Cleveland Fed Hosts Research Seminar on Financial Education
Financial literacy levels are alarmingly low across many segments of the U.S. population, with knowledge deficits evident in groups ranging from individuals with little formal education to high school seniors and teachers.
That was the assessment of some of the nation’s leading scholars on financial literacy who gathered April 25 at the 2008 Research Seminar on Financial Education, hosted by the Federal Reserve Bank of Cleveland at its Cincinnati branch. In all, the event provided an eye-opening perspective on Americans' financial savvy and on the effectiveness of financial education programs in general.
Despite the relatively grim view of the nation’s financial literacy, a growing body of research suggests some potentially powerful new methods for addressing the problem, the scholars agreed.
One of the more innovative approaches was advocated by Annamaria Lusardi, an economist at Dartmouth College whose papers on saving behavior are among the world’s most widely cited. “In many other ways, people rely on the advice of experts. We have the food pyramid to give people advice on what is good to eat,” Lusardi said, in describing conclusions from her recent paper, Household Saving Behavior: The Role of Financial Literacy, Information, and Financial Education Programs. “It’s not obvious to me why we don’t have a “saving pyramid” to explain to people that compound interest is good for you.”
The day opened with a sobering presentation on the financial sophistication and learning curve of high school students. Lewis Mandell, a professor of finance and managerial economics at the University of Buffalo, summarized results from the Jump$tart Coalition for Personal Financial Literacy project, which has been conducting national surveys of high school seniors since 1997. In 2008, the average financial literacy test score was 48.7 percent – which is down from 57 percent in the survey’s inaugural year.
To be fair, some of the questions asked of high school seniors were not terrifically easy. Consider the following question: “Which of the following types of investments would best protect the purchasing power of a family’s savings in the event of a sudden increase in inflation?"
A 10-year bond issued by a corporation.
A certificate of deposit at a bank.
A twenty-five year corporate bond, and
A house financed with a fixed-rate mortgage.
Number 4 is the correct answer. This year, 35.8 percent of students answered correctly. However, the correct response rate was down from 44.6 percent in 2006. According to Mandell, this may have been in part due to the perception that in the current economic environment, a home purchase is no longer a sound hedge against inflation.
The finding that students who completed a semester-long course in financial management scored no better than those who didn’t worried Mandell. But he concluded with some potentially useful insights – that students who participated in stock market games, for example, scored higher. As moderator George Vredeveld, director of the Economics Center for Education & Research at the University of Cincinnati, noted, it seems that programs that engage and motivate students have a positive effect on learning.
For future efforts, the most promising approaches may involve reaching even younger students, as well as specific, targeted programs for older adults. As prospective homebuyers apply for a mortgage, for example, programs that instruct them about different loan products may be more effective because the buyers’ motivation to pay attention is high. “Maybe we need to start education earlier to instill certain behaviors,” Mandell said. “And maybe we need education much later for adults, conceivably at the point of sale.”
Other presentations included:
- Cazilia Loibl, an assistant professor with the department of consumer sciences at Ohio State University. Loibl studied personal finance instructors in Ohio, assessing teacher confidence in their academic content, information acquisition, and subject-matter knowledge. Her findings point to the need for tailored teacher-training and spreading personal finance instruction across several academic content areas.
- Urvi Neelakantan, an assistant professor in the Department of Agricultural and Consumer Economics, looked at the extent to which theory can be useful in explaining people’s financial decision-making habits. While financial planners may push low-income households to reduce debt and save more, what’s economically “optimal” for such households based on their lifetime expected incomes may be quite different. “If financial education programs ignore what theory suggests, they may fail simply because they have set infeasible goals,” Nellakantran said.
- Daniel Gorin and Jeanne Hogarth, with the Federal Reserve Board of Governors, described initial findings from their financial literacy surveys of soldiers based at Ft. Bliss in El Paso, Texas. In general, the surveys showed that soldiers display many of the same inadequacies when it comes to financial literacy as the general population. The next phase of their research will compare groups of soldiers who have undergone financial training and those who haven’t.
In an increasingly complicated financial world, the importance of basic financial literacy has also increased. Lusardi’s work – including several papers co-authored by University of Pennsylvania economist Olivia Mitchell – has highlighted the direct linkages between financial literacy, planning and wealth. In new modules that Lusardi and Mitchell were able to add to the nationwide Health and Retirement Study, it was learned that only one-third of households with a member older than 50 have tried to determine how much they might need to save for retirement; and of those, just over half developed a plan for retirement saving.
Meanwhile, “planners” accumulate almost three-times more wealth than non-planners, Lusardi found. In related work, Lusardi and Mitchell documented a connection between financial literacy and planning, thus suggesting the chain that first literacy then planning leads to greater wealth. On the flip side, financial illiteracy can bring much less wealth, perhaps digging some people into deep debt.
Though the link between exposure to financial education programs and literacy is tenuous, Lusardi said she has found some evidence of a causal relationship. In fact, the largest literacy gains are generally seen among people in the bottom tail of the income distribution – those with the least wealth – and people with low levels of education.
During question-and-answer periods, discussants addressed some challenging questions Mandell analyzed the link between financial literacy and general academic performance – are the Jump$tart surveys merely measuring intelligence and general academic achievement? Other questions: Why don’t some people seem to be saving according to their lifetime expected income, as economic theory suggests? How can you make comparisons among financial literacy tests given that there are so many of them and target different demographic groups? Would stricter consumer disclosure regulations help, or is financial education alone sufficient to make consumers reliable financial decision makers?
Francisca Richter, Community Affairs Research Manager with the Cleveland Fed and organizer of the seminar, said that the event was useful on several fronts. It underlined the widespread problem of financial illiteracy in this country and suggested possible approaches for improving the effectiveness of financial education programs. At the same time, it broadened the discussion to consider general education and consumer protection as important factors in reaching the ultimate goal of financial security and well-being of individuals, particularly of low and moderate income. “Today we were reminded that too many individuals have serious deficits in understanding basic financial principles. But recent research is helping us to more clearly understand why those deficits exist, and which strategies might be most effective in addressing them.”