What is financial literacy? Why do I need to have it—is it important? The discussion of financial literacy represents the construct by which any discussion around money takes place. So that in itself makes it pretty important and necessary to acquire. But what is it? If you search for the term, you get the following: the ability to understand how money works in the world: how someone manages to earn or make it, how that person manages it, how he/she invests it (turn it into more) and how that person donates it to help others.
A lot of what I do on a daily basis allows me to traverse in and out of this subject. One thing that interests me are all the different expressions or reactions to financial literacy that individuals have. These expressions are the subject of this writing and I’d like to make the argument that the better-versed you are in understanding your own expressions as they relate to financial literacy, the better off you will be financially. Here's why. (For related reading, see: Investing: How to Focus on Your Control.)
What’s Our Baseline?
This financial literacy quiz provides our baseline. I’m only referencing it because in order to find a solution, there first has to be an acknowledged problem. Many studies have shown that Americans are not that financially literate. Sadder still, this is prevalent across the globe. Most Americans would be considered below average. This is a quote from the study: "Only 44.3% of those with college degrees answered all three questions correctly, compared with 12.6% for those with less than a high school degree, 19.2% of those with only a high school degree and 31.3% for those with some college."
This provides context for the problem. I will admit that 63.8% of survey respondents got all three questions right, but then again they all had post graduate degrees. As a financial professional, I can tell you that a post graduate degree is not necessary to be financially literate.
Is This Really a Problem?
Here is why I think this is such a big problem. Prior to the 1970s, a lot of retirement programs were designed to pay a benefit to retirees until their death. However, more recently, retirement programs have been steadily changing to defined contribution plans instead of defined benefit plans. The retirement payouts from these plans are not based on a promise, but on the contributions made by the retiree and the investment choices made by the retiree. This change has huge implications, because now the individual is forced to make choices about investments that he or she may not be qualified to make in order to create income in retirement. (For related reading, see: Don't But What You Don't Understand.)
As companies shift this responsibility to individuals, the performance of the investments becomes more important. Naturally, this phenomenon has given rise to the financial services industry as a way for individuals to shift some (or all) of this newfound responsibility to professionals. Essentially, this is why being financially illiterate is not an option any longer. Even now it has become important to either hire a financial professional or know enough to do it yourself. At a minimum, you need to be financially literate enough to have a thoughtful discussion with an advisor, because ultimately it will impact the transfer of wealth for an entire generation.
A Long-Term Solution to the Problem
The solution is knowledge. However, to make real progress on teaching a generation how to handle money, it must start early. The obvious conduit is school and it would likely be the most efficient. One consideration would be the development of some type of program to supplement what is already being taught on financial literacy. As an educator, my wife spends a considerable amount of time teaching the state-mandated curriculum, but more time on the subject of money and personal finance is needed to change those survey results. For older adults, the challenge will be learning enough to reach a status of financial literacy that will allow them to provide for their future self. (For related reading, see: Behavioral Finance: How Bias Can Hurt Investing.)