A noted researcher discusses the state of financial literacy in the U.S., the connection with income inequality, and what works with financial education.
Our guest on the podcast is Annamaria Lusardi, an authority on financial literacy and financial education. Lusardi is the Denit Trust Distinguished Scholar and Professor of Economics and Accountancy at the George Washington University School of Business, where she also serves as the academic director of the Global Financial Literacy Excellence Center. Prior to joining George Washington University, she taught at Dartmouth College for 20 years. She has also taught at Princeton University, the University of Chicago Harris School of Public Policy, the University of Chicago Booth School of Business, and Columbia Business School. She received her doctorate from Princeton.
Background
Annamaria Lusardi curriculum vitae
Annamaria Lusardi publications
Financial Literacy
"The Economic Importance of Financial Literacy: Theory and Evidence," by Annamaria Lusardi and Olivia S. Mitchell, Journal of Economic Literature, 2014.
"A Financial Literacy Test That Works," by Annamaria Lusardi and Olivia S. Mitchell, Forbes, Dec. 14, 2017.
The 2019 TIAA Institute-GFLEC Personal Finance Index
"Financial Literacy and Wellness Among African-Americans," by Paul J. Yakoboski, Annamaria Lusardi, and Andrea Hasler, Global Financial Literacy Excellence Center.
"Financial Literacy and Retirement Planning in the United States," by Annamaria Lusardi and Olivia S. Mitchell, Journal of Pension Economics & Finance, October 2011.
“Financial Literacy Around the World: An Overview," by Annamaria Lusardi and Olivia S. Mitchell, Journal of Pension Economics and Finance, October 2011.
Implications of Financial Illiteracy
"Optimal Financial Knowledge and Wealth Inequality," by Annamaria Lusardi, Pierre-Carl Michaud, and Olivia S. Mitchell, The National Bureau of Economic Research, January 2013.
"Financial Literacy and Stock Market Participation," by Maarten van Rooij, Annamaria Lusardi, and Rob Alessie, The National Bureau of Economic Research, October 2007.
"National Financial Capability Study," Finra Investor Education Foundation, December 2019.
“Financially Fragile Households: Evidence and Implications,” by Annamaria Lusardi, Daniel J. Schneider, and Peter Tufano, The National Bureau of Economic Research, May 2011.
"Financial Literacy and Planning: Implications for Retirement Wellbeing," The National Bureau of Economic Research, by Annamaria Lusardi and Olivia S. Mitchell, May 2011.
Financial Education
"Are States Providing Adequate Financial Literacy Education?" by Matt Kasman, Benjamin Heuberger, and Ross A. Hammond, Brookings, Oct. 3, 2018.
"Five Steps to Planning Success. Experimental Evidence From U.S. Households," by Aileen Heinberg, Angela A. Hung, Arie Kapteyn, Annamaria Lusardi, Anya Savikhin Samek, and Joanne Yoong, The National Bureau of Economic Research, June 2014.
"John Lynch: Rethinking Financial Education," The Long View podcast, Morningstar.com, Dec. 11, 2019.
"Financial Literacy, Financial Education, and Downstream Financial Behaviors," by Daniel Fernandes, John G. Lynch, and Richard G. Netemeyer, Management Science, Jan. 6, 2014.
"Ariel Community Academy Students Are Investing on Wall Street by Fourth Grade," by Rodney Brooks, The Undefeated, Oct. 18, 2017.
Christine Benz: Hi, I'm Christine Benz, director of personal finance for Morningstar, Inc.
Jeff Ptak: And I'm Jeff Ptak, global director of manager research for Morningstar Research Services.
Benz: Our guest on the podcast today is Dr. Annamaria Lusardi, an authority on financial literacy and financial education. Dr. Lusardi is the Denit Trust Distinguished Scholar and Professor of Economics and Accountancy at The George Washington School of Business, where she also serves as the academic director of the Global Financial Literacy Excellence Center. Prior to joining GW, she taught at Dartmouth College for 20 years. She has also taught at Princeton University, the University of Chicago Harris School of Public Policy, the University of Chicago Booth School of Business, and Columbia Business School. She received her Ph.D. from Princeton University.
Dr. Lusardi, welcome to The Long View.
