It's kind of amazing to me how financially illiterate our country is. I'm not talking on a national level, although our government needs some help, but on an individual level. I am just now, in my senior year of college, taking my first wealth management class (I am not counting that joke of a class consumer ed that we had to take in high school). This got me thinking, why so late? We all need to learn this stuff sooner and be reminded of it more often. The average score on a financial literacy test for high school students was 48%. That is an F ladies and gentlemen. The average score on that same test for a college students? 62%. Better but still awful. My question is, why aren't kids being taught wealth management sooner? Money management is basic math. It's pretty simple, yet people don't know it.
Let me give you a test:
1. Suppose you had $100 in a savings account and the interest rate was two percent per year. After 5 years, how much do you think you would have in the account if you left the money to grow?
a. More than $102
b. Exactly $102
c. Less than $102
d. I don't know
2. Imagine the interest rate on your savings account was one percent per year and inflation was two percent per year. After one year, would you be able to buy more than, exactly the same as, or less than today with money in this account?
a. More than today
b. Exactly the same as today
c. Less than today
d. I don't know
Got your answers? I'll give you another minute to really think those over. I will start by telling you that only 56% of Americans would get those two questions correct. Ready to see if you are in that 56%? The answer to question #1 is "a" and the answer to question #2 is "c." If you did not get both of those right, you are not alone. If you did, well then, it's only two basic questions so don't get cocky. One last question:
3. Do you think the following question is true or false: "Buying a single company stock usually provides a safer return than a stock mutual fund."
a. True
b. False
c. I don't know
This one should be a bit easier. The answer is "b." Now if you answered all three of those questions correctly, you are part of 34% of Americans who may be somewhat financially literate. That means 66% of Americans don't know this stuff. Stephen J. Dubner in Freakonomics makes a wise point. He says:
"I am all in favor of a well-rounded education, but seriously: what good is it if high-school students learn Flaubert, biology, and trigonometry if they don't learn how to take care of their money? One bright side to the increasingly dark economic news these days is that more and more people will learn (albeit the hard way) Rule #1: Do not buy what you cannot afford."
In middle school and high school we learn about biology, chemistry, physics, algebra, geometry, history, english, and maybe a foreign language, but where is the class that teaches financial literacy? Sure some schools have economics, maybe a basic accounting class, and a consumer education class, but I would bet that those classes aren't teaching students what they really need to know and what they will need to apply when they get older. Heck, I'm a finance major, and I'm learning about essential aspects of financial literacy as a senior in college! Two things are wrong with that. One, I am a senior in college. Why wasn't I taught this earlier? It's not like I haven't been earning and spending money for the past 6+ years. Aspects of financial literacy should be introduced in elementary school and be a mandatory subject to take every year until you graduate high school. Second, I am a finance major, and I am learning this stuff. Not that I don't need to know this stuff, because I definitely do, but what about all the other non-finance majors? Do they not get to learn the stuff I'm learning? It's kind of like "the rich get richer" because most finance students already know a decent amount about money and how it works, so they don't need to know these things as much as non-finance majors and yet, they are the students who get taught how to manage money. My point is, everyone needs to be financially literate, not just finance and accounting majors. Everyone. Everyone will most likely earn money some point in their life and everyone needs to know how to handle it! I'm dumbfounded that this stuff isn't taught to more students.
Dubner goes on to list 5 pieces of financial literacy that he believes should be taught in schools. They are:
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).
Now how many of you can tell me you know this stuff? Very few I imagine, and that's a problem.
So the point of this blog is to share information. Share information that most would consider an afterthought. But also I want to start a conversation. I want to know what you think. I will continue to post interesting and debatable topics in the coming weeks and months, and I would love to hear your thoughts and feedback! Leave a comment or feel free to send me an email at dan.boduch@gmail.com.
Take Care.
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