Module 1
Why Financial Literacy Is So Important
Few are prepared as financial decision-making grows more complex
TOPICAL GUIDE:
1. Financial Literacy in Decline
2. What Is Financial Literacy?
3. Trends Making It More Important
4. Why Financial Literacy Matters
5. The Bottom Line
TOPIC SUMMARY:
Financial literacy is the education and understanding of various financial areas
including topics related to managing personal finance, money, borrowing, and
investing.
Trends in the United States show that financial literacy among individuals is
declining, with only 34% of respondents correctly answering four out of five
questions posed by FINRA on the topic.
At the same time, financial literacy is more important than ever as people
manage their own retirement accounts, trade personal assets online, and carry
student, medical, credit card, and mortgage debt.
Financial Literacy in Decline
As consumer habits and financial products change, financial literacy has taken a
blow. In past generations, cash was used for most daily purchases; today, it's rarely
flashed—particularly not by younger shoppers. The way we shop has changed as well.
Online shopping has become the top choice for many, creating ample opportunities to
use and overextend credit—an all-too-easy way to accumulate debt, and fast.
Meanwhile, credit card companies, banks, and other financial institutions are
inundating consumers with credit opportunities—the ability to apply for credit cards
or pay off one card with another. Without the proper knowledge or checks and balances,
it is easy to get into financial trouble.
Many consumers have very little understanding of finances, how credit works,
and the potential impact on their financial well-being for many, many years. In
1
,fact, the lack of financial understanding has been signaled as one of the main
reasons many people face problems with saving and investing.
Every few years, the Financial Industry Regulatory Authority (FINRA) issues a five-
question test as part of its National Financial Capability Study, which measures
consumers' knowledge about interest, compounding, inflation, diversification, and bond
prices. On its most recent test, only 34% of those who took the test got four out of five
questions correct, which suggests that the basic economic and financial principles that
underpin these problems are widespread, touching every state in the country in different
ways.1
What Is Financial Literacy?
Financial literacy is the confluence of financial, credit, and debt management
knowledge that is necessary to make financially responsible decisions—
decisions that are integral to our everyday lives. Financial literacy includes
understanding how a checking account works, what using a credit card really
means, and how to avoid debt. In sum, financial literacy has an impact on families
as they try to balance their budget, buy a home, fund their children’s education,
and ensure an income at retirement.
A lack of financial literacy is a problem not only in emerging or developing
economies. Consumers in developed or advanced economies also fail to demonstrate
a strong grasp of financial principles in order to understand and negotiate the financial
landscape, manage financial risks effectively, and avoid financial pitfalls. Nations
globally, from Korea to Australia to Germany, are faced with populations that do
not understand financial basics.
The level of financial literacy may vary with education and income levels, but evidence
shows that highly educated consumers with high incomes can be just as ignorant about
financial issues as less-educated, lower-income consumers (though, in general, the
latter do tend to be less financially literate). And it seems consumers are hesitant to
learn. The Organization for Economic Co-operation and Development (OECD) cited a
survey conducted in Canada in which people reported that they found choosing the
right investment for a retirement savings plan was more stressful than a visit to
the dentist.2
Trends Making Financial Literacy More Important
Compounding the problems associated with financial illiteracy, it appears
financial decision-making is also getting more onerous for consumers. Five
trends are converging that demonstrate the importance of making thoughtful and
informed decisions about finances:
2
,1) Consumers are shouldering more of the financial decisions
Retirement planning is one example of this shift. Past generations depended on
company pension plans to fund the bulk of their retirement. Pension funds,
managed by professionals, put the financial burden on the companies or governments
that sponsored them. Consumers were not involved with the decision-making, typically
did not even contribute to their own funds, and they were rarely made aware of the
funding status or investments held by the pension. Today, pensions are more a rarity
than the norm, especially for new workers. Instead, employees are being offered the
ability to participate in 401(k) plans, in which they need to decide how much to
contribute and what to invest in.
2) Savings and investment options are more complex
Consumers are also being asked to choose among various investment and
savings products. These products are more sophisticated than in the past,
requiring consumers to choose among different options that offer varying interest rates
and maturities, decisions they are not adequately educated to make. The choices made
from among complex financial instruments with a large range of options can impact a
consumer’s ability to buy a home, finance an education, or save for retirement, adding
to the decision-making pressure.
3) Government aid is lacking
A major source of retirement income for past generations was Social Security.
But the amount paid by Social Security is not enough, and it may not be available at all
in the future. The Social Security Board of Trustees reported that by 2034 the Social
Security trust fund may be depleted, a scary prospect for many. So now, Social
Security acts more like a safety net that barely provides enough for basic
survival.3
Longer lifespans mean we need more money for retirement than earlier
generations did.