Annamaria Lusardi: Thank you so much for having me.
Benz: Let's start by talking about how you go about determining whether someone is financially literate or illiterate. Can you talk about the things that you might test someone on to make that determination?
Lusardi: Yeah. Over time, we have measured financial literacy in a variety of ways. I started working, for example, with Olivia Mitchell from the Wharton School and we are testing the basic knowledge, the basic ABC of personal finance, so concepts like knowledge of interest compounding, inflation and risk diversification. Over time though, we have moved also to much more comprehensive measures. For example, incorporating knowledge of basic asset pricing, working of mortgages, and more recently, with the support of the TIAA Institute, we have looked at what is called a personal finance index, looking at as much as and as many as eight areas in which people routinely make financial decisions. So, concepts like borrowing, saving, consuming, investing, insuring, comprehending risk, asking as many as 28 questions. And so, we have a very simple measure, simply three questions, and very comprehensive measure, as many as 28 questions.
Benz: So, let's talk about how we as a population are doing. In some of the work that you did with Professor Mitchell, you showed that certain segments of our population really don't look good when you run them through this literacy testing. Can you talk about those groups of people that seem to be particularly financially illiterate?
Lusardi: Let me start by saying that overall the numbers do not look good, and we see that even the average Americans, and I have to say, we also look around the world, doesn't know even about these very basic concepts. But not just financial literacy is very low, there are also groups whose knowledge is particularly low. And among those groups I would the put actually women, those with low income and low education, and minorities such as African Americans. We have done very recently actually a report focusing on African Americans. It came out just last fall.
Just to give you some perspective, while overall, for example, the wide population only answer about half of the 28 questions, the personal finance index questions—again, this is not the passing grade—you would get an F if you take my course, and you only answer about half of the questions. The number for the African Americans is only 38%. So, some of the groups, which are already, I would say, vulnerable in other dimensions, may be economically or so on, they are also vulnerable when it comes to financial literacy.
Ptak: So, I'm sure we'll talk some more about the groups you mentioned that are more vulnerable as you put it. Before we do that, to make this even more tangible for our listeners, can you give an example of a question that one of your respondents would be attempting to answer that helps you to draw a conclusion about their levels of financial-education literacy?
Lusardi: Sure. I'm going to talk about, for example, the big three financial literacy questions. In one case, we just asked a simple 2% calculation in the context of interest rate. So, we say, if you invest $100 at 2% interest rate, at the end of five years how much you have in the account if you left the money to grow? And we don't ask people to provide us a precise number. We list those numbers. And to make the question very easy, we say, is it more than one or two, 100 or two? So, we don't even test, in a sense, interest compounding but whether people can do a 2% calculation in the context of interest rate.
Another question is about understanding of inflation. And we say suppose that the inflation is 2% and the interest you earn on your checking account is 1%, at the end of one year, would you be able to buy more or less with the money in your account? So, we are trying to test this kind of very basic, but yet fundamental knowledge on the basis of financial decision-making.
Ptak: And people struggle with these questions that you just gave examples of? These wouldn't be outliers that trip up a lot of your respondents? Are these pretty representative of the types of questions that you would be asking that perhaps they would struggle with?
Lusardi: So, these are the relatively simple questions. And I have to tell you that even in those two relatively simple questions, only about half of the population can answer them both. There are questions which are of course more complex, and we want more complex questions as well because we want to test whether people also have much more sophisticated knowledge. So, for example, we ask, what do you think is safer: Invest in a single company stock or in a stock mutual fund? So, kind of, try to assess whether people, first of all, know even what a stock or a stock mutual fund is, and what are some of the investment understanding. So, even these simple questions, we find that overall in the U.S., about one third of the population can answer these three fundamental, kind of, ABC-type concept of personal finance.
Benz: How does level of wealth correlate with a level of financial literacy or illiteracy?
Lusardi: That's the important question. When we look at financial literacy and how it is linked to important outcomes—and I'm happy to speak more, of course, of research and not just correlation—but financial literacy very strongly correlates with the level of saving and wealth. In other words, it is those who are more financially literate, who also have much higher amount of wealth, much higher amount of saving, are more likely to plan for retirement, and so on. And they are not simple correlations. But the correlation in the raw data is very strong and very important, and I think it tells the story of why also it's so important today to be financially literate.
