Expert FAQ: The Financial Illiteracy Epidemic: Why Young Adults Need Help With Their Finances, and How to Help

Investing

Many of today’s twenty-somethings and young adults are pretty clueless when it comes to their finances: retirement savings, smart investing, credit card debt – you name it.  No offense, but our generation has a lot of catching up to do.  Why isn’t more being done about it, and how can we change that?

Financial literacy is a vital aspect of life that is largely neglected in our high schools, and even colleges.  Every day, young people are confused deciding which credit cards to apply for, which retirement plan is best for them, and whether they should rent or buy a home.

By comparison, in order to graduate, every middle and high school student is required to take a civics class at some point to prepare them to be informed participants in America’s democratic process.  But at no point is a money-oriented skills class (like how to invest or how to budget) required; aren’t these skills equally important for those on the brink of adulthood?  Perhaps those who major in economics and finance have an upper hand, but even these classes don’t always focus on teaching the personal skills needed to succeed at investing and personal finance.

The Dangerous Facts About Financial Illiteracy

Sadly, study after study has shown that many people are not prepared to make informed decisions on financial issues.  Required financial literacy classes would not only make individuals lives better, but also, as the all too recent financial crisis reminds us, would help the financial system as a whole function more healthily.

Several studies have recently concluded that Americans lack basic financial literacy.  A study by the SEC this year demonstrates that an alarming amount of Americans don’t understand basic investment concepts, including compound interest and inflation.  Concepts like these are absolutely fundamental for assessing the benefits and costs of loans, credit cards, and savings accounts.

The SEC study casts doubt on the ability of many Americans to retire comfortably, especially when so many have defined-contribution plans which require individuals to make decisions about where to invest their savings for retirement.  It also shows that many Americans are uninformed about investment fraud, as well as many of the basic mechanisms that led to the housing crisis.

Can Mandatory Financial Education Help Solve the Crisis?

One 2011 survey conducted by the Council on Economic Education had a particularly bright finding; students from states that have required personal finance classes in high school are far more likely to save money and pay off credit card debt in the future and are also less likely to buy compulsively.  Unfortunately, only 13 states require such courses and, even worse, only 16 states require testing in economics, which is down from 19 states in 2009. 

Various states are crafting legislation to improve financial education in their schools, including providing support to nonprofits, like the National Endowment for Financial Education, that provide financial instruction to students.  But with so many states with strained budgets it’s difficult for them to make the momentous changes needed to fully address the problem.  Many colleges are following suit by making finance classes a graduation requirement and by providing free personal finance workshops, which is especially appropriate since so many of their students will leave with a huge amount of student debt.

Expert Opinions: What More Can Be Done To Educate Young Adults?

Although these efforts are heartening, financial illiteracy is a massive national problem that could even lead to another financial crisis in the future, and a full solution will require a unified national effort.  We speak with the experts to find out what they think will work best.

  • Professor Joetta Forsyth, PhD and Assistant Professor of Finance at Pepperdine University, explains why financial ignorance is so widespread:

“Young adults are so poorly informed about personal finance because their parents are also poorly informed. It used to be that most people grew up working at a family business or farm. However, with modern times, parents left to work in corporations, and stopped training their children in how to handle money. The schools never picked up the slack. Personal finance courses should definitely be mandatory in high school, and even sooner. It is essential to the prosperity of our country that our children learn the basics of money and how to take care of themselves. The financial crisis is stark evidence of this.

It is of utmost importance that our children learn the basics of debt, and the burden that debt can cause. They should also learn how to save, including how to use basic tools to anticipate how much they can save based on their contributions. They should be given tools to plan for retirement, and counseling in how to finance college.”

  • Professor Xavier Gabaix, Professor of Finance at the NYU Stern School of Business, notes that the financial lessons that may seem obvious to us can really go a long way if taught and implemented widely:

“I think that some classes should be made mandatory in high school — high school rather than college, because it’s the least educated who need those classes the most.  Finance is a somewhat novel and abstract field, and it should be learned. Some basic rules of thumb are pretty simple to learn, but they will go a long way towards avoiding catastrophic finances down the road.  These include:

  • Have a couple of months of savings in the bank;
  • How to avoid fees;
  • How to diversify;
  • Save on average 10% for retirement.”

“It is absolutely the public school’s responsibility to teach personal finance – and make those courses mandatory. Our future as consumers and as a country depends on smart spending at the individual level.  As a nation and as an economy, we simply cannot afford to continue to have individuals living on debt, financing homes we cannot afford, and overspending.

Young people are a mess when it comes to personal finance for two reasons.  One: money in this country is still a very taboo subject.  It is simply considered rude to talk about how much you make, how much things cost and details about your savings and investments. But by abiding by this social norm, we stop talking about money all together, and just spend, spend, spend.  Two: Personal finance has changed dramatically over the past 30 years, and most adults have a hard time keeping up. There are simply far more tools at our disposal today than in recent history: credit and debit cards have suddenly become the norm for daily spending, but the types, terms and rules vary dramatically from card to card. Today there are so many weird types of mortgages and savings accounts and investment and retirement accounts.

At the very root, there is a disconnect between how much money we have, and how much we can spend. Aside from the plethora of new and changing personal finance tools, we can blame media messages that tell us that we can all have expensive handbags and sneakers and buy every music album that comes to market — regardless of whether we can truly afford it.

I would like to see mandated public school course that gives each student a smart phone money app and a mock budget that includes housing, food, utilities and maybe even baby-related expenses. Then set them free in the world with the requirement that that they keep track of all of their spending, and help them align their wants and needs. Another important component is to have real people from the community come in and give testimonials about how debt, bankruptcy and poor credit scores impacted their lives. These issues can be devastating, and young people need to hear these stories first hand – not unlike seeing videos of car crashes in driver’s ed. The shock value is powerful.”

  • Professor Barbara O’Neill, specialist in Financial Resource Management at Rutgers University, explains why it’s important to implement mandatory financial literacy classes and then evaluate them to ensure their effectiveness over time:

“I do think personal finance classes should be mandatory.  New Jersey made it a high school graduation requirement beginning with the class of 2014 and a few other states have done the same.  Passed in the wake of the financial crisis, the program sets up strong curriculum standards as well as pilot tests across 8 school districts to evaluate effectiveness – so that in a few years we’ll know how well the mandatory program works.  These programs cover all the basics, but sometimes it’s hard to get them passed because of statewide or local school board politics.

There’s definitely a widespread underappreciation of the power of compound interest and how it can either be your friend or enemy – I give assignments specifically targeted at discovering this concept.  I teach undergrads at Rutgers, and there remains a lot of financial information that today’s young adults just don’t know: the rule of 72, the time value of money, how to balance a checkbook, and so forth.”