Annamaria Lusardi On Improving Financial Literacy

Introduction

As the world becomes increasingly financialized, an understanding of financial concepts has become essential for navigating daily life.

So what percentage of the population is actually financially literate? Are there differences in the rates of financial literacy of various demographic groups? And what should be done to improve financial literacy?

I sat down with Professor Annamaria Lusardi of Stanford University, a leading expert on financial literacy, to discuss her research into these questions.

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Professor Lusardi’s Background

Aiden Singh: You’re an economist by training. There are, of course, numerous areas of specialization within economics. What drew you, in particular, to the topic of financial literacy? 

Annamaria Lusardi:  I was drawn to it because when I was looking at, for example, savings behavior, I wasn't able to explain all of the differences that I found between people. And it struck me that people who seem very similar - similar income, similar education - would end up at retirement with vastly different amounts of wealth.

I thought the explanation required something more than what we have included in our thinking, in our economic models. 

And I always thought that knowledge of some of the important concepts about planning or investing could be an important determinant of the differences in wealth. 

That’s how I started to investigate financial literacy. 

And I discovered that there was no data on financial literacy, which then led me to design financial literacy survey questions in collaboration with other academics.

Now I use that variable - financial literacy or knowledge of basic financial concepts - to explain differences in behavior and to explain why it is that some people are more likely to plan, to have precautionary savings, to invest in financial markets, to insure, and so on.

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Defining Financial Literacy

Aiden Singh: Before we discuss how you and your colleagues have attempted to measure it, could you share with our readers how you define financial literacy?

Annamaria Lusardi: We had to work a lot on coming up with a definition.

A short non-technical answer is that financial literacy is the knowledge of and ability to use the fundamental concepts in finance to make financial decisions.

Back in 2010, I worked with the OECD which had put me in charge of leading a team who had to measure financial literacy for the Programme for International Student Assessment (PISA). We had to assess whether 15 year olds are financially literate. 

We came up with the following definition: “Financial literacy is knowledge and understanding of financial concepts and risks, and the skills, motivation, and confidence to apply such knowledge and understanding in order to make effective decisions across a range of financial contexts to improve the financial well-being of individuals and society, and to enable participation in economic life.”

This definition emphasizes several important things.

First, it emphasizes that financial literacy is, of course, about knowledge, but also about the motivation and ability to apply that knowledge. So it treats knowledge as a means to an important objective: effective decision-making which enables achieving financial well-being.

Second, it emphasizes that financial literacy is not just for the benefit of the individual, but also for the benefit of society.

Third, it emphasizes that the final objective of being financially literate is participation in economic life. I always say that financial literacy today is as important as reading and writing. You can be an extremely smart person, but if you cannot read and write, you cannot participate in society. And the same is true for financial literacy.

We all have to make important personal financial decisions constantly. And we also vote, and a lot of the things we vote on are related to important financial concepts - think of pension reforms or changes in student loans. It’s very important for people to understand the financial concepts underlying these policies.

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Measuring Financial Literacy

Aiden Singh: So you and a colleague, Professor Olivia Mitchell, developed a three question survey - known in the literature as ‘the big three’ - to measure financial literacy. 

At the time, circumstances limited you to asking only three questions. Obviously trying to assess financial literacy in so few questions is a tall task. 

Can you share with our audience the three questions you devised, how you did so, and why you felt those three questions were well suited to the task given the constraints you faced?

Annamaria Lusardi: We were told we had to limit our survey to only 3 questions. And this was a big constraint. 

As a result, we worked for almost a year to design these three questions.

We consulted with a lot of experts in methodology and survey questioning because at that time, it was certainly not our area of expertize. We had previously always used data that was already collected. 

What we ended up considering were three fundamental concepts that are at the basis of every financial decision: interest compounding, inflation, and risk diversification.

We wanted to measure whether people know that interest compounds over interest, which can be critical for growing your wealth. This also describes how financial markets work.