Benz: So, you referenced that you've conducted this research globally, not just in the U.S. Can you talk about how rates of financial literacy compare in the U.S. relative to other markets where you've done this research?
Lusardi: Probably because we were able to design three relatively simple questions. It was also possible to add those questions in a lot of other surveys internationally. So, we have worked with central banks, regulators, other institutions, to be able to add this question in many other countries. We have a project that we call Financial Literacy Around The World, or FLAT World, as it is with the acronym of the project. And when we look at the financial literacy measured by, for example, these three simple questions, we find that the world is flat also when it comes to financial literacy. In other words, other countries have well often displayed low level of financial literacy. And interestingly, it is the same groups around the countries, and I would say around the world, that display this lowest level of financial literacy.
So, there is a gender difference in financial literacy around the world. It is true that those, which for example, are minorities or have low income or low education, tend to have low financial literacy. And of course, the young and the old are also those less likely to be financially literate. And this is true overall around the world as well. Of course, there are countries which have higher level of financial literacy overall than potentially others. And among them, we see prominently the Nordic countries, but also countries like Canada, Australia, New Zealand, countries which have a very strong education system, or where financial literacy has been added in school a long time ago.
Ptak: So, back to the relationship between financial literacy and wealth or level of savings--what has your research suggested? Is it those who possess wealth and greater savings that they're afforded more plentiful education opportunities? Or is it they are afforded reps? They get more opportunities to draw on their wealth and that wherewithal and learn lessons by doing, so to speak?
Lusardi: Yeah, this is actually a very important question. Where does the causality go, right? So, we have actually done a lot of research on this topic and tried to document not just the level of financial literacy, but the consequences of financial literacy and whether and how financial literacy matters. As you can imagine, it's hard to do that analysis because simple correlation might not tell us the whole story. So, more recently, we have done a kind of theoretical model trying to add financial literacy, like, into a simple, in a sense, financial decision-making model. And in our simple stories, financial literacy allows people to basically better invest their savings.
And the conclusions were very striking, which actually shows that a very large proportion of the wealth inequality close to retirement, as much as one third, is actually due to financial literacy. There, we don't have a problem of causality because we incorporate--it's a model--that incorporates all of this endogeneity, this learning and this effect that indeed people who have more to gain from financial literacy are more likely to invest into it. But even for us, it was striking just how much financial literacy matters.
Using data set, and because we were able to use national surveys, we have also looked very closely at a variety of behaviors. So, we have looked at how much financial literacy, for example, explain wealth and wealth holdings and tried to address the problem of causality, not just by looking at financial literacy per se, which can be endogenous--your financial literacy can change because of your wealth, because of your desire to save--but tried to look at people, for example, who were exposed to financial education in school or the workplace. So more in a sense, like an experiment. And what we found is that financial literacy is a very strong determinant of people being more savvy about their saving, their wealth, and by the way, also their debt and debt management.
Benz: So, one of the behaviors that people who are more financially savvy tend to exhibit is that they invest more in stocks. So, can you talk more about that finding, which I know has surfaced in your research? And what you think the reasons are for that, whether it results from a lack of financial education or is it possible that someone is less likely to invest in stocks because they feel they have less to lose and maybe they are financially stressed or something like that? Let's talk about that finding.
Lusardi: Absolutely. So, this is a research we have done, for example, working with the data from the Federal Reserve system in the U.S. where we could have access to how people invest in their pension accounts. But we have done also research internationally looking at the link between financial literacy and investing in the stock market. And there are other studies done in the U.S., and again around the world, that shows this very strong correlation indeed that, as you have mentioned, among the fact that the people who are financially literate are much more likely to invest in the stock market.
This is actually not a surprising finding because it's the same for education. If you look at just higher education, it is disproportionately those who have a college degree that are more likely to invest in the stock market. And interestingly, when you look at financial literacy, it doesn't affect above and beyond education. So, you also need that specialized knowledge in a sense to invest in the stock market. We do think that the data speaks of the importance of having that knowledge, because after all the stock market is a sophisticated concept. You need to understand what it is, how it works. You need to understand the variability and so on. So, if you are never exposed to financial literacy, this is not such a simple concept.
