Financial Literacy

What should universities be teaching?

A few months ago, I agreed to act as faculty advisor to the W&M student-run financial literacy project. Since then, I have been thinking more about the role of financial literacy education at the university level. My thoughts on this are still evolving, but I would love to hear from readers ,who have comments to share, either publicly on this site or privately by email. You can reach me at: carl.tack@mason.wm.edu

One does not need to look very hard to find examples of apparent financial illiteracy in this country. Each year, American survey respondents fail to answer correctly half of the personal finance questions comprising the annual TIAA Institute-GFLEC Personal Finance Index. American adults find themselves regularly flummoxed by important financial decisions, such as how to prioritize spending, debt repayment and saving for retirement. University students incur large student loan debts, in many cases with no sense of the likely financial return on their educational investment or any real plan for how to meet their repayment obligations. Widespread ignorance of fundamental economic concepts regularly distorts the financial decisions of American individuals and businesses. And each summer at the Martha’s Vineyard Agricultural Fair, people from all walks of life choose to pay $12 for a double cheeseburger rather than pay $5 apiece for two singles, a clear pricing arbitrage which I look forward to exploiting with great pleasure. You might even say that I ‘relish’ this opportunity.

And so it may be that we do in fact have a financial literacy problem in this country. But what exactly is the problem and what role should universities play in addressing it?

Let’s explore.

Do we really have a financial literacy problem in this country? Based on personal experience, including 30+ years working in and around the financial services industry and another 10+ years teaching finance at the university level, I am prepared to accept the claim that too many Americans are not as financially literate as we should be. Rarely a day goes by that I don’t witness some sort of human behavior—on the street, in class or on the front pages of the Wall Street Journal—which suggests to me a troubling lack of basic financial understanding on the part of someone or another.

And I am not talking here about the inability of Joe Sixpack to calculate bond yields. I am referring instead to the fact that Joe cannot answer simple questions about his retirement plan; bright college students do not know how to think about the expected return on their educational investments; and many corporate executives, directors and investors regularly conflate expected revenue growth with shareholder value creation. And then of course there is the whole meme stock craze, which no doubt has Benjamin Graham rolling in his grave, where he may soon be joined by some large and presumably financially sophisticated short sellers.

It is of course possible that I have drawn the wrong conclusions from some or all of these observations. It may be that Joe Sixpack knows a lot more about his pension plan than seems to be the case, but he simply lacks the financial lingo to explain it in terms that I would understand. Many of those college students may in fact be making sound educational investment decisions, but they are doing so based on their intuition rather than explicit quantitative analysis. Revenue growth does often generate increased shareholder value, even if some corporate decision makers are a bit hazy on the reasons why. And it is certainly possible that Roaring Kitty and his followers know exactly what they are doing with GameStop, and that it may be the short sellers who do not know as much about finance (or human behavior) as they think they do.

All of this is possible, but I think quite unlikely. And so I am going to start from the premise that we do in fact have a financial literacy problem in America. But what is it?

What do we mean by “financial literacy”? In common parlance, the term “financial literacy” generally refers to matters of personal finance—budgeting, credit, taxes, insurance, basic investing etc—and these are in fact the topics covered in most university financial literacy programs (FLPs). But perhaps the term ‘financial literacy’ should be understood to encompass a broader range of financial understanding than just personal finance, particularly when we are talking about financial education at the university level, where students are presumably capable of learning more than just how to balance their checkbooks, file their tax returns and open an IRA.

I share the view that university graduates should understand at least the basics of personal financial management by the time they leave college, which seems to be the primary objective of most university FLPs. But shouldn’t we expect more than this, particularly from our top universities? Is it unreasonable to expect that students who graduate from top four-year universities—and not just the Finance and Econ majors—should be able to read and interpret simple financial statements and related financial data, have a sound grounding in elementary probability and statistics, and understand at a high level how banks and insurance companies work and why the Fed is important? Shouldn’t they also have at least a passing familiarity with basic financial concepts like the time value of money, opportunity cost and sunk cost, marginal and effective tax rates, and the relationship between investment risk and return? And be able to converse intelligibly (if not always intelligently) on a wide range of civic financial matters, including the future of Social Security and the federal debt?

I for one do not think this is at all unreasonable, at least as an aspirational goal, and I would like to see our university FLPs go beyond their current focus on personal finance and incorporate into their programs some of the more conceptual material taught in introductory finance, economics and statistics courses, for the benefit of those students who for whatever reason are not currently getting this.

How widespread is American financial illiteracy, and what are the consequences? I really have no idea, and I am not sure that the experts do either. I am familiar with various reports on the state of financial literacy across the world, including this one from S&P, and while I am skeptical about some of the methodology and the quantitative extrapolations, I do not challenge the overall conclusion that too many people here and abroad seem to be financially illiterate. The S&P study, for example, concludes that the share of ‘financially literate’ adults in countries around the world ranges from a low of 13% to a high of 71%. The US is near the top of the ranking, just below 70%, but this still means that 30% or more of our adult population is deemed not to be “financially literate”, as measured by test questions that strike me as hard to get wrong.