The second concept, inflation, is also fundamental because a very important fact for our financial decisions is that prices increase over time. This is an important consideration for our finances. If we don't grow our wealth at least as much as inflation, we become poorer. And we wanted to assess whether people understood what inflation is and does. 

The third survey question was the one we had the most difficulty crafting: we wanted to measure people’s understanding of risk, which is an essential component of finance and financial markets. 

Risk is everywhere. Even leaving money in your drawer is unsafe because of inflation. So we tried to assess people’s understanding of risk and risk diversification.

The first question in our survey assessed whether people can do a 2% interest rate calculation. It asked, if you have $100 in your savings account and the interest rate is 2% per year, how much would you have in 5 years? It’s a simple test of whether people understand interest rates and interest compounding.

The second question was about knowledge of inflation. We asked respondents whether they would be able to buy more or less with the money in their account in a year’s time if inflation is 2% while the interest rate on their savings account is 1%. In the question, we use the word inflation without saying what inflation is. So this question is a joint test of knowledge of terminology and of what inflation does.

And the third question was a true/false question about whether buying a single company's stock is safer than buying a stock mutual fund. This question was a joint test of whether people know what risk diversification is and whether they know what a stock and a stock mutual fund are.

It's a complex question because it uses technical terms, but finance has its own language. And we wanted to assess whether respondents speak the language of finance.

We have since been able to add these three questions to national surveys in the US and around the world. We have now collected so much data over time, across countries, and across demographic subgroups that we know a lot about how much people know about these very basic concepts.

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The Overall Level of Financial Literacy

Aiden Singh: So you and Professor Mitchell put these three questions to respondents in an effort to measure financial literacy. At the aggregate level, what did you find?

Annamaria Lusardi: The results of our very first survey were striking: few Americans knew these basic concepts. Even in the most recent data, we found that only 43% of the population in the US can answer these three basic financial literacy questions. 

So not even half of the population in the most advanced country can answer the questions correctly. In the U.S., we ask people young and old to plan for their retirement, to manage student loans, to deal with credit cards, to invest in financial markets; there are cryptos, there are buy now, pay later programs, and so on. They do so with low levels of financial literacy.

And our most recent surveys confirm the early studies.

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Gender Differences in Financial Literacy

Aiden Singh: You’ve also broken down your findings by gender. Can you share with our readers what differences in financial literacy you found across genders?

Annamaria Lusardi: The gender difference is large: According to data from the 2019 Survey of Consumer Finances, 43% of the U.S. population are financially literate, but 48% of men are financially literate, while only 29% of women are.

We found gender differences in every data set we have looked at and it is a stable finding across countries. We did a global survey with as many as 140 countries around the world. There is a gender difference in financial literacy in almost every country in the world

In most surveys, the gap is 10 or 15 percentage points. It's a big difference.

And I have to say, as two female professors looking at this data, it was such an unpleasant finding.

Aiden Singh: What can be done to reconcile that gender difference?

Annamaria Lusardi: I think it's very important that we have programs targeting different groups of the population, because the needs are so much different.

And to do so, we need to understand where this gender difference comes from.

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Lack of Confidence Explains 1/3 of the Gender Gap

Aiden Singh: What explains the gender gap?

Annamaria Lusardi: The gender difference is present across every age group, in some countries it’s even present among 15 years old. So it starts early.

People might think, well, maybe it's just the older generations: women didn't participate in the market, and didn’t make many decisions.

But the gap is present even among the very young and it is also present among highly-educated women.

As we looked very carefully at this data, we found something very interesting.

Our financial literacy questions are multiple choice and there is a choice to say “I don’t know” or “refuse to answer”. 

What we found - and this result held true around the world - was, yes women are more likely than men to choose the incorrect answer, but they are also disproportionately more likely to choose “I do not know”.

We did an experiment in the Netherlands in which we asked respondents the big three questions in the normal way - with the option to choose “I do not know” - and then about six later, we took away the “I do not know” option.