4) The financial environment is changing
The financial landscape is very dynamic. Now a global marketplace, there are many
more participants in the market and many more factors that can influence it. The
quickly changing environment created by technological advances such as
electronic trading makes the financial markets even swifter and more volatile.
Taken together, these factors can cause conflicting views and difficulty in creating,
implementing, and following a financial roadmap.
3
, 5) We are inundated with choices
Banks, credit unions, brokerage firms, insurance firms, credit card companies,
mortgage companies, financial planners, and other financial service companies
are all vying for assets, creating confusion for the consumer.
Why Financial Literacy Matters
Financial literacy is crucial to help consumers manage these factors and save
enough to provide adequate income in retirement while avoiding high levels of
debt that might result in bankruptcy, defaults, and foreclosures. Yet in its Report
on the Economic Well-Being of U.S. Households in 2019, the Board of Governors of the
Federal Reserve System found that many Americans are unprepared for retirement.
One-fourth indicated that they have no retirement savings, and fewer than 4 in 10 non-
retirees felt that their retirement savings are on track. Among those who have self-
directed retirement savings, nearly 60% admitted to feeling low levels of confidence in
making retirement decisions.4
Low financial literacy has left millennials—the largest share of the American
workforce—unprepared for a severe financial crisis like the coronavirus
pandemic, according to research by the TIAA Institute. Even among those who
report having high knowledge about personal finance, only 19% answered questions
about fundamental financial concepts correctly. Forty-three percent report using
expensive alternative financial services such as payday loans and pawnshops, more
than half lack an emergency fund to cover three months' expenses, and 37% are
financially fragile (defined as unable or unlikely to be able to come up with $2,000 within
a month in the event of an emergency). Millennials also carry large amounts of student
loan and mortgage debt—in fact, 44% say they have too much debt. 5
While these may seem like individual problems, they have a broader effect on the entire
population than previously believed. All one needs to do is look at the financial crisis of
2008 to see the financial impact on the entire economy that arose from a lack of
understanding of mortgage products (and therefore a vulnerability to predatory lending)
or the lack of financial preparedness that threatens a rise in mortgage foreclosures due
to job loss during the COVID-19 crisis. Financial literacy is an issue with broad
implications for economic health and an improvement can help lead the way to a
global economy that is competitive and strong.
Learning Capsule:
Any improvement in financial literacy will have a profound impact on consumers
and their ability to provide for their future. Recent trends are making it all the more
imperative that consumers understand basic finances because they are being asked to
4
Why Financial Literacy Is So Important
Few are prepared as financial decision-making grows more complex
TOPICAL GUIDE:
1. Financial Literacy in Decline
2. What Is Financial Literacy?
3. Trends Making It More Important
4. Why Financial Literacy Matters
5. The Bottom Line
TOPIC SUMMARY:
Financial literacy is the education and understanding of various financial areas
including topics related to managing personal finance, money, borrowing, and
investing.
Trends in the United States show that financial literacy among individuals is
declining, with only 34% of respondents correctly answering four out of five
questions posed by FINRA on the topic.
At the same time, financial literacy is more important than ever as people
manage their own retirement accounts, trade personal assets online, and carry
student, medical, credit card, and mortgage debt.
Financial Literacy in Decline
As consumer habits and financial products change, financial literacy has taken a
blow. In past generations, cash was used for most daily purchases; today, it's rarely
flashed—particularly not by younger shoppers. The way we shop has changed as well.
Online shopping has become the top choice for many, creating ample opportunities to
use and overextend credit—an all-too-easy way to accumulate debt, and fast.
Meanwhile, credit card companies, banks, and other financial institutions are
inundating consumers with credit opportunities—the ability to apply for credit cards
or pay off one card with another. Without the proper knowledge or checks and balances,
it is easy to get into financial trouble.
Many consumers have very little understanding of finances, how credit works,
and the potential impact on their financial well-being for many, many years. In
1
,fact, the lack of financial understanding has been signaled as one of the main
reasons many people face problems with saving and investing.
Every few years, the Financial Industry Regulatory Authority (FINRA) issues a five-
question test as part of its National Financial Capability Study, which measures
consumers' knowledge about interest, compounding, inflation, diversification, and bond
prices. On its most recent test, only 34% of those who took the test got four out of five
questions correct, which suggests that the basic economic and financial principles that
underpin these problems are widespread, touching every state in the country in different
ways.1
What Is Financial Literacy?
Financial literacy is the confluence of financial, credit, and debt management
knowledge that is necessary to make financially responsible decisions—
decisions that are integral to our everyday lives. Financial literacy includes
understanding how a checking account works, what using a credit card really
means, and how to avoid debt. In sum, financial literacy has an impact on families
as they try to balance their budget, buy a home, fund their children’s education,
and ensure an income at retirement.
