Could Financial Literacy Change the World?

Full Transcript

Note: This transcript was generated by an automated system and has been lightly edited for clarity. It may contain errors or omissions.

Kevin Cool: How did you learn about personal finance?

Amanda Studebaker: My very first boss was the one who taught me about personal finance.

Kevin Kelleher: I grew up with a father who was an accountant, then CFO, who was always you know very aware and paid a lot of attention to money.

Rachel Baker: I learned how to manage my money when I was about eight or nine years old.

Amanda Studebaker: When I graduated university, I went to Louisiana and I took this oil field job where, you know, being 20 years old, you’re making quite a lot of money. And so my first boss on my very first day took me around this workshop, and then at the end he was like, oh, if you have a couple more minutes, I would like to talk to you about something else. He had already created this spreadsheet that basically had columns for Roth IRA, 401(k), brokerage account, and he was showing me what it would look like when I was 30 and when I was 40, if I maxed out my retirement accounts every year and just seeing the numbers as a 20 year old of what I could have at 30 and 40 was amazing.

Kevin Kelleher: He would spend several hours a week, sitting at the dining room table, doing the family finances, reconciling all the credit card receipts.

And from that, I sort of grew up learning that that money was something valuable, something to pay attention to.

This also caused me to sort of learn the difference between assets and expenses. If I go buy an expensive set of pots and pans, that’s an asset that I’m going to be using for 10 or 20 years. Or if I go do something, well it’s a one time thing and it won’t be with me for 20 years.

Rachel Baker: I was in fourth grade and Mrs. Moy had us do this really creative project where we got to design our own checks. We earned money, in air quotes, for doing our work and we could get extra if we volunteered for things like wiping down the whiteboard in between classes.

Each month we had known expenses and then what was left could be used at the marketplace or school store. We would track everything in our checkbooks, which for the Gen Zers out there, that is an Excel spreadsheet on paper, and we learned to write checks — which is probably a lost skill now, too.

Amanda Studebaker: So he said, you can go out and use your paycheck and buy a big house, a big boat, a big car, keep up with the Joneses, or you can use it to invest and buy yourself freedom later on. I’ve learned there’s a term for that called “F-U Money.” and, I really like that term for it.

So he said at some time, at some point, this company is going to ask you to do something you don’t want to do, whether it’s at work or whether it’s moving to a location where you don’t want to live. And if you have money saved and you invest, then you can say no. And that was really powerful to me.

So I did what he said and started investing and maxed my 401(k) and IRA, and that’s the reason I’m now at Stanford because otherwise I never would have had the ability to determine I want to do something else and quit my job and take two years out of the workforce, so that single conversation was like the greatest gift you could have ever given me as a 20 year old.

Kevin Kelleher: I’d say the biggest benefit is, decisions about money are conscious decisions. I pay attention to what’s going on. I pay attention to how much things cost.

Rachel Baker: I learned a lot and those skills stayed with me.

Amanda Studebaker: Maybe it’s really kind of the anecdotes about like, this company is going to ask you to move somewhere you don’t want to move, so here’s a specific example of why you should be saving and investing.

Kevin Kelleher: I happened to be in high school when the first requirement came out from the State of California that kids learn how to do a checkbook. I knew how to do a checkbook already, but the curriculum was so poorly written, I actually failed that module.

Rachel Baker: I was amazed when my friends graduated college and didn’t know how to make a simple budget. Thanks Mrs. Moy.

Kevin Cool: Those are the voices of Amanda Studebaker, Kevin Kelleher, and Rachel Baker, who responded to our call out for your personal finance stories.

Their stories are emblematic of how many of us learned about money. And how we learn about money has meaningful consequences, not only for individuals, but for the global economy, according to Annamaria Lusardi, an economist and faculty director of the Initiative for Financial Decision-Making.

Today we’re going to talk about financial literacy, why so many people struggle with it, and what we can do about that.

Kevin Cool: This is If/Then, a podcast from Stanford Graduate School of Business, where we examine research findings that can help us navigate the complex issues facing us in business, leadership, and society.

I’m Kevin Cool, senior editor at Stanford GSB.

Annamaria Lusardi: We want to change the conversation about money in the U.S. And it is time. It is time to do that. Money is a topic that people consider difficult, that is taboo, that is also very complex. Personal finance is not just about the well being of an individual, it’s also about the financial stability of a country.

Kevin Cool: So let’s get into some of your research, and I want to base it on what seems to be the foundation of that research, which are the three questions that you developed to test a person’s financial literacy. So what did those questions deal with and what did you learn?

Annamaria Lusardi: First of all, let me just tell you that these questions measure the very basic concepts that we need to have in order to make financial decisions. In other words, they are at the basis of the financial decision we make every day.