What we discovered is many women know more than they think they do: when forced to answer, many women chose the correct answer. But when we asked them about their level of confidence in their answer, they told us they were not confident.

I see this in my classroom as well. I've been teaching personal finance for more than 10 years now. And when I ask a question in class, a lot of hands go up and normally it's not the female students. But if I ask a female student, she normally gives me the correct answer.

If women are not 100% sure they are correct, they don't want to venture to answer. They don't want to take the chance. They want to be sure. 

In finance, that's not a bad attitude: it might prevent you from doing something that's not good for you.

But it can also prevent you from growing wealth.

Our research into the causes of the gender gap found that lack of confidence explains about 1/3 of the difference, according to our Dutch data. Thus, confidence explains a good deal of the gender difference, but not all. 

There are probably a variety of explanations for the remaining difference. 

I would imagine that gender norms and culture really play a role. And maybe that explains why we see a difference in financial literacy even among 15 year olds.

Our findings also show that, unfortunately, a lack of knowledge and a lack of confidence prevent woman from investing in the stock market. 

And that can prevent them from growing wealth.

Our paper is titled: Fearless Woman: Financial Literacy and Stock Market Participation. Women need to be more fearless when it comes to behavior toward financial markets and toward investing.

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International Differences in Financial Literacy

Aiden Singh: You’ve also looked at differences in financial literacy across countries. What did you find? Are there differences between developed and developing countries?

Annamaria Lusardi: As mentioned above, in the U.S., less than half of people are financially literate. And we found pretty much the same result internationally: even countries that belong to the G7 or the G20 bloc have a low level of financial literacy. 

Even the Nordic countries, which do so well in education, have low levels of financial literacy. 

So there isn't a big distinction in the level of financial literacy amongst developed countries.

Nor is there a better result in the less developed countries. 

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Differences Between Immigrants & Those Born In The U.S.

Aiden Singh: And you’ve found differences between immigrants and those born in the U.S.?

Annamaria Lusardi: There is a difference between people who have immigrated versus the people who were born here.

Remember that what we are capturing in our surveys is also the level of understanding of the language of finance, and that means familiarity with the relevant institutions and concepts. So if you have recently migrated here from another country, you might be lacking some of the knowledge of how financial markets and institutions work here - you’re probably less likely to be familiar with terminology like 'stock mutual funds’ or ‘401(k)’ for example. 

Interestingly, our data suggests that immigrants who come from countries that have experienced high inflation tend to have a little bit more financial knowledge.

But unfortunately, overall, immigrants tend to be less financially literate than those born in the U.S.

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Correlation Between Level of Education & Financial Literacy

Aiden Singh: Is there is a correlation between the level of education a person has (e.g. university education vs. no university education) and their financial literacy? 

Annamaria Lusardi: Yeah, so as you can imagine there is, overall, a very strong correlation between financial literacy and education attainment. 

And, of course, education is also linked to income and wealth. 

The concepts in our surveys are very basic, and a college-educated person can probably do a 2% calculation in any context and probably has some idea about inflation.

But - and this was a striking finding - we still can’t take financial literacy for granted even among the college educated: although education is correlated with financial literacy, financial knowledge can be low even among those with high education.

And what this tells us is that general knowledge is not enough today: learning math and English in school doesn’t ensure financial literacy - we need financial education. Financial literacy is specialized knowledge not covered by general education.

As you can imagine, here at Stanford we have very talented students, very accomplished students. Yet many of them are financially illiterate.

And I'm not surprised - many students are not exposed to financial knowledge anywhere during their general education. In the US, some states have mandated financial education in school, but not all of them.

So of course people do not have this knowledge and being intelligent or being accomplished doesn't necessarily mean that a person is financially literate. 

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Differences Between Young & Old

Aiden Singh: Are their differences between younger and older generations?

Annamaria Lusardi: Interestingly, in our early data, we saw an inverted U shape when it comes to financial literacy: the young and the old tended to be less financially literate. 

