This is an extract of an article which first appeared on the front page of the Personal Finance section of The Wall Street Journal on March 19, 2017. Read the full online version by clicking here.
Think about driving. To ensure orderly traffic, we create speed limits and roadway rules. We erect signs to warn where turns are difficult or roads are treacherous. And before we allow someone behind the wheel, we make sure they understand the basics. That’s where a driver’s license comes in. We take those precautions to protect the drivers and to protect others.
It is time to extend that type of thinking to financial knowledge by making personal finance a required course at U.S. colleges and universities. For people—especially young people—to survive and thrive in today’s financial environment, knowledge of personal finance is a necessity.
We’re already seeing what happens when young adults juggle high-impact financial decisions without the benefit of financial knowledge. Take the well-known burden of student-loan debt. Student loans are the second-largest part of the consumer credit market, after mortgages. The lion’s share of that debt sits in the hands of millennials—and our research shows they worry about their ability to pay off those loans. As well they should. The default rate on student loans is sobering.
Multiple studies confirm that students have little understanding of how student loans work. Our analysis of the latest National Financial Capability Study, or NFCS, finds that more than half of millennials take on student loans without even attempting to calculate what their payments will be. Given that student loans are pursued to acquire an education, it seems only prudent to have that education include the knowledge needed to manage that debt.
But student debt is just one of the challenges. These young people will have to support long retirements on savings and investments managed throughout their careers. To accomplish that feat, they will depend on interest compounding—a basic concept that they don’t fully understand. They also struggle with two other critical concepts: risk diversification and inflation.
These are the ABCs of personal finance, the benchmarks by which we measure financial literacy. By age 40, when a majority of Americans have already made most of their important financial decisions, only 1 in 3 has mastered these concepts, according to the NFCS. Unless something changes, millennials will become part of that disturbing statistic.
Such courses must be well designed to be effective. There is mounting evidence that personal-finance courses with a rigorous curriculum and trained teachers are influencing behaviors of young people in matters such as debt and defaulting on debt. Teaching personal finance is not about describing financial products, it is about teaching the principles of financial decision-making so that people understand how financial instruments work. When people are knowledgeable, they also are better able to benefit from the services of financial advisers.
Those opposed to requiring personal-finance courses say that the main thing students should learn is skepticism about the financial industry and its products. Some skepticism is always warranted, and I teach my students about the potential conflicts of interest that financial advisers may have. But the purpose of a personal-finance course goes beyond those topics.
Financial literacy is about prevention. Regulators simply cannot keep up; they tend to come in when a problem already exists. This is why regulation is not enough.
The lack of financial literacy—just like the lack of a driver’s license—is more than a personal problem. It is dangerous for our country’s economic health. The Great Recession was driven by mortgages and loan terms consumers didn’t understand. The entire nation went into an economic tailspin as a result of that lack of understanding.
Looking ahead, will young people saddled with student loans be less likely to buy cars and homes? Will their ability to engage in transactions that require not just liquidity but good credit ratings be hampered? Will they veer away from starting their own businesses or pursuing advanced degrees? If they are not saving enough for retirement, will they have to be rescued from poverty in old age—and at what price to the country?
One of the basic lessons in personal finance is that time is money. But time is starting to run out. Young people are already behind the steering wheel of their financial decision-making. It’s time we step in to make sure they know how to navigate the highway ahead.