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Friday, April 22, 2011

Financial Literacy - Some Thoughts

Most interested observers agree the nation has a financial literacy problem.  In honor of Financial Literacy month, Digerati Life presents her thoughts and argues in favor of mandatory high school classes in money management skills. Most agree that financial illiteracy played an important  role in the 2008 housing crisis and is the fundamental factor in the ongoing struggle families have with credit card and other types of debt.

The departure point in the debate is how to solve the problem. Many people are quick to jump on the bandwagon calling for classes in high school and elsewhere, mandatory testing, and the usual type of solutions. Many are willing to throw a lot of money at the problem. Some, in fact, would have a lot of money thrown their way if their solutions were adopted.

A different view is expressed by Lauren Willis. A professor at Loyola Law School of Los Angeles, she has written "Against Financial literacy Education."  Ms. Willis does something  not typically done in this debate. She brings to bear evidence, and she thinks in terms of costs and benefits. She finds that the costs far outweigh the benefits.

One of the difficulties, I believe, is that financial literacy is such a wide-ranging subject area and  means different things to different people. Ms. Willis mentions the futility of turning people into " experts."  This, to me and I suspect many others, is a bit of a strawman argument. Few proponents of financial literacy would even put themselves forward as "financial experts."  Most, themselves, use experts on complicated financial questions. They will have attorneys look over contracts and mortgages. They'll turn to financial advisors for investment advice and financial planners to do financial planning.

But, at the other end of the spectrum, there is the basic thinking about wants and needs. There is the basic understanding of compound interest and the value of saving and investing at a young age. There is the understanding of the basics of investing.

Extending these concepts to study how to think about buying a car or the analysis that goes into thinking about renting an apartment or even the whole subject of student loans is fairly straightforward. In fact, from the teacher's perspective, all of these subjects readily lend themselves to highly interactive classroom projects that students are interested in.

Even closer to home is the fact that there are really good blogs that speak to young people and cover these subjects in an entertaining way. I frequently recommend, for example, Ramit Sethi's blog to young people. Reading his blog for a year will ramp up people's financial literacy - both young and old.

The part that is not so easy is teaching when people need to get advice, when they need an objective analysis of whether they can afford the mortgage or whether they should take the adjustable rate loan or fixed rate loan.


  1. It is going to be hard to mandate this task on teachers. I think the parents, play a more important role in financial literacy than teachers.

    Unfortunately, most parents themselves need education in this area. Vicious cycle.

  2. I think that some financial education would be good for high school students. Many students will use the knowledge wisely, and they will make better financial decisions than they would have otherwise. For many other students, knowing how to use an amortization table isn't going to stop them from borrowing as much as lenders are willing to give them. Knowledge and good judgment are often only weakly correlated, and I think judgment is harder to teach in the classroom. So, my view is that financial education for high school students is a good idea, but we shouldn’t overestimate the likely benefits.

    My MBA is from the University of Chicago, and I remember hearing several of my classmates enthusiastically describe "investments" which seemed to me to be nothing more than sophisticated gambles. Surely, these classmates had more "financial literacy" than the average American will ever have, but I don't think they had good judgment...or, maybe I was just too dumb to recognize the excellent opportunities they had identified!

  3. Two facts, as food for thought:
    - Only 202 of the 500 biggest companies in the United States in 1980 were still in existence 20 years later.
    - On December 29, 1989, Tokyo's Nikkei stock average reached its all-time peak of 38,915.87. Twenty years later, the Nikkei has never again reached that level — and, in 2009, reached a new low of 7,054.98.

  4. @MoneyCone You are absolutely right about the comment on parents. They have the biggest influence and if they all did their job the rest of it would be fairly easy. Also, the comment about teachers is right on. They defend their turf and, at least in my experience , don't seem to be receptive on ideas.
    @Chad I agree that common sense is an important element. Many super smart MBAs from the top schools have learned the hard way that they can't outsmart the market. Read "When Genius Failed" by Lowenstein for the story of how Nobel Prize winners and quants almost brought the global financial system down.
    @Financial Independence Good facts. In fact, the second one is a prime example of why markets don't always revert to the mean and it isn't automatic that equities always outperform over the long term.