Many consumers have little understanding of finances, how credit works, and the potential hit to financial well-being that poor financial decisions can create for many, many years. In fact, a lack of financial understanding has been signaled as one of the main reasons many Americans struggle with saving and investing.

Every few years, the Financial Industry Regulatory Authority (FINRA) issues a five-question test as part of its National Financial Capability Study, which measures consumers’ knowledge about interest, compounding, inflation, diversification, and bond prices. On its most recent test, only 34% of those who took the test got four out of five questions correct, which suggests that the basic economic and financial principles that underpin these problems are widespread.

Some changes in consumer habits and financial products have made it harder for Americans to manage their finances. In the past, most people used cash for daily purchases. Today, credit cards are more frequently used. In 2019 credit use accounted for 23% of payments, up from 21% in 2017. The way we shop has also changed. Online shopping is now the top choice for many, which can make it easy to use and overextend credit, an all-too-convenient way to accumulate debt quickly.

Meanwhile, credit card companies, banks, and other financial institutions are inundating consumers with credit opportunities—the ability to apply for credit cards or pay off one card with another. Without the proper knowledge, it is easy to get into financial trouble.

Financial planning is long term, and people cannot depend on one-time windfalls such as the recent $1,400 stimulus checks sent due to the American Rescue Plan. Instead, individuals need to shore up their financial knowledge to manage their day-to-day financial lives while also taking a longer view for the future.

Key Takeaways


  • Trends in the United States show that financial literacy among individuals is declining, with only 34% of respondents correctly answering four out of five questions posed by FINRA on the topic.
  • Fnancial literacy is increasingly important as people manage their own retirement accounts, trade personal assets online, and carry student, medical, credit card, and mortgage debt.
  • The FINRA study also reveals some disparity in the ability of different ethnic groups to successfully manage their money.

What Is Financial Literacy?

Financial literacy is the confluence of financial, credit, and debt management knowledge that is necessary to make financially responsible decisions—choices that are integral to our everyday lives. Financial literacy includes understanding how a checking account works, what using a credit card really means, and how to avoid debt. In sum, financial literacy has a material impact on families as they try to balance their budget, buy a home, fund their children’s education, and ensure an income at retirement.

A lack of financial literacy affects people in developed or advanced economies, as well as those who live in emerging or developing countries. Consumers in advanced economies also fail to demonstrate a strong grasp of financial principles that can help them understand and negotiate the financial landscape, manage financial risks effectively, and avoid financial pitfalls. Nations globally, from Korea to Australia to Germany, are faced with populations that do not understand financial basics.

The level of financial literacy may vary with education and income levels, but evidence shows that highly educated consumers with high incomes can be just as ignorant about financial issues as less-educated, lower-income consumers (though, in general, the latter do tend to be less financially literate). And consumers perceive financial decision-making and education as difficult and anxiety-producing. People reported choosing the right investment for a retirement savings plan was more stressful than a visit to the dentist, according to the Organisation for Economic Co-operation and Development (OECD).

Trends Making Financial Literacy More Important

Compounding the problems associated with financial illiteracy, it appears that financial decision-making is also getting more onerous for consumers. Five trends are converging that demonstrate the importance of making thoughtful and informed decisions about finances.

1. Some groups may be falling behind

The FINRA study found that when it comes to financial literacy, the playing ground is far from level, with a persistent gap between haves and have-nots that may be widening, even amid the economic growth and strengthening employment of the past decade. The study also revealed disparities among different ethnic groups, with White and Asian adults showing more proficiency than Black and Hispanic survey respondents. White and Asian adults correctly answered 3.2 of six questions. Hispanic adults answered 2.6 of six questions correctly, and Black adults were able to answer 2.3 questions correctly.

This disparity shows up among younger people as well. White and Asian 15-year-olds had substantially higher financial literacy scores, on average, than the overall U.S. average of students in this cohort. Hispanic and Black students had substantially lower than average scores.

2. Consumers are shouldering more financial decisions

Retirement planning is an example of the increasing responsibility Americans must take for their own financial security. Past generations depended on company pension plans to fund the bulk of their retirement. These pension funds, managed by professionals, placed the financial burden on the companies or governments that sponsored them. Consumers were not involved with the decision-making, often did not even contribute to their own funds, and were rarely made aware of the funding status or investments held by the pension.