So the concept are about interest compounding. So that’s how the financial market works. Interest compounds on interest. Inflation, or the fact that prices change over time. And risk diversification, the fact it’s important to spread your money into many assets rather than investing just in one stock or in one investment.

What we found is that even if you look at the population, which has already made many decisions, for example, the older group, in fact, the financial literacy is very low. In other words, people don’t have the knowledge of the ABC of personal finance.

Probably because it’s true that in many other countries as well, not just the U.S., this is not a topic that is taught in class or in school or taught formally, and so people don’t acquire this knowledge, but at the same time, we all have to make financial decisions.

Kevin Cool: So it’s not just an American issue that we’re dealing with here?

Annamaria Lusardi: No, it’s not at all just an American issue. Only one-third of the population globally is financially literate. In other words, financial illiteracy is as big as two-third of the global population.

Kevin Cool: And Annamaria, what’s the relationship between levels of financial literacy and overall financial well being?

Annamaria Lusardi: This was the most important questions we wanted to look at, right? Because the important question is, but does this knowledge matter? And in particular does it matter for the type of behavior that is important for people and that is linked to well being, so, for example, does it matter for growing your wealth? Does it matter for managing your debt well? Does it matter for making the type of decision, for example, about your house, or buying a car?

And one of the things I tell my students, but I also show it in many calculations, is that all of these decisions, in particular when you sum them up, they really matter. Perhaps all of that little saving that you did here and there, they can sum up to a large amount, and over time, they can really compound.

I wanted to tell you another striking statistic. When we ask people how many hours per week they dedicate to taking care of their finances and also, if they worry about their finances, to calculate that time as well, on average, people spend eight hours per week dealing with their finances, but much less so if they are financially literate. And that’s important too, and that’s why sometime we use the word financial freedom.

Kevin Cool: Right. So that leads me to wonder whether this is not only a concern in terms of how their money is being spent and what kind of wealth they might be able to build over time, but their mental health. Eight hours a week, that’s the equivalent of one working day every week worrying about money. That’s a lot.

Annamaria Lusardi: It’s a lot, and in fact, other surveys have shown when people think about personal finances, half of the Americans are actually worried about their finances and they feel anxiety.

And so that can be an effect, not just in term of saving and that, you know, we think of them as indicators of financial well being, but also in term of your mental health, of your feeling financially secure, feeling free to make good choices.

Kevin Cool: So as we think about this, and one of the things that you mentioned earlier that was striking to me was that these findings cut across age groups, because when I think about how do people attain financial literacy, how do they know more about money or how to make good decisions, one would assume that just life experience gives you a certain amount of knowledge maybe because you you’ve made some terrible mistakes along the way, but that doesn’t appear to be the case necessarily.

Annamaria Lusardi: No, and I think for several reasons. First of all, many decisions in terms of finance, we don’t repeat many times. You don’t retire many times. You don’t buy many houses. You don’t buy many cars so much so that you can learn by repeating these decisions.

Second, I think sometimes it’s really hard to understand interest compounding just by looking at your credit card. Right? Some of these calculations are relatively complex. So if you look at the credit card and you see that these minimum payment changes over time, do you really understand what’s the mechanism behind that?

The other thing I would like to argue is that, I think it’s very inefficient and painful to learn by mistakes. You know, I’m always thinking of this comparison with health. Prevention is always better than the cure, and it’s also cheaper.

Think of during the financial crisis, people who took up the wrong mortgage. It seems to me a very painful lesson to learn and potentially there are better ways to learn about mortgages.

Kevin Cool: Well, that resonates with me because I made some of those mistakes when I was in my 20s and I was, someone who grew up in a household with a college educated parent, but there wasn’t really any instruction about how to use money and so when I started, accumulating credit card debt month to month, I had a very small amount of discretionary income.

Well, I don’t want to pay three-fourths of my discretionary income to pay off this credit card when I can only pay $20 and push it to next…Well, of course, that’s a terrible trap to get into. You’re just paying the interest and so on. So yes, these mistakes can happen, without you really noticing, I think.

Annamaria Lusardi: You know, we face a financial system that’s very clever. And where there is always a lot of innovation in what they do. We spend millions of dollars for people to spend. And we know all of the tricks to make people spend. We have not used any of those tricks to make people save.

Kevin Cool: So we know the problem, do we fix it?

Annamaria Lusardi: I think there are ways to fix it. One big solution, which I think is particularly important, is to add financial education in school as soon as possible.

We learn about literature, we learn about history, we learn about geography very early on and we should learn about money as soon as possible. I think I would say, as soon as the tooth fairy comes.

