How Much Financial Inequality Is Due to Financial Illiteracy?

[crcballer55]

This is an interesting article I came across. I would agree for the most part that the lack of wealth in many households is due to lack of knowledge followed closely by a lack of discipline. Most people I have counseled didn't realize how little it takes each month to build a comfortable source of wealth to send kids to college and retire with a decent income.

http://www.freakonomics.com/2013/01/07/how-much-financial-inequality-is-due-to-financial-illiteracy/

Annamaria Lusardi, whose ground-breaking research on financial literacy has been  featured here several times, has put out a new working paper (with co-authors  Pierre-Carl Michaudand  Olivia S. Mitchell) that could be read as laying much of the blame for the lack of household wealth at the foot of the members of said household. The paper is called “Optimal Financial Knowledge and Wealth Inequality” (abstract;  PDF):

While financial knowledge is strongly positively related to household wealth, there is also considerable cross-sectional variation in both financial knowledge and net asset levels.  To explore these patterns, we develop a calibrated stochastic life cycle model featuring endogenous financial knowledge accumulation.  The model generates substantial wealth inequality, over and above that of standard life cycle models; this is because higher earners typically have more hump-shaped labor income profiles and lower retirement benefits which, when interacted with precautionary saving motives, boost their need for private wealth accumulation and thus financial knowledge.

Our simulations show that endogenous financial knowledge accumulation has the potential to account for a large proportion of wealth inequality.  The fraction of the population which is rationally financially “ignorant” depends on the generosity of the retirement system and the level of means-tested benefits. Educational efforts to enhance financial savvy early in the life cycle so as to produce one percentage point excess return per year would be valued highly by people in all educational groups.

Not to get  all self-referential, but one good way to “enhance financial savvy early in the life cycle” might be to let people know that it is a bad idea to consistently invest your income in a scheme whose expected value is about -40% (yes, I’m talking about  the lottery, again!). That is of course not so easy when the lotteries are run by states who see them as profit centers.

 

[villansfinest]

i've always thought that there should be a high school class after basic math, and after intro to economics that would cover personal finance issues for young adults, adults and the elderly

the career centers i've seen are a bit too reserved in describing financial aid options, situations and outcomes for hs seniors.

most people don't learn finances the easy way, they learn the hard way: personal mistakes (experiences)



i made a big change in my life when i stopped hanging around people that talked about ABV and started hanging around people that talked about ROI. wish i'd done it sooner.

 

[skyline]

"The things I think about the most are things I never know though, like, why don't school teach more mathematics, less trigonometry and more about taxes. They at the chalkboard, teaching us *** backwards. How about preparing us for life, instead of lab rat us?"

 

[Betonblck]

Looks like the typical right wing propaganda that millionaires work 500 times harder than everyone else and should make 500x more money

 

[mrbrown]

Too bad many don't even have the capital to make something decent

what about the real real world... where some make just enough to pay the bills and have spare change to buy a pack of gum, nothing more

 

[picknroll24]

A good portion is definitely due to financial illiteracy. People have believed in the YOLO philosophy way before Drake uttered his first rhyme. Making hedonic purchases in the short term often jeopardizes the long term. And Big Sean was right on the money, a Personal Finance and Accounting class should be mandatory in public high schools, then again if they did that, there wouldn't be as many clueless consumers for corporations to prey on.

 

[Rootin4EverybodyBlack]

A good portion is definitely due to financial illiteracy. People have believed in the YOLO philosophy way before Drake uttered his first rhyme. Making hedonic purchases in the short term often jeopardizes the long term. And Big Sean was right on the money, a Personal Finance and Accounting class should be mandatory in public high schools, then again if they did that, there wouldn't be as many clueless consumers for corporations to prey on.

I've always said this. Never understood why kids have to learn Chemistry to graduate (which most will never use), but its perfectly fine to leave without knowing how to balance a checkbook or know how much of your income you should save.