A lack of financial literacy is a problem not only in emerging or developing
economies. Consumers in developed or advanced economies also fail to demonstrate
a strong grasp of financial principles in order to understand and negotiate the financial
landscape, manage financial risks effectively, and avoid financial pitfalls. Nations
globally, from Korea to Australia to Germany, are faced with populations that do
not understand financial basics.
The level of financial literacy may vary with education and income levels, but evidence
shows that highly educated consumers with high incomes can be just as ignorant about
financial issues as less-educated, lower-income consumers (though, in general, the
latter do tend to be less financially literate). And it seems consumers are hesitant to
learn. The Organization for Economic Co-operation and Development (OECD) cited a
survey conducted in Canada in which people reported that they found choosing the
right investment for a retirement savings plan was more stressful than a visit to
the dentist.2
Trends Making Financial Literacy More Important
Compounding the problems associated with financial illiteracy, it appears
financial decision-making is also getting more onerous for consumers. Five
trends are converging that demonstrate the importance of making thoughtful and
informed decisions about finances:
2
,1) Consumers are shouldering more of the financial decisions
Retirement planning is one example of this shift. Past generations depended on
company pension plans to fund the bulk of their retirement. Pension funds,
managed by professionals, put the financial burden on the companies or governments
that sponsored them. Consumers were not involved with the decision-making, typically
did not even contribute to their own funds, and they were rarely made aware of the
funding status or investments held by the pension. Today, pensions are more a rarity
than the norm, especially for new workers. Instead, employees are being offered the
ability to participate in 401(k) plans, in which they need to decide how much to
contribute and what to invest in.
2) Savings and investment options are more complex
Consumers are also being asked to choose among various investment and
savings products. These products are more sophisticated than in the past,
requiring consumers to choose among different options that offer varying interest rates
and maturities, decisions they are not adequately educated to make. The choices made
from among complex financial instruments with a large range of options can impact a
consumer’s ability to buy a home, finance an education, or save for retirement, adding
to the decision-making pressure.
3) Government aid is lacking
A major source of retirement income for past generations was Social Security.
But the amount paid by Social Security is not enough, and it may not be available at all
in the future. The Social Security Board of Trustees reported that by 2034 the Social
Security trust fund may be depleted, a scary prospect for many. So now, Social
Security acts more like a safety net that barely provides enough for basic
survival.3
Longer lifespans mean we need more money for retirement than earlier
generations did.
4) The financial environment is changing
The financial landscape is very dynamic. Now a global marketplace, there are many
more participants in the market and many more factors that can influence it. The
quickly changing environment created by technological advances such as
electronic trading makes the financial markets even swifter and more volatile.
Taken together, these factors can cause conflicting views and difficulty in creating,
implementing, and following a financial roadmap.
3
, 5) We are inundated with choices
Banks, credit unions, brokerage firms, insurance firms, credit card companies,
mortgage companies, financial planners, and other financial service companies
are all vying for assets, creating confusion for the consumer.
Why Financial Literacy Matters
Financial literacy is crucial to help consumers manage these factors and save
enough to provide adequate income in retirement while avoiding high levels of
debt that might result in bankruptcy, defaults, and foreclosures. Yet in its Report
on the Economic Well-Being of U.S. Households in 2019, the Board of Governors of the
Federal Reserve System found that many Americans are unprepared for retirement.
One-fourth indicated that they have no retirement savings, and fewer than 4 in 10 non-
retirees felt that their retirement savings are on track. Among those who have self-
directed retirement savings, nearly 60% admitted to feeling low levels of confidence in
making retirement decisions.4
Low financial literacy has left millennials—the largest share of the American
workforce—unprepared for a severe financial crisis like the coronavirus
pandemic, according to research by the TIAA Institute. Even among those who
report having high knowledge about personal finance, only 19% answered questions
about fundamental financial concepts correctly. Forty-three percent report using
expensive alternative financial services such as payday loans and pawnshops, more
than half lack an emergency fund to cover three months' expenses, and 37% are
financially fragile (defined as unable or unlikely to be able to come up with $2,000 within
a month in the event of an emergency). Millennials also carry large amounts of student
loan and mortgage debt—in fact, 44% say they have too much debt. 5
While these may seem like individual problems, they have a broader effect on the entire
population than previously believed. All one needs to do is look at the financial crisis of
2008 to see the financial impact on the entire economy that arose from a lack of
understanding of mortgage products (and therefore a vulnerability to predatory lending)
or the lack of financial preparedness that threatens a rise in mortgage foreclosures due
to job loss during the COVID-19 crisis. Financial literacy is an issue with broad
implications for economic health and an improvement can help lead the way to a
global economy that is competitive and strong.
Learning Capsule:
Any improvement in financial literacy will have a profound impact on consumers
and their ability to provide for their future. Recent trends are making it all the more
imperative that consumers understand basic finances because they are being asked to
4