Kevin Cool: As soon as the tooth fairy comes, yeah.

Or lots of kids still get allowances, right? And so if you’re getting $10 this week, are you going to spend the whole $10? What are you going to do with it? Right.

Annamaria Lusardi: Look, what happened is you give people money, and the idea is you spend it. No, that’s not the point.

Then I want to argue not just in school, but also at college. And it should be a continuous education because the financial system continues to change and continues to be complex in a way that allows us to do things we weren’t able to do before.

We also should have, for example, some education in the workplace, because for the adult population already out of school, that’s another place where I think both the employer and the employee can benefit from that financial education. And what we found is that on average, people spend four hours at work dealing with our personal finances. So no matter how, if you have personal finance concern about, you know, not being able to pay your credit card or having the mortgage come due and so on – your productivity is going to be affected. And if you’re not saving enough for retirement, you might not be able to retire. And that’s going to affect your work and how long you stay at work. If you made poor financial decision, you might also make bad judgments and do things at work that might not be beneficial for your work environment. And so even the employer can benefit from investing in financial education.

Kevin Cool: Even something as simple as knowing what a 401(k) is. Because, a lot of people when they begin retirement, they don’t know what a 401(k) is.

Annamaria Lusardi: Absolutely. You know, sometimes when we speak to firms, the first thing we say, you know, one of the benefits of personal finance education is that the worker will finally appreciate the benefit that you offer to them. Many people, indeed, they don’t know what a 401(k) is, what an HSA is, what are the benefits that the employer offers.

Kevin Cool: Does this have an effect on the macroeconomy at some level?

Annamaria Lusardi: So we are able to certainly establish that there is a strong connection, a strong link, and I would say, we were able to show it’s also a causal link between financial literacy and behavior. I think the one time where we have seen this is during the Great Recession or the financial crisis, where basically people engage often in mortgages they could not afford.

And we did see the consequences in the economy. It was quite dramatic also, it was one of the most long lasting recession because it affected one of the assets that most people have, which is the house.

Kevin Cool: And it had effects on neighborhoods, communities.

Annamaria Lusardi: And so this is why I would argue it’s not just an individual effect. It does have a strong spillover effect to the macroeconomy and to your community.

The second time we have seen it very clearly is during the COVID pandemic and the shutdown of the economy,

And we saw also the line to the food bank starting right away. And we saw that the cars that were lining up sometime were expensive cars. So it wasn’t just the lower income and lower education who were, in a sense, lacking those types of support, meaning many people don’t make provisions for shocks.

And we saw that this is very strongly linked to financial literacy as well. Again, we cannot always count for the economy doing well. We cannot always count on our capacity, for example, to work.

Kevin Cool: So when we think about education broadly across the population, one of the interesting findings from one of your studies is that people think they know more about finances than they actually know. And so it would seem that that kind of overconfidence could be a barrier to education in itself. What are your thoughts about that?

Annamaria Lusardi: So when we look at the older population, for example, we see that they assess their knowledge as being a good one. And in fact, it’s quite low. And so there is a wide gap between the perceived self-assessed knowledge and the actual knowledge. And I think it is a risk because the older population is also the one that has wealth. So they can be particularly subject to scams and so on.

And that’s why, in my view, it’s important to also change this conversation about money. It’s even important to tell people, perhaps, tests are good. Perhaps, you know, before you make a judgment about yourself, before you make an important decision, maybe you want to assess how good you are at this. Perhaps you need to discuss this with other people so you can make a more informed decision.

Kevin Cool: So, to your point that we don’t teach financial literacy in public schools right now, so how do the people who are financially literate, where do they get that information? How do they become literate?

Annamaria Lusardi: I’m so glad you asked this question because I have a paper that very few people cite, but I think is one of the best paper I’ve written or the one where I’ve learned the most. And we are able to measure financial literacy in this sample of young people where they are 23 to 28 years old.

And we are able to show that this financial literacy actually can be linked to the wealth of the parents when they were growing up.

What does it mean? That this knowledge is acquired at the dinner table in the families and households where, of course, there is, guess what, high income and savings, retirement savings, and investment in stocks.

In fact, one of the results that we show is that the level of financial literacy among the young is very low, but disproportionately so among women, minorities, Black and Hispanics, and family where parents didn’t go to college and with low-income and low education.

In other words, financial literacy is a privilege today, is disproportionately concentrated in the high-income, highly educated families. And those families transmit knowledge to their children.

For some of these families, this is normal and they learn it at home. But how about everybody else? And this is why it is so important to have it in the school. Because then everybody can have access to that education.

Kevin Cool: We’ve talked about the importance of teaching financial literacy in schools. So clearly it would benefit those students themselves. But is there also a multiplier effect?

