Over the course of the past several decades, the financial environment of the United States has changed considerably. Families and individuals must deal with stagnant wages and escalating expenses, predict future financial needs and manage risk in a complicated financial marketplace both before and after retirement. Simultaneously, financial products, including mortgages, banking products and investment options, have become increasingly more complex and numerous, forcing families and individuals to select from a vast assortment of choices.
Within this environment, the impact of not possessing the skills and knowledge necessary to make prudent financial decisions has the potential to be even more damaging than before. This is particularly the case during times of economic distress, as was evidenced by the Great Recession, when resources became more limited and negative financial contingencies, such as unemployment and unexpected expenses, became more commonplace.
According to the U.S. Department of the Treasury (Treasury), financial literacy is "the ability to use knowledge and skills to manage financial resources effectively for a lifetime of financial well-being." Financial literacy is closely related to financial capability, which Treasury defines as "the capacity, based on knowledge, skills and access, to manage financial resources effectively." Financial literacy has been shown to improve financial decision-making in a number of areas, including budgeting, managing credit, discretionary spending, saving, investing and planning for retirement. For instance, a recent study conducted by the TIAA-CREF Institute reveals that people with lower levels of financial literacy are more likely to engage in high-cost borrowing, more likely to pay only the minimum amount due on credit cards, less likely to invest in the stock market and less likely to actively plan for retirement.
Yet, the current state of financial literacy and capability among our country's population is less than ideal, as demonstrated by a number of surveys. For example, one study conducted by Lusardi and Tufano in 2009 showed that more than half of older adults did not understand the concepts of inflation, simple compounding or investment diversification, and just one-third of participants understood how credit cards work or what factors determine their credit score.
Unfortunately, the first national survey of financial capability, commissioned in 2009 by the Financial Industry Regulatory Authority (FINRA) in partnership with Treasury and the President's Advisory Council on Financial Literacy, revealed similar results. A considerable proportion of U.S. households have low financial capability and find it difficult to meet their financial obligations, plan ahead and manage financial products. On average, measures of financial capability were found to be lower among vulnerable and marginalized populations, including the less educated, low-income earners, seniors, African-Americans and Hispanics. Perhaps unsurprisingly, the same study found that America's youth are less likely to be financially capable than older Americans. The results of this and other surveys underscore the need for better financial education in and outside of our nation's schools.
So, what can we as a country do to address this problem and improve the financial literacy and capability of our nation?
Parents must make a commitment to improve the financial literacy of their children. It is often said that children learn what they live. Parents should make a conscious effort to engage in frequent, substantive conversations about financial issues with their children. These discussions are opportunities to provide children with tools that will pay dividends long after college.
Financial education must become an embedded part of K-12 education. Similar to math, science and reading, financial education must start early. However, even though financial decision-making is more complicated now than ever before, only 24 states require this type of instruction. And only four of those states require students to take a course devoted to personal finance in order to graduate. High school graduates represent a significant population of future financial decision-makers, and although their market presence is currently insignificant, it will inevitably grow in the coming years. Thus, the need to educate our youth on the importance of budgeting, investing, saving, choosing financial products, establishing good credit and dealing with negative financial events, such as the loss of a job or a sudden decrease in income, so that they can make prudent financial decisions as their wealth increases.
Teachers need proper training to teach financial concepts. The National Endowment for Financial Education recently conducted a survey that showed that almost 90 percent of the participating K-12 teachers believe that students should be required to take a personal finance course, or at least pass a competency test. However, only a fraction of those teachers felt that they were qualified to teach such a course. In the 24 states that require personal finance education, almost two-thirds of the teachers surveyed believed that they were not well prepared to teach the required personal finance curriculum.
Government agencies and financial institutions should collaborate more in financial education programs. Money Smart is a financial education curriculum of the FDIC that is designed to help low- and moderate-income individuals improve their financial skills and develop positive banking relationships. Since its launch in 2001, Money Smart has reached more than 2.75 million consumers. Research shows that the curriculum has a long-term positive influence on how participants manage their finances. Financial institutions and other organizations interested in sponsoring financial education workshops may use the Money Smart program, and banks can even fulfill part of their Community Reinvestment Act obligations through participation. More collaborative programs like Money Smart are needed.
Financial literacy and financial capability are issues that are extremely important to our nation's economic future. To maintain a globally competitive economy in the years to come, the U.S. needs a population that is capable of planning for and managing its financial well-being. For that to occur, financial literacy and capability among Americans must improve, and parents, schools, financial institutions and government must all take an active role in improving our citizens' level of financial literacy.