And in our empirical work, we take into account the many characteristics that people have. So, we do account for whether people have wealth. So, the fact is, even if you look at people which have the same and potentially higher amount of wealth, the people who have more education, the people who have higher income, those who have higher financial literacy are much more likely to invest in the stock market. Our intuition is because they know more, and they are better able to take advantage of the opportunity offered by the markets. And by the way, it's true in other situations--the people who, for example, refinance mortgages when interest rate goes down are disproportionately those with higher financial literacy and higher education. So, knowledge really matters and allows us to take advantage of the opportunity around us.
Ptak: What would you say to the argument that it's not so much a financial education challenge as it is an income-equality challenge, and that if you do that sort of leveling that it would serve to remove some of these trends that you've described, where those who perhaps have less wherewithal aren't as financially literate and therefore disadvantaged in various ways that you described? If we were to level that out from an income standpoint, is there a reason to believe that the outcomes across the income and social spectrum would change markedly?
Lusardi: So, clearly, if you give people more income, they might indeed be more likely to invest in the stock market. We see this in our data as well. But also, financial knowledge has that effect. So, we think that that's another channel in which people can operate and make better financial decisions. It's clear that if you don't have, for example, any money to invest, if I give you a lot of knowledge, it's not that you're going to invest nevertheless. So, of course, the economic system--and we always speak in terms of the ecosystem in which people operate--is very important. And your financial situation is very important for the type of decision you make, but also how you are able to manage the resources that you have is important, and this is, I think, where we would like to put our attention now that, so much more than in the past we are asked to make decisions, many more decisions than we were asked before, young people need to make decisions about student loans, young workers need to make decisions about their pensions. We face very complex mortgages and financial instruments. When we retire, we face very complex decisions about how to decumulate our wealth. Those skills of how to manage our resources are becoming so important, so essential to navigate this ecosystem.
Benz: So, you mentioned that things are getting more complex in terms of our financial system and the various instruments that we all have to navigate. So, how about trends in financial literacy since you've been studying this area? Has it gotten worse?
Lusardi: So, we are able to study this in the U.S. because we were able to have question on financial literacy, for example, in the National Financial Capability Study, and this has been done every three years starting in 2009. So, if I look at the financial literacy in 2009, and then the financial literacy in the latest wave in 2018, I don't see that financial literacy is improving. And this to me is not surprising. In fact, it might even get worse also because the inequality of the population is worse. And so, as I mentioned earlier, people with lower income and lower education that tend to have lower financial literacy.
But we have not, irrespective of these major changes that are happening in our financial market, stepped up much of the effort, for example, to have financial literacy in school or in the workplace. Very few states have added financial literacy to their curriculum, yet student loan looms at $1.6 trillion. We have shifted the responsibility to saving and invest the retirement saving to workers, yet we don't see a lot of initiative necessarily in the workplace. So, it's not surprising that financial literacy has not improved very much. It's not that people learn necessarily by just watching the world around them. And this is, by the way, true when we look globally. The level of financial literacy is not necessarily higher in the people in the countries with the higher income and more developed financial markets. There is limited learning by just breathing the air and watching the world around you. In this very complex world, we need to find a way to provide those skills if we want people to be financially literate.
Ptak: So, can you give a couple of examples of what your research has found to be especially successful in imparting the important lessons that are really the bedrock of financial literacy? And maybe we can use a couple of examples that may be bookend the population of those you'd be looking to get that education? Maybe somebody who's very early in their career just starting out, and then someone who's about to enter retirement, I mean, what are the things that they really need to know and what has your research suggested as most effective in educating and preparing them?
Lusardi: So, a lot of our research has been focused, for example, on workplace financial education. So, we have done several programs looking, for example, at millennials, women, people contribute, making decisions about their retirement savings and investment. And in all of the projects that we have done, we actually show that not just financial education works or initiative works, but sometimes how simple or how little you can do to help people make this decision. I want to mention one of the dearest project I have done and it's because I've done it in my own institution when I was at Dartmouth College, for example, the vice president of finance and administration called a few people in his office to say, you know, I would like to promote much more retirement savings in our nonfaculty population. And what we did, we provided simple planning aid, which listed the steps that people like to take in order to make financial decisions. And the way we actually taught to the employees was not just by lectures or bringing them back to the classroom or anything like this, but we did it via simple videos and simple stories, where some of these concepts in a sense were explained in a very simple way. And according to our test, even this very simple intervention, kind of, low-cost, limited had really an impact both on participation and contribution to retirement account.