Today, pensions are more a rarity than the norm, especially for new workers. Instead, employees are being offered the ability to participate in 401(k) plans or 403(b) plans, in which they need to decide how much to contribute and how to invest the money.

Social Security was a major source of retirement income for past generations, but the amount paid by Social Security is no longer adequate for many people. What's more, the Social Security Board of Trustees reported that by 2034 the Social Security trust fund may be depleted. There are a variety of proposals for shoring up Social Security, but the uncertainty only increases the need for individuals to adequately save and plan for their retirement years.

3. Savings and investment options are more complex

Consumers are also being asked to choose among various investment and savings products. These products are more sophisticated than in the past, requiring consumers to select from different options that offer varying interest rates and maturities, decisions they are not adequately educated to make. The choices made from among complex financial instruments with a large range of options can impact a consumer’s ability to buy a home, finance an education, or save for retirement, adding to the decision-making pressure.

Then, too, the number of institutions offering products and services can be daunting. Banks, credit unions, insurance firms, credit card companies, brokerage firms, mortgage companies, financial planners, and other financial service companies are all vying for assets, creating confusion for the consumer.

4. Government assistance may be sporadic

The global COVID-19 pandemic has wreaked havoc on many Americans’ financial lives. Stimulus checks sent in 2020 to taxpayers were meant to boost spending and spur economic activity, and a third round of checks is being issued in March and April of 2021.

Of 12,000 U.S. households surveyed in 2020, just 15% of stimulus check recipients said they spent or planned to spend most of the payment, according to the National Bureau of Economic Research. Most respondents said they’d either save the money (33%) or use it to pay down debt (52%). 

Black respondents to the survey were far likelier to report using the stimulus payment to pay off debt, as were older individuals, people with mortgages, unemployed workers, and those reporting earnings lost because of COVID.

Longer lifespans mean we need more money for retirement than earlier generations did.

5. The financial environment is changing

The financial landscape is dynamic. Now a global marketplace, it has many more participants and many more influencing factors. The quickly changing environment created by technological advances, such as electronic trading, makes financial markets even swifter and more volatile. Taken together, these factors can cause conflicting views and difficulty in creating, implementing, and following a financial roadmap.

Why Financial Literacy Matters

Financial literacy is crucial to help consumers manage these factors and save enough to provide adequate income in retirement while avoiding high levels of debt that might result in bankruptcy, defaults, and foreclosures. Yet in its Report on the Economic Well-Being of U.S. Households in 2019, the Board of Governors of the Federal Reserve System found that many Americans are unprepared for retirement. One-fourth indicated that they have no retirement savings, and fewer than four in 10 of those not yet retired felt that their retirement savings are on track. Among those who have self-directed retirement savings, nearly 60% admitted to feeling low levels of confidence in making retirement decisions.

Low financial literacy has left millennials—the largest share of the American workforce—unprepared for a severe financial crisis, such as the coronavirus pandemic, according to research by the TIAA Institute. Even among those who report having high knowledge about personal finance, only 19% answered questions about fundamental financial concepts correctly. Forty-three percent report using expensive alternative financial services, such as payday loans and pawnshops. More than half lack an emergency fund to cover three months’ expenses, and 37% are financially fragile (defined as unable or unlikely to be able to come up with $2,000 within a month in the event of an emergency). Millennials also carry large amounts of student loan and mortgage debt—in fact, 44% say they have too much debt.

While these may seem like individual problems, they have a broader effect on the entire population than previously believed. All one needs to do is look at the financial crisis of 2008 to see the financial impact on the entire economy that arose from a lack of understanding of mortgage products (and therefore a vulnerability to predatory lending). Financial literacy is an issue with broad implications for economic health, and an improvement can help lead the way to a global economy that is competitive and strong.

The Bottom Line

Any improvement in financial literacy will have a profound impact on consumers and their ability to provide for their future. Recent trends are making it all the more imperative that consumers understand basic finances because they are being asked to shoulder more of the burden of investment decisions in their retirement accounts, all while having to decipher more-complex financial products and options. Becoming financially literate is not easy, but once mastered, it can ease life’s burdens tremendously.