Estimates of the impact of financial illiteracy on the US economy vary widely, but it is not unusual to see calculations of the annual cost in the hundreds of billions of dollars, equivalent to 1% or more or US GDP. As with the financial literacy estimates, I would suggest that we take these cost estimates with a very large dose of salt, but once again I do not challenge the overall conclusion that the impact of financial illiteracy may be large, at least for those individuals who regularly find themselves on the wrong end of perhaps ill-advised financial transactions, if not for society as a whole.

However we attempt to measure the extent or cost of financial illiteracy, we should be cautious about inferring (or assuming) a direct causal relationship between financial literacy and the precarious condition of many US household balance sheets. Press reports on financial literacy often reference the fact that something like half of American households have little or no cash set aside for emergencies or in defined retirement accounts, or that Americans have incurred almost $3 trillion of credit card debt and student loan debt, not all of which they will be able to repay on time and in full. And these reports often go on to attribute these economic outcomes (or choices) to the impact of widespread financial illiteracy in large portions of the American public, a conclusion which I think should be challenged more often than it is.

There are of course many reasons why so many US households seem to have so much trouble making ends meet, and end up with large net debt positions as result. We live in a country with a strong consumer spending culture, which has led some to suggest that Americans are “simply not wired to save”. The United States also has a highly skewed distribution of income and wealth, and the median US household income no longer pays for what many of us might consider to be a middle-class American lifestyle, which large portions of the population nevertheless struggle to achieve. As a nation, we have over the years made conscious public policy choices—for example with respect to tax policy, educational funding and housing finance—which have incentivized the incurrence of some forms of debt and penalized saving and investment. And so it should come as no surprise that Americans spend more and save less of their income than do people in other similarly wealthy countries, despite broadly similar levels of financial literacy (at least as measured in surveys).

There is no doubt that the level of financial literacy is lower in poor households than in wealthy households. And wealthier families of course have more money socked away for emergencies and retirement than do poorer families. But once again we should be cautious in drawing inferences about the causal relationship between financial literacy and financial outcomes (or financial choices). I am not suggesting that financial literacy does not play a role here—it almost certainly does—but I am suggesting that financial illiteracy may be as much a consequence as it is a cause of the skewed economic demographics in this country.

Finally, I will note that the consequences of financial illiteracy likely go well beyond matters of personal finance. To cite just one timely example, polling data suggests that a large portion of American voters regularly cite ‘the state of the economy’ as their top voting priority, but voters’ perceptions of the current condition of the economy often bear little resemblance to the actual state of the economy as reflected in the published economic data. A large number of voters apparently believe that US unemployment and inflation are both today at all-time highs, which of course is not even close to true, even if we measure this just over the past five years. But is this really an example of public financial illiteracy (for example confusing the current level of prices with the rate of change of prices), or is it rather an example of some other social ill (like fact-free hyper-partisanship among voters) which may have quite different implications?

What are American universities doing to promote financial literacy? The short answer for most American universities appears to be ‘very little’ and I think we should ask why. As far as I can tell from my admittedly selective review of public websites, many universities today do not offer much in the way of formal financial literacy education. And what little they do offer seems targeted primarily to financial aid recipients and particularly to those with student loans.

At the other end of the spectrum, some public and private universities have developed quite extensive FLPs. [See links at the end of this post.] These programs are often housed in ‘financial literacy centers’ with dedicated staffing and presumably a large amount of financial support. The content of these programs seems to cover all of the key personal finance topics, delivered via online courses and tutorials, in-person group presentations, links to third party sites and in some cases personal financial consulting. I cannot tell from the outside how effective these programs have been either in reaching their target audiences or in impacting financial learning and behavior, but the scale and scope of the programming on offer is quite impressive, and a stark contrast to what seems to be available at most American universities.

Why haven’t more American universities followed the path forged by the leaders and developed their own FLPs? Do these universities really not see a pressing need for enhanced financial literacy across their student bodies, and not just among financial aid recipients? Do they perhaps believe that financial literacy education is somehow beneath them and should be taught elsewhere, say at home or in high school, like learning to read, swim or drive a car? Is the lack of university financial literacy education simply a matter of “insufficient funding”, which often translates as “other higher priorities”? Or is it something else entirely?

I don’t know, but frankly I am not sure that we should expect much to change in this regard without a big push from students, parents, alumni and donors, or perhaps as a result of expanded government mandates as we have seen at the state level for K-12 schools.