One of the things I've really learned in particularly doing focus group and in that interviews and many started there, is just how articulate people are in their dreams, their aspiration, what they would like to achieve, but the gulf there is between those goals and kind of the knowledge requires often to get there. And so, I hope that is financial literacy, this program, can really help filling the gap.
In another project that we have done this time targeting millennials, we just did simple videos. I say simple, but these were short, they were done with actor where we were very precise and tried to be very rigorous in providing the type of information that people needed in order to make saving decisions. And we call the project Five Steps to Planning Success, where these five steps are really that basic and fundamental knowledge that young people require, including, for example, contributing to employer pensions by particular if there is a match in taking advantage of tax-favored assets. These were short videos. Again, like, the cost was not very high and the importance of doing it in the workplace is, you have a centralized place and you have often an institution that people trust. A lot of employees would like to get financial information and financial education from their employers. And we tested these actually in a very large sample. And we found that not just the young people we have targeted improving their knowledge and self-assessed behavior, but even actually, the entire group, the entire sample showed an improvement in both their knowledge and self-assessed behavior.
Benz: So, in talking to Professor John Lynch, who has also studied this area, one concept that he talked about was this sort of just-in-time financial education intervention. It sounds like you're talking about a similar type of intervention and you think that those sorts of things are the types of financial education that really do work. Is that correct?
Lusardi: No, I don't consider just-in-time necessarily; I actually consider these interventions that we can do in, for example, places where people are. So, it's very convenient to, for example, do it in the workplace because people are at work, and I would call them more teachable moments. So, we are exploiting, for example, you know, when people enroll, when people participate to some events in order to provide the education. In my view, just-in-time education is too late. If you provide education when people are making the decisions, they've already taken, I think, a lot of steps to get there. And so, the decision might not be ideal, and you might do very little with this just-in-time education.
Just let me give you a couple of examples. If you give just-in-time education to people that are trying to get a mortgage, so they are sitting there at the real estate office or they are making this decision, chances are they have already set their eyes and their heart on the wrong house. And you know, they might not have done any search and they might not have calculated which type of house they can afford, but yet when they get there and you try to actually provide education, they have already made up their mind. Another story could be the student loans. By the time a student might apply to student loan, they've already set their eyes to the colleges they want to go where their friends go and so on. And so, you are not really able to provide much information. The other problem is, often there is not the time. Like, think of planning for retirement. Where is that time where you are provided information? The time is now. The time is as early as possible. And before people make financial decision, not after. We need to provide financial education, so they elaborate their dream and aspiration that they are able to achieve.
Ptak: So, what do you say … when we when we spoke to her Professor Lynch, one of the things that he pointed to in favor of just-in-time education was this concept of decay that you can impart a lesson, but if it basically just sits unused for some period of time, it loses its efficacy and its hold and people forget. And so, I guess, what have you found in your own research that gives you conviction that providing this sort of foundation for investors through education yields good outcomes because it sticks?
Lusardi: So, we did the analysis that John Lynch did in his paper published in 2014, and it's because--you know, what I found, first of all, is that the literature on financial literacy exploded in the past, I would say, 10 years. So, his analysis was done on what was at that time relatively limited amount of studies. In fact, if I look at the paper that you looked at to the most rigorous evaluation, they are only 13. So, we have extended the analyses on all these new studies that have been done and a lot has been done in the last six years. And we don't replicate the findings that he had. We don't replicate the fact that financial education doesn't have an effect. In fact, in all of--it's not just our studies. But when we put together all the recent evidence, including the evidence it looks at, but including this very large work which has been done recently, we find that financial education shows quite a strong effect. We also don't find the evidence of decay that he found in his work. In other words, it's not that our evidence doesn't show any decay. But it doesn't show this very strong decay that defines … in fact, in our story, we don't find either evidence of decay or no decay.
