Snarky Behavior

On Financial Literacy

July 21, 2008 · 1 Comment

Last month I mentioned that for the first time, I had a floating balance on my credit card.  While I wasn’t able to acquire a new card to do a balance transfer (I lack a permanent address at the moment), I was able to call and talk down my interest rate from 17.99% to 11.99%, saving myself a few bucks in the process.

I wouldn’t have known that I could even do that until I conducted research into balance transfers.  Indeed, I had to admit:

It’s strange that it took me until the age of 25 to seriously research and understand basic personal credit.  I really wish personal finance would have been a “home-ec” type class in high-school.  Ah well.  Live and learn.

Well, as it turns out, my ignorance/inexperience is (unsurprisingly) indicative of our nation at large.  Over at Freakonomics, Stephen Dubner links to Professor Annamaria Lusardi at Dartmouth.  Professor Lusardi does survey research on how well Americans approaching retirement age understand basic (and I do mean basic) financial concepts.  The results are dismal.

In an interview with Professor Lusardi, Dubner asks:  “If you were President for a day, what are five concepts of financial literacy you would try to have taught to everyone?”  She responds:

1. Basics of how markets work. Things like: it is the law of demand and supply that determines prices in competitive markets, and the interest rate is the price of money.

2. Time value of money and the working of interest compounding: Because so many payments in finance happen at different points in time, one needs to know how to compare payments. Discounting is at the basis of asset pricing. What is the price of bonds? It is the present value of its payments. Interest compounding is a fundamental concept and it requires a little bit of math. It is critically important to understand interest compounding to be able to fully appreciate the importance of starting to save young and how to borrow and handle debt.

3. The concept of risk and the working of risk diversification and insurance: A lot of the decisions about saving and investing have to do with how to handle risk.

4. Basic accounting: To know the net values one needs to subtract assets and liabilities, and that it makes a big difference between whether we choose market prices versus book prices.

5. Rights and responsibilities of consumers and institutions. People need to know there is a Federal Deposit Insurance Corporation, bank deposits are safe (up to $100,000), and there is no need to line up to withdraw deposits; they should know who does and does not have fiduciary duties and what it means to use a financial advisor (you cannot sue them if the stock market plummets).

I would agree that 1.) and most of 2.) are must-knows.

3.) and 4.) should be understood, at least conceptually.

5.) is wonky and isn’t really important that people know, except in times of crisis (so there aren’t banking panics).

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