Financial Literacy: The Time Is Now

It's more essential than ever to educate Americans of all ages about how money works. Can new efforts finally make a difference?

By Ben Steverman

When it comes to financial matters, Americans are functionally illiterate.

That's the growing consensus among policymakers and educators, many of whom contend that the country's lack of financial sophistication is one cause of its current economic problems.

Advocates for financial literacy are seizing on the economic crisis as an opportunity to confront the issue directly. Thanks to the recession, they're getting a response from governments, nonprofits, schools, and employers.

Perhaps that's because there is plenty of evidence that, when it comes to money, Americans really don't know what they're doing. The recession has produced thousands of anecdotes of Americans buried in debt, stuck in foolish mortgages, or stung by huge investment losses.

Those misfortunes can strike people with PhDs in economics, of course. But surveys show Americans also fail to grasp important abstract ideas about money.

Boomers Fail Finance 101

Take the concept of compound interest, the notion that interest isn't a one-time event. It builds on itself over time. That compounding is the bane of those in credit-card or mortgage debt, but it benefits long-term investors. When the University of Michigan 2004 Health & Retirement Survey asked a simple math problem requiring a knowledge of compound interest, only 18% of baby boomers got it right.

Another basic concept for investors is diversification. Only about half of respondents correctly said that investing in a pool of stocks, or a mutual fund, is safer than investing in just one stock. And, says Wharton School of Business professor Olivia Mitchell, since the question was posed as a true-or-false statement, many of the correct respondents were probably just guessing.

Some financial blind spots have direct consequences. Women, who live longer than men, are more likely to underestimate their predicted life spans. In retirement, Mitchell says, "that puts them at much greater risk for running out of money."

Students and Workers Score Poorly

Young people are equally confused about financial topics. In a 2008 survey by the Jump$tart Coalition for Personal Financial Literacy, just 17% of high school and 19% of college students knew that, over an 18-year span, stocks tend to provide better returns than government savings bonds or bank checking and savings accounts.

Things don't get much better up the age ladder. The 2009 Retirement Confidence Survey, conducted by the Employee Benefits Research Institute, found that 47% of workers think they will need less than $500,000 for a comfortable retirement. "Which is just not realistic," says Ken McDonnell, the institute's program director. "Consistently, we found that individuals don't have a realistic understanding of how to save for retirement."

None of this is new. Economists have been lamenting for years Americans' low savings rate. The U.S. personal savings rate, about 11% in 1981, had fallen to near zero in recent years.

But in an era of relative prosperity, as home values and stock prices moved higher, Americans' lack of crucial financial knowledge didn't attract as much notice.

Literacy Advocacy Gains Support

When talking about financial literacy, "10 years ago everyone would nod their heads," says Laura Levine, executive director of the Jump$tart Coalition, which advocates for financial education for students. But "it wasn't a priority for anyone. There weren't many opponents but there also wasn't an enormous amount of support."

Now, she says, "our time has come."

It's all become clear, not just to financial experts but to the general public: Americans weren't saving enough. They got themselves into sticky financial situations, like credit-card debt. They signed expensive mortgages, subprime or otherwise, that they didn't understand.

For years, the Center for Working Families in Atlanta has taught low-income people how to build up savings through its Moving to Wealth program.

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