But let me just mention that, you know, education is always like this. I don't expect education to stay the same. If you were to ask my student, not my student of personal finance, but the student who took my macro course, this year, I'm sure that their knowledge has decay, but it doesn't mean that we shouldn't teach macro or I should teach macro with just-in-time so they get bits and pieces of information as they go through life. I mean, a lot of the knowledge that we have, almost any knowledge--I mean, I can test you on any of the courses you have taken, I'm pretty sure that by now you don't remember them very well. Again, it doesn't mean that they are not helpful. They provide you this tool that then you can use later on to articulate or so on. If you go back to your French, it might come back to mind; if you go back to your math, it might come back, and you still have a tool that you can use.
I also think this is related to the way in which people think, we teach personal finance, that we only explain what a mortgage is, or what a checking account is. Like the description of a checking account belongs in a history course. I don't teach anything that you can Google. In my course I teach how to make financial decisions. And people probably, particularly students, now are making financial decisions all the time. So, I think we are going to exercise our muscle a lot. And that's why I think we don't see that strong decay in financial knowledge given that we make financial decisions every day. Having said that, of course, it's important to have experience an d the experience allows us to be fresh and know some of these topics and continue to exercise our knowledge.
Benz: So, speaking of actually teaching financial education, let's talk about balancing the more sort of conceptual knowledge alongside the very tangible sort of information that you might choose to impart. It sounds like you would favor more the tangible takeaways. That's what you think people should seek to impart when trying to improve levels of financial literacy?
Lusardi: So, the way I teach personal finance, I actually try to teach the basic of financial decision-making. So, I teach the concept so that people can make their own financial decisions. A lot of people, and also the theory, suggests that there are behaviors that are similar to everybody, and that's why in a sense, some people feel like, how about rule of thumbs, how about teaching those? Clearly, there are concepts that are fundamental and useful to everybody. One suggestion is start saving as early as possible; use time in your favor; diversify your portfolio; contribute to your retirement account up to the match; be careful about the effect of inflation because if you leave the money under the mattress, inflation is going to make you poorer over time. So, there are things that are absolutely universal and that everybody in a sense should do, and everybody should be careful about. But overall, personal finance is personal. And people should decide according to their own financial circumstances. Personal finance is like a dress, it should fit you well. One size doesn't fit all. So, rules like save 10% are probably too much for some and too little for others, and they might not fit a person's financial situation. So, in my course, you know, I teach to make sure that people are able to make the best decisions that are suitable to their own preferences and financial circumstances.
Ptak: So, given that, do you think one-on-one financial tutoring is superior to, say, teaching financial literacy in a classroom setting?
Lusardi: So, I actually think personal finance is a course that you can teach, and you can teach in the high school and in college. A one-to-one is always useful, but we don't need to do the one-to-one. My objective is really to make personal finance to be a regular course at every university and to make a regular course in high school and even in elementary school. So, that, I think, is the ideal setting where people can learn.
Ptak: So, when you're in a classroom setting, acknowledging that sometimes these lessons and teachings have the most uptake when they've been sufficiently personalized. What have you found to be successful in making sure that you're imparting these lessons in a way that really connect with those who are sitting in on your class or others that you've observed?
Lusardi: So, first of all, I have incorporated a lot of my research into my teaching. So, for example, because of--I'm aware of the gender difference in financial literacy. And so, I motivate my class in ways that appeal to both the male and female students. So, for example, I know that language, the language of finance, is particularly, let's say, foreign to women. And so, I start my class by saying, you know, we start in plain English and we are going to build the language of finance. And this is actually one way in which I engage both my female and male students rather than going in and starting with, in a sense, sophisticated concept.
The other thing is very important that personal finance is not about saving more and borrowing less. It's about achieving your dream, achieving your objectives. So, when my student asked what is this course about, actually, the best way I can describe it, this is a happiness project. This is how you can be able to achieve your objective and be financially safe and financially secure. So, motivating, providing example, making sure that I take into account the differences among the students and what are some of those so the decision that they are going to be making is very important. By the way, people think that students are not interested in this topic, or you're not in interested in finance. And this is certainly not true. And it's also not true that students are only interested in student loan or in decisions that are the ones that they have to make. They are certainly interested in figuring out the world around them and how to navigate that world and how to be able to be financially fit through their life.