We interpreted this as being the result of the young being young and therefore not having a lot of experience. 

And the poor result for the older generations could be explained by an age effect - for example, declining cognitive abilities. But it could also be that they belong to a generation where it was not as necessary to be financially literate.

For example, most of these people probably had a defined benefit retirement plan, unlike younger generations who have to face decisions about how to save for retirement.

So in our earlier data we found this inverted U profile. 

But interestingly, in our more recent data, we don’t find that result: financial literacy now seems to increase with age or generation. That’s probably because older generations today have to make important financial decisions much more so than in the past.

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Has Overall Financial Literacy Changed Over Time?

Aiden Singh: You’ve also looked at how overall financial literacy has changed over time. Unfortunately, your findings indicate it hasn’t really improved. Can you elaborate on this finding?

Annamaria Lusardi: Absolutely. We published an international comparison of financial literacy in 2011. And we’ve continued that work and our most recent comparison was published in 2023.

The results are very similar across years, meaning we see very little improvement over time. 

It's not surprising, I have to say, because I don't think that people learn by just watching the world around them: you don’t just acquire financial literacy because you are born in a country with advanced financial markets.

This finding is reflective of the fact that many of the initiatives to improve financial literacy have come about more recently and picked up after the 2008 financial crisis, which I think was a great wake up call. And 2008 was also a great demonstration of how much financial literacy matters: it showed that there are costs both at the individual level and the aggregate level. 

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Common Mistakes

Aiden Singh: So we’ve discussed how we might set about trying to measure financial literacy and what results studies have found. Do we have an idea of what areas of financial literacy people struggle with the most? What are some common mistakes?

Annamaria Lusardi: In addition to designing the three question survey in 2004, we have subsequently worked with the TIA Institute in collecting data on personal finance knowledge. 

In this research we didn’t have any constraints on the number of questions we could ask. We increased our survey to as many as 28 questions to measure financial literacy. And we built a personal finance index that covers the 8 major areas of financial decision-making today.

One of the things we discovered is that the topic that people are least familiar with are risk and risk diversification. And this is consistent with our findings with the big three.

Turning to behavior, we also find that people do not hold precautionary savings, so they don't have a capacity to handle an unexpected expense. This is a common finding among a large part of the population.

We also see that people tend to borrow in an expensive way: by carrying credit card debt. I always say to my students, I do not know of any stock that gives you a 25% return risk-free. So paying off credit card debt is really a good investment.

We also find that people often don’t try to get the best possible credit score. A high credit score is important for getting the best interest rates possible when borrowing. And getting a lower interest rate on a mortgage or on a car loan can save an enormous amount of money. So it’s very important.

We also see that people do not plan for retirement and for the future. But without a plan, people don't accumulate as much wealth as they could. Just engaging in planning really helps - setting a budget and having an objective is consequential for building wealth and financial security. 

We live in a world where millions of dollars are spent on trying to making us spend. When I was teaching at George Washington University, which is located in a very urban environment, I always told my students: “By the time you exit this classroom and get back to your dorm, you have a bunch of opportunities to spend money. In just that short walk there are probably five different places you could stop and buy something. But there is nothing on that short walk that tells you to save.” 

We know every trick to make people consume. 

And so, if you don't have a plan, you're probably going to spend more than what you would like to.

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Where Should Financial Education Occur?

Aiden Singh: Your research has found some pretty negative results about the levels of financial literacy. Where do you believe the financial education needed to improve this situation should occur? 

Annamaria Lusardi: I think it's incredibly important to have it in schools, for three reasons. 

The first reason is that financial literacy is a ‘privilege’: it is heavily concentrated among white males from college-educated and wealthy families.

We did a study where we looked at people aged 23 to 28 years old. And because we had panel data, we could look at the financial literacy of these young people when they were 12 to 17, so basically, when they were growing up.