Annamaria Lusardi: There is a multiplier effect. We see it in our classroom, in particular among the first generation student. You give this course and you provide financial education to a first generation student, they bring it back to their parents, to their community. And it’s amazing, in fact they come to our office hours and they tell us they have become the financial advisor to their parents and it’s one of the most gratifying parts of teaching personal finance.

I also see it in the data. We have published a very large study of financial education among a very large set of schools in Peru. And the findings are impressive. So first of all, not just financial education improves the knowledge of the students, but improves the knowledge of the teachers and improves the knowledge of the parents.

In fact, when they look in particular at the parents, they found a differential effect, which is that it is the parents of low socioeconomic status who gets more financial literacy, basically because the children are at school, and it is even better, which is it is the daughters who teach their lower education parents.

So I feel not just if you give financial education to a girl, you will empower the girl, but this girl is going to go and change the world, is going to bring financial education to their parents, and my bet is going to bring it to other community as well. And it can really be life changing.

Kevin Cool: Do you see any direction that would lead you to be optimistic that this will happen soon?

Annamaria Lusardi: So I am optimistic because we see, for example, that many states in the U.S. are now making financial education mandatory in school. I see also many more universities and colleges teaching personal finance. This was not the case when I went to college, for example, and now, at Stanford, we have a course on personal finance. It’s one of the most popular courses in economics.

By the way, we teach corporate finance. So when it comes to the money of the firms, it’s very obvious that the CFO need to have knowledge about finance. But how about our own finances? We are our own CFO. So we also need to have that basic knowledge of finance to manage our money well. And by the way, it can be as little as possible. In fact, if we have little money, we have to be even more savvy.

Kevin Cool: So this sounds like something that if we instituted this in all the public schools in America, for example, it probably will still take half a generation, maybe, to make a difference, right?

Annamaria Lusardi: We need to start and we need to do it as soon as possible: anytime we lose a year, you know, we are not informing and not empowering a generation of young people. But we need to do more.

We need to have this conversation, and we can have this conversation in many places. You know, we can have it at the church. We can have it on TV. We should have a good website where we go and get the information. Artificial intelligence will potentially provide that information as well.

Kevin Cool: You actually anticipated my next question, which was, how do you respond to the argument that, well, I mean, in the age of AI, what’s people’s answer to something they don’t know how to do, whether it’s, fix their screen door or whatever. I’ll Google that.

Annamaria Lusardi: Yeah, so you cannot Google yourself to financial independence because you need to know which question to ask. If you are passive and you don’t know which question to ask, you might not be getting yourself on the good path to financial independence. So artificial intelligence is artificial, I think, you know, it’s not going to necessarily make us smarter if we don’t know how to use it.

Kevin Cool: So you’ve been teaching for decades and twenty years or so involved in the financial decision making. How does an economist end up there?

Annamaria Lusardi: This is a new field. It’s a new topic. and I come to this having done a lot of research on it. And I think it’s a great field because first of all, it’s a good application of economics and also by teaching personal finance I can tell more about the working of the financial system.

Overall, I think it’s also a course about general knowledge. You know, when student take this course, they learn not just how to frame financial decisions, but they know a lot more about the working of the economy, the working of financial markets. They know about rules and regulations and why they exist.

Kevin Cool: You could argue they’re better citizens as a result.

Annamaria Lusardi: Absolutely. In some countries, by the way, financial education has been added to civil education. By knowing personal finance, they’re also better able to understand, for example, the working of central banks, the working of government and what they are doing for the citizens, so I think we will be better citizens with more financial literacy.

I would like to teach a course, which is titled “Personal Finance for Poets.”

Kevin Cool: Oh, that’s brilliant.

Annamaria Lusardi: Because if you don’t hint to the student that this is going to be fun, right? The course is “Introduction to Financial Decision Making.” If you are a student in the classic, you are never going to take that.

Kevin Cool: If/Then is a podcast from Stanford Graduate School of Business. I’m your host, Kevin Cool. Our show is written and produced by Making Room and the content and design team at the GSB.

Our managing producers are Michael McDowell and Elizabeth Wyleczuk-Stern. Executive producers are Sorel Husbands Denholtz and Jim Colgan. Sound design and additional production support by Mumble Media and Aech Ashe.

And a special thanks to Amanda Studebaker, Kevin Kelleher and Rachel Baker.

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Kevin Kelleher:  At one point I bought a mid 1950s fire truck that I owned for two years, paid about $3,000 for it. And then about 10 years later, due to trouble finding a place to park it, I sold it for about the same amount I purchased for it. I wish I hadn’t sold it because I had a lot of fun driving it around.