Benz: A philosophical question is, if we note that people are systematically undereducated when it comes to financial matters, is there a role for policy to step up and provide more defaults that would help short-circuit some of the bad behaviors that can get people into financial trouble? So, I mean, maybe building off the success of defaulting people into target-date funds within their 401(k)s, for example, and defaulting them in at a set percentage of their salary?
Lusardi: Absolutely. We have always to think of the ecosystem and I think there is an important role to make the world in a sense better suitable for what is best for people. So, why should the default be zero savings and we should simplify, we should provide, in a sense, the suggestions. We should make decision be easier to make. There is an important role for a choice architecture that I think facilitate decision-making in the best interest of individual like there is a role for regulation. So, these are very important parts. But I think there is also a role for financial education. They shouldn't be seen as substitute. They should be seen as complement. And I underline the word “complement,” because often I think we have done only one thing. Often, we only do regulation, or we only want to do, for example, default. If I look at the state of retirement saving now, we have done a lot about defaulting people into retirement account and for example, also having them invest in target-date funds and so on.
But again, this is not enough. One size doesn't fit all. People are not the same. If you default them at 3% into a retirement account and in a target-date fund, and they don't even know the difference between bonds and stock, first of all, they might stick at this very low, for example, contribution. If the stock market goes down, they might be very worried, and they might sell exactly when there is a loss. And then, when people change jobs, they might withdraw those retirement savings. So, we need to, in this complex world, complement all of this with education. I always give the analogy that, you know, we need to think of an ecosystem when we think of financial literacy and I think financial literacy is the water in that ecosystem. If there is too low--little water to lower water, things cannot flourish, things cannot grow. And even you can put a lot of regulation, you can put a lot of choice architecture, but things can dry up and people might end up not being in a good financial situation.
Ptak: Let's say I'm a financially savvy person listening to this podcast and I want to try to improve my community by teaching financial concepts. What do you think would be the best use of my time?
Lusardi: I'd say two things. First of all, I would say become an advocate of financial literacy in your local school. I think this is great because, first of all, you're going to prepare the next generation to the different financial world that they are going to face. And also, the school is such an important part of the community that sometimes, particularly if it is, let's say, in a school in a low-income neighborhood, potentially that knowledge, that information provided by trained teacher might also trickle back to the parents. And so, not only you will be better able to equip the young people, but this might even go back to the community.
The other things, and this is actually what we have done in Italy, where I direct the Financial Education Committee, I would say also speak to the city council. In Italy, we have found that the mayor of some small city has come to us and said, you know, we have several problems in our community. We have several people that go into financial trouble, they are in financial distress and so on, and how can we help them, how can we prevent some of this behavior? The nice thing about the city council is they really have a handle on the population more, on their community. They can organize things in the community. And that would be, I think, a very useful way in which you can improve your own community.
Benz: Going back to the school setting, one common way of teaching children, high school children oftentimes, about stock market investing is the stock market game where kids pick a company to follow, to invest in. What do you think of that as a strategy? I'll reserve my own judgment. I want to hear what your thoughts are on that stock market game that's so common in schools.
Lusardi: So, personal finance is not just about investing. So, I just want to make that clear that sometimes we identify to match personal finance with just investing and in just investing in the stock market. So, I find that this is a part of personal finance but is kind of only one part. Overall I think there are good things about that. I mean, I like the idea of teaching with games, because I think it takes away the sentiment of finance being potentially difficult, not fun, and so on. And so, that would be one way in which you can take that away. The other reason why I like games is that you can learn, in particular, if there is a repetition, better because sometimes you wouldn't otherwise be exposed to that. And judging from--you know, this is not a stock market game, but there are institutions like, for example, the Ariel Academy in Chicago, which has shown that by exposing these young African American kids in this low-income community, you find them really empowered by that knowledge.
So, there are good opportunities in using games, in using the stock market. Again, the stock market, as I mentioned earlier, is a very sophisticated, difficult, complex and if you are a person that leaves in a family that has never invested in the stock market, doesn't know much about the stock market, this can be helpful. But this is only one component of a personal finance course. And I think, personal finance, this could be maybe one part of personal finance, but hopefully not the only part. People need to learn a lot of other concepts, not just investing in the stock market.