We had a lot of information about them, reported by them. And we have information about their parents that is reported by the parents. 

What we found is that less than 30% of young people are financially literate - so a much lower percentage than the overall 43% of the general population that is financially literate. 

Of that 30%, the financially literate are disproportionately white males from college educated families. And we found that if you grew up in a family that has retirement savings and stocks when you were a teenager, you are more likely to be financially literate 10 years later.

This suggests that people learn financial literacy at the dinner table: if you have college-educated parents who have wealth, they're probably discussing their retirement decisions or the stock market and so on with their children. 

But, unfortunately, not many people have such parents.

So to level the playing field, it's incredibly important to have financial education in the schools. Otherwise, some people will never acquire that knowledge.

We have a a good proportion of first-generation college students here at Stanford. And it's amazing to see that, when you provide them with financial knowledge, they bring it home to their parents and their community.

So school is very important in term of access. 

We need to give this access to everybody because financial literacy is basic knowledge, like reading and writing. And to participate to society, you need to have this knowledge.

The second reason why financial education should occur in school is that we need this education to be rigorous. One of the problems of learning from others is that you might learn the wrong lessons - you might learn from people that know as little as you do. Basic financial education should be delivered in school by teachers and in a rigorous way.

And the third reason why I think it’s important that financial literacy training be provided in schools is that learning by experience is inefficient and painful. 

Why should people learn by mistakes? It’s much better to learn by being taught. We can think of financial education as mistake prevention.

Aiden Singh: What role should government play in the provision of basic financial education?

Annamaria Lusardi: There is a very important role for government because there is a big negative externality of financial illiteracy. The financial crisis of 2008 showed this.

As an economist, I'm almost never in favor of mandates, but I'm in favor of mandates here. I think it's important to mandate financial education in schools for the three reasons I've mentioned and, in particular, because we want that broad access to it.

And I also think that the role of a modern government should include equipping people with the skills they need to succeed in the future: we should promote the skills that are important for economic productivity. And finance is part of that. I would say it's also part of taking care of your citizens.

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When Should Financial Education Begin?

Aiden Singh: Is there an ideal time for financial literacy education to begin?

Annamaria Lusardi: There is an ideal time - when the tooth fairy comes. 

As soon as children get some money, they should start getting lessons on financial literacy - try to invest that dollar or whatever.

People think that children are not interested in money, but I always say “Give a kid a piggy bank and you will transform that kid into a very clever banker”. Kids are very interested in money because they understand it is important: ask a kid what money is for and they will tell you with no hesitation it is to achieve dreams.

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How Effective Are Low-Cost Financial Education Programs?

Aiden Singh: I want to talk about an area of optimism. You’ve conducted a global meta-analysis that found that low-cost financial education programs can work well. Can you tell me a little about the findings of that analysis?

Annamaria Lusardi: We looked at all of the available randomized controlled trial programs covering financial education in as many as 33 countries and 6 continents.

Our study shows that financial education is effective at improving a variety of financial behaviors.

And these effects cut across age. People sometimes think that such programs would be likely to affect only the young because it's hard to change the behaviors of the old. But we find evidence of improvement across all age groups. 

And we found that financial education programs are effective across countries - rich and poor.

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Conclusion

Aiden Singh: So I think a good note to end on would be to ask you the following question: to the non-investment professional out there who will read this interview, what are some of the key things you would want them to know? And to educators - financial or otherwise - who will read this, what would you like them to know

Annamaria Lusardi: Financial literacy is an essential skill for the 21st century - that's what I would like the educators to know and take away. 

I really hope that financial literacy education is going to be added to every school in every state in the US and in every country in the world because we all need this skill today to participate to society.

So that's really my main message for the educator. 

For the other people as well, I want to say that financial literacy should be part of our knowledge set. We are making a lot of financial decisions everyday and financial knowledge matters. We should be aware of that. We should use financial literacy to achieve our objectives. Financial literacy helps us to live better.

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