Improving Financial Literacy Is a Work in Progress
Nearly half of the residents of the U.S. don't understand finance. Why is this and what can we do to improve financial literacy?
The results are out. The Canadians are more financially literate than we are. And we are slightly better than Botswana. Standard & Poor’s Ratings Services’ global financial literacy survey is the first major global financial literacy study with results for over 140 countries.
The survey consisted of five questions measuring four key indicators of financial literacy: interest rates; interest compounding; inflation; and diversification. Whether these questions really absolutely measure one’s money knowledge can be debated. But to be considered financially literate, a respondent had to answer three of five correctly.
Nearly half of the residents of the U.S. are financially illiterate.
The survey has a lot of information of interest to researchers, policymakers, and financial practitioners, but here are five key takeaways relevant to those of us who are participants in the financial system:
1. Only one in three people in the world is financially literate.
Wow! And this is not a complex test of higher-level financial understanding. This is a test of very basic financial principles that affect our everyday lives.
Things like how compounding interest adds up and how inflation reduces purchasing power by making things more expensive. And you only needed to get 60 percent to pass!
In the United States, only 57% of the respondents received a passing grade. (We edged Botswana by a couple of points but came in significantly behind Canada.) Nearly half of the residents of the U.S. are financially illiterate.
2. People understand the effects of inflation better than they understand interest, compounding or diversification.
This is especially true in areas of the world where there have been recent bouts of high inflation. Experience is a great teacher. The least understood financial concept was diversification, which — in its simplest form — is really about reducing risk by not putting all your eggs in one basket.
3. Women are less financially literate than men.
But they are also more likely to admit when they don’t know. Men guess, women confess, as they say. Women trail men by about five percentage points, with 35 percent of the world’s men being financially literate compared with 30 percent of its women. The difference holds across the spectrum of ages, education levels, and incomes. For example, while wealthy people scored better than poorer people did, wealthy men still outscored wealthy women and poor men still outscored poor women.
4. Financial literacy works two ways.
There seems to be a bi-directional factor to financial behavior. Those with higher financial literacy make more use of the financial system, and those who use the financial system become more financially literate.
Much like just reading cookbooks does not make you a great cook without a lot of work in the kitchen, financial skill requires practice. Those who use banks and credit cards become more financially literate than those who do not. There is an experiential component to financial literacy: You learn by doing — by engaging in and using the financial system.
5. Some positive news for millennials.
Worldwide, the highest average financial literacy scores belong to the under-35 age group. In major advanced economies, the under-35 group comes in second behind the 36-to-50 group. But even in the major advanced economies millennials performed better than the 51-to-65 and the over-65 age groups.
And math matters! Those who perform well in math tend to be more financially literate than those who perform less well. Not advanced calculus kinds of math, but just basic numeracy — being able to calculate percentages and other routine math tasks. As the young become more financially literate, it will change the world!
The global financial literacy survey is based on good, sound methodology, and is a major advance in the world’s understanding of the present state of financial literacy. Policymakers and others need to address major gaps — especially when one sees how women, the poor, and the less educated are at higher risk of being financially illiterate.
But there is good news here as well: Financial literacy is a skill, and it is learnable. You can engage in the financial system, embrace the learning and growth, and take charge of your financial future.