What is W&M doing in this regard? W&M is not yet where we want to be with respect to financial literacy education, but we are working toward a goal of offering a formal campus-wide, student-run FLP sponsored by the Boehly Center for Excellence in Finance. This will be in addition to the more advanced co-curricular financial education programs and activities already hosted by the Boehly Center. As at other universities, the initial focus of the W&M FLP will be on personal finance, with a mixture of created and curated content delivered to students through a combination of online and in-person programming, including special topic mini-courses. In contrast to the FLPs at other universities, however, W&M plans to expand the scope of our programming beyond personal finance to address some of the other subject areas mentioned above (basic accounting and finance, financial institutions, civic finance, etc). Our goal is to produce liberal arts graduates who are capable not only of managing their own personal financial affairs, but who also understand how to use some of the basic tools of finance to make more informed decisions in their roles as engaged employees, citizens and civic leaders.

W&M is still in the very early stages of rolling out its FLP, but thanks to the efforts of a small group of dedicated student volunteers, we have now introduced some elementary personal finance content into the summer orientation program for all new W&M students. Over the next few years, we intend to improve and expand this programming into a more fulsome four-year financial literacy curriculum addressing topics of particular concern to students as they progress from incoming freshmen to graduating seniors. And down the road we hope to make some of this material available to other university constituents, including faculty, staff, alumni and the local community.

How effective are financial literacy programs? For some time now, there has been a large amount of good financial literacy material widely available to the public, provided by a wide variety of commercial, non-commercial and governmental sources. We also have years of experience with formal financial literacy programs offered in many K-12 schools, if not yet at most universities. But despite these efforts, the empirical evidence on the efficacy of financial literacy education is generally not encouraging.

I am not sure why this is, but I suspect that part of the problem may be that we do not really understand how to measure or quantify the state of financial literacy in this country, let alone how to isolate the impact of financial literacy education on financial outcomes at either the personal or national level. It may also be that many of our national financial literacy efforts are either too new and/or too modest in scale and scope to generate the sort of results that we seem to expect. But it may also be the case that we are not teaching financial literacy in ways that will be most effective, even in our schools.

I am not an expert in pedagogy at any level, either university or K-12, but I have observed enough to question the efficacy of some of our traditional teaching methods. As with other subjects, financial literacy education seems to be most impactful when it is delivered to the right people, at the right time and in the right way. One-off “Personal Finance 101” seminars and lengthy YouTube tutorials on selected topics do not seem to be very effective, even when they are well-done, and students will not readily absorb content which they do not perceive as directly relevant to them personally in the here and now. And this absorption or retention rate does not seem to improve when students are required to pass mandatory financial literacy tests in order to graduate (as is the case in some high schools). Even poor students are generally good at passing exams (if not by much), but this doesn’t always mean they learned very much, or that their learning will last much beyond the final exam date, particularly when this material is not regularly reinforced.

This may seem obvious, but we need to think very differently about teaching financial literacy to elementary and high school students than to college students and adults, and we need to teach it differently to college freshmen living away from home for the first time than we do to graduating seniors about to begin working full-time without an overdraft line from mom and dad. I also suspect that we may need to focus more on teaching students ‘how’ to think financially, rather than just ‘what’ to think or how to behave. When we teach basic budgeting, for example, I would like to see us get away from presenting simple ‘saving rules’ (“set aside X% of your income and you will live a happy life”), and instead help students understand why saving is important and how to think more deeply about some of the tradeoffs between spending now and spending later. And in the process, perhaps we can introduce more students to the notion of ‘time value of money’, a foundational concept of financial economics which the vast majority of students graduating college today have probably never heard of or thought about, at least not explicitly.

Change is possible. For all of these reasons, I think we should remain cautious about the magnitude of the impact which we expect expanded financial literacy education programs to have on individuals’ financial decision making, let alone the aggregate state of American household finances. But this does not mean that significant change is not possible, and worth pursuing, even if the progress at times seems very slow.

As noted, W&M is still in the very early days of launching our own FLP, but we already see more students file tax returns to recover the excess taxes withheld on income from their summer jobs and cut back on their spending at Starbucks to fund savings accounts or even newly-opened Roth IRAs. We see students rethinking their plans for graduate school based on their estimation of the true economic cost of the investment and the likely financial returns. And we see students discovering that the civic and social issues that they care so deeply about have important financial aspects that they had not previously considered and may not have understood. All of this is good, and exactly the sort of thinking which universities should be encouraging and promoting, whether or not it moves the meter on a national scale.

And change is apparently possible even here on Martha’s Vineyard, where rumor has it that the West Tisbury Fire Department has finally woken up to the incongruity in its Ag Fair burger pricing model, unfortunately by increasing the price of single burgers. I will miss my $2 arbitrage, but I have to admit that this seems a rather small price to pay for such a clear demonstration of enhanced financial literacy here on the Island. And despite my personal monetary loss, I am thankful to the members of the WTFD not only for grilling such tasty burgers over the years—and of course for putting out all those fires—but also for providing me with such good financial food for thought, which needless to say I relish sharing with my students.

And, of course, with all of you.

Links to Selected University FLPs

UVA

VCU

Indiana

Penn State

Stanford

Yale