university educator, I have seen the same behaviors in adolescents and young adults. Unless educated, the status quo is that it’s almost comical to be financially responsible unless you have accumulated debt from middle school through the college years.

This does not mean, however, that these groups are aggregate disasters, as there is at least a small percentage of parents/guardians that plant the seeds of economic awareness at a young age and, through hands-on activities, continue to guide their children. These activities include counting, shopping, banking and various other activities that parallel a “rite of passage”. They help to form the potential for kids to grow up to be financially literate and aware of our economic systems.

It is clear that children have the ability to learn to be financially prudent, though their parents might not show them the way.
Because of these experiences, I feel that we need to focus our efforts on setting a goal to define how we will educate our children. Then, we must then implement pilot programs that offer basic knowledge of how the US economy works. Finally, we must assess their effectiveness to make the programs even better.

Let’s not wait too late in life to teach a lifetime skill.