Ptak: I also wanted to ask you what has your research shown has been most effective in maybe imparting the lesson of the importance of having an emergency savings fund, sort of, a rainy day fund. And what are the things that we've probably unmistakably found as practitioners or researchers is that there's such a thing as a chain reaction, right, where somebody doesn't have sufficient emergency savings, and so they end up raiding their retirement plan, which then basically does a number on their retirement preparedness from which they might not recover. And so, it seems like that's a pretty important lesson to impart. What has your research shown to be particularly effective in imparting it?
Lusardi: So, first of all, our research has documented over time what you have mentioned, which is this financial fragility of people. So, we had designed a question many years ago together with Peter Tufano, a former professor at HBS, and tried to assess indeed whether people add precautionary saving. And so, we asked these kind of simple, but it turns out, sophisticated, question because it's able to really assess the state of the balance sheet, which is the confidence that people have to come up with $2,000 in 30 days. And what we found is that indeed, such a large proportion of the U.S. population don't have, in a sense, those precautionary saving or don't even have, like, the capacity to come up with those savings apart from doing something kind of very dramatic like selling their possessions or going and borrow using payday lenders and so on.
And I do think that there are lots of consequences of doing so. In our research, I actually find that there is a very strong correlation between financial literacy and financial fragility. So, again, it is those which have higher financial literacy that are much more likely to be able to have the capacity to face a shock. And this is, again, important, you might think surprising, because this is more to do with the kind of day-to-day financial management, illiquidity, and you might feel that if people have faced a shock, then they should have, in a sense, an incentive to really avoid that situation again. But I think that even in simpler potentially financial decision, this is certainly a simpler financial decision than investing in the stock market, right or saving for your retirement or calculating how much you might need to save, even in those day-to-day financial decisions and management of your liquidity, financial literacy seem to be so important. In my class, I talk a lot about the importance of having that buffer stock of saving, and the consequences that might bring about not having it.
Benz: So, your research points to there being a definite connection between levels of financial illiteracy and retirement unpreparedness. And one piece of your research that really stuck out to me was how people seek information. So, people who are less financially literate are more likely to kind of rely on the friends and family network versus going out and looking for information from perhaps more reliable sources. Can you talk about the finding there and how that could be addressed through education?
Lusardi: Yeah, that’s a very important point. We found this over and over that when it comes to financial literacy or illiteracy, I mean, it operates in many ways, right? It operates potentially with the fact that you don't provide, or you don't set aside a stock of savings in case of an emergency, you might not save for retirement, you might not manage that well. But it also is related to who you consult for your financial decision, the type of sources of information you go to. The fact that people, in particularly lower-financial literacy, people consult disproportionately family and friends as the problem that potentially those family and friends have the same type of information or the same type of knowledge that they have. So, it's not very augmenting, or it's not very helpful, potentially.
We also found connected to the same point that it is disproportionately those who have higher financial literacy, the ones who actually consult a consultant or who get the professional advice. So, financial literacy is not a substitute for financial advice. It's actually a complement. And potentially, it's the people who have more knowledge, the ones were better able to get a good advice and really take advantage of the advice of a good advisor. And this is, again, another channel, it's another important reason why we do need that financial education. It's not that people are going to otherwise buy necessarily in the market, and they might end up--we might end up in this situation where many of the people who, in a sense, do not have the knowledge do not acquire it also because the people around them might not be the best ones to provide knowledge and advice.
Benz: Well, Dr. Lusardi, this has been a fascinating conversation. We really appreciate you taking the time to join us today. I've learned a lot. Thank you so much for being here.
Lusardi: Thank you so much for this opportunity.
Ptak: Thank you. Have a good day.
Lusardi: Thank you. Bye-bye.
Ptak: Thanks for joining us on The Long View. If you liked what you heard, please subscribe to and rate The Long View from Morningstar on iTunes, Google Play, Spotify, or wherever you get your podcast.
Benz: You can follow us on Twitter @Christine_Benz.
Ptak: And at @Syouth1, which is, S-Y-O-U-T-H and the number 1. Finally, we'd love to get your feedback. If you have a comment or a guest idea, please email us at TheLongView@Morningstar.com. Until next time, thanks for joining us.
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