 

[octobersillest]

A good portion is definitely due to financial illiteracy. People have believed in the YOLO philosophy way before Drake uttered his first rhyme. Making hedonic purchases in the short term often jeopardizes the long term. And Big Sean was right on the money, a Personal Finance and Accounting class should be mandatory in public high schools, then again if they did that, there wouldn't be as many clueless consumers for corporations to prey on.

I've always said this. Never understood why kids have to learn Chemistry to graduate (which most will never use), but its perfectly fine to leave without knowing how to balance a checkbook or know how much of your income you should save.

no doubt

 

[powerballin]

How else can you keep the uneducated poor Americans working jobs the rich Americans don't want?  They aren't gonna change nothing in the school system.

 

[AZwildcats]

I've always said this. Never understood why kids have to learn Chemistry to graduate (which most will never use), but its perfectly fine to leave without knowing how to balance a checkbook or know how much of your income you should save.

While I think Chemistry and other sciences are important, teaching financial literacy is probably more important. I had to take an economics class before I graduated HS . helped a lot for me at least

 

[Rootin4EverybodyBlack]

While I think Chemistry and other sciences are important, teaching financial literacy is probably more important. I had to take an economics class before I graduated HS . helped a lot for me at least

I was just using Chemistry as an example, but I agree everything is important in its own way. Just IMO after reading, writing, and arithmetic, financial literacy should be the next important subject that students should be required to learn.

I can't speak for other states, but when I went to school in VA you could graduate (with honors) without taking ANY class about financial literacy.

 

[TYE_The Time Traveler]

Would be cool to study how the economy would be if more people were financially literate, im sure we would have more efficient spending, but how many things wouldnt exist if people were more tight with there money throughout history and didnt risk supporting ideas which are innovative and great now. Would make for an interesting find.

 

[teamjordan79]

I think the financial jargon has been developed and perpetuated to deliberately confuse the average folk.

Quantitative easing? *****wtbs

But obviously you will be a better player if you understand the rules of the game.

 

[crcballer55]

Too bad many don't even have the capital to make something decent

what about the real real world... where some make just enough to pay the bills and have spare change to buy a pack of gum, nothing more

Unfortunately, it's not just the minority that are just getting by. Now, 70% of people live paycheck-to-paycheck. That's unacceptable when the majority make more than enough to live decently and plan for the future. For those who don't make enough, being more financially literate would help make the money they do make go farther and would allow those who do make enough to help out be able to help out more instead of having to worry about themselves.

Would be cool to study how the economy would be if more people were financially literate, im sure we would have more efficient spending, but how many things wouldnt exist if people were more tight with there money throughout history and didnt risk supporting ideas which are innovative and great now. Would make for an interesting find.

Financial literacy isn't just about sticking your money in a hole and saving it. If people were financially literate, how many people would have been evicted from their homes these past 4 years? How many would have invested in tech stocks during the bubble? How many students would be $50K in student loan debt if their parents had chosen to plan for that?

If we are more financially literate, it won't be as easy for businesses to use gimmicks to get our business. Instead, we would return to a system that valued service and quality over the cheapest price.

 

[651akathepaul]

i've always thought that there should be a high school class after basic math, and after intro to economics that would cover personal finance issues for young adults, adults and the elderly.

I'm pretty sure they've slowly started to introduce classes like this here in Washington State, but I haven't looked too much into it. I'm looking to become a teacher in the next few years and this is something I definitely wouldn't mind teaching.


As far as the post...I would agree. People have a sheep mentality when it comes to money, of all things, and it's extremely unfortuante because those that know this, use money to manipulate people.

That's just one aspect of it, I guess, but if people were more financial literate then they wouldn't rely so much on the opinion or ideas of others and would already know the simplicity of how to handle their funds.

 

[andycrazn]

il like to add that social programs and these "safety nets" are put into place to the point where they dont really need to be financially literate because those safety nets are in place, they just need to understand how to get it. these programs create a huge dependency for the person receiving it thats why they have a hard time getting off of it because sometimes it seems irrational to get off of it.