Most states are behind the times when it comes to promoting personal financial education in schools. Image: CC kevinmarsh/Flickr

Some people believe that a national financial crisis begins at home. Generations of Americans were raised to be financially illiterate and turned loose upon the world. As the country struggles to emerge from the worst economic downturn since the Great Depression, a movement is afoot to make financial literacy education part of growing up.

Personal finance and financial reform

Legislators drafting the financial reform bill that became law in 2010 believed that financial literacy education can be a powerful compliment to financial regulation. The financial reform law includes the establishment of an Office of Financial Literacy. Through online tools and educational programs, The Office of Financial Literacy will supposedly try to make it easier for teachers to educate students about personal finance and for consumers to educate themselves about money management.

Financial literacy education is good PR

The private sector is recognizing the glaring need for financial literacy education as a PR opportunity. For example, Genworth Financial announced a program this week to help personal finance education in more than 300 high schools across Virginia called “My Money, My Future.” Earlier this year Visa, Inc. introduced “Financial Football,” a free online game that teaches kids about money using personal financial decisions to influence the outcome of football action. American Express introduced a website this year called “Currency” that offers financial knowledge for young people about paying off student loans, renting an apartment, buying a house and surviving on unemployment.

Not tested, not taught

When it comes to financial literacy education in schools, teachers have their work cut out for them, according to Dan Kadlec at MoneyWatch. Kadlec attended a recent Financial Literacy National Educators Conference in Washington D.C. Teachers there told Kadlec that they have to focus on topics that are included in standardized tests. Right now financial literacy and personal finance are subjects that don’t show up on the tests many state governments give students in order to evaluate teachers and schools.

Sources

MoneyWatch

Sacramento Bee

PR Newswire

The Treasury Department is seeking public comment about a proposed set of financial education guidelines that will help Americans avoid personal financial meltdowns. Thinkstock photo.

The Treasury Department wants to distill the basics of financial literacy into a “food pyramid” for personal finance that makes money management as easy to understand as eating right. Even though a little more than one-third of adult Americans are considered obese despite the food pyramid, the Treasury Department is forging ahead. Public comments are being requested on a set of “financial education core competencies” the Treasury Department is proposing for use in financial education programs across the country.

Personal finance meltdowns a national issue

If there’s a lesson to be learned from the Great Recession, it’s that when it comes to personal finance, too many Americans are financially illiterate. A fundamental lack of knowledge about budgeting, investing, credit, lending and saving was exposed by meltdowns in finance, housing and credit. Investment Advisor reports that the Treasury Department’s Financial Literacy and Education Commission is conducting an annual review of its national strategy to promote basic financial literacy and education as mandated by the Fair and Accurate Credit Transactions Act of 2003. Using the “food pyramid” as an example, the Commission is trying to define the basics of financial literacy education for the public in ways that can be readily understood.

Financial education basics

The Treasury Department is accepting comments on or before Sept. 12. According to a Federal Register notice released Aug. 26, the Commission has identified five proposed personal finance concepts – or “financial education core competencies” – that it says “every American should have command of.” They include:

Earning:  Understanding the difference between gross pay and net pay, employee benefits and taxes and the importance of education.

Spending: The difference between needs and wants, learning how to create a budget, tracking spending and living within one’s means.

Saving: Understanding how saved money grows, how to meet long-term goals and wealth building, learning about bank accounts, understanding financial assets, such as savings accounts and investments.

Borrowing: Understanding the cost of borrowing and the role of credit scores.

Protecting: Learning how to protect assets, choosing the right insurance coverage and knowing how to guard against identity theft.

Seeking consensus on financial education

The financial education field lacks common ground on what it aims to achieve, the Treasury Department said in the Federal Register. It wants to facilitate agreement on appropriate basic content for financial literacy and education. Ted Beck of the National Endowment for Financial Education, who helped develop the core competencies, told the Dallas Morning News that in schools “there’s a wide variance in different kinds of programs, the quality of programs,” he said. “The idea of having a very straightforward checklist about the basics is something we think is very important.” A Texas education official told the newspaper that the core competencies listed by Treasury are a “good start” but the list is incomplete. For example, students should be taught the pros and cons of credit cards, mortgages, payday loans and other forms of borrowing.

Simple, easy changes to everyday personal finance habits can get you started on the road to debt proof living. Think Stock photo.

The best way to deal with debt problems is to avoid getting into debt. Too many people end up owing tens of thousands of dollars on credit cards, student loans or car loans. If you haven’t yet joined the crowd, there’s still time to adjust your personal financial behavior for debt proof living. When it comes to personal finance, some key actions can produce the best results. Identify and focus on those things. Avoiding debt problems could be as simple as becoming more financially literate about credit card debt, saving money and buying wholesale.

How to start debt proof living

One of the most basic tenets of financial literacy will help you the most: understanding credit card debt. Practical Money Skills talks about the “power of 50.” If you have a credit card with a $3,000 balance at 18 percent APR and pay only the 2 percent minimum monthly payment of $60 per month, it will take you 8 years to pay off your card. What’s worse, you will pay $5,780, not the $3,000 you figured you were spending when. But if you can pay an additional $50 per month for a total payment of $110 you will pay it faster and leave less money for the credit card company to charge interest on. The result: the debt is gone in 3 years and more than $1,800 in interest payments has been saved.

Saving money: start small and watch it add up

Saving money is easier than you think. Saving money for an emergency fund avoids debt if you need something like car repairs. Saving money to buy something instead of using a credit card means you will enjoy that something more. Succeed by starting small, recommends ehow.com. Every time you get a paycheck, put $20 into your savings account. You’ll be surprised at how quickly it adds up. Simple things like refilling your water bottle or brewing your own coffee can make a big difference. Add up how much you spend on bottles of water and coffee in a week. It’s amazing how much thicker your wallet can be.

Buy wholesale: cut out the middle man

By developing a wholesale mentality, you can take out the middle man before he takes his cut. Tips on buying wholesale to save money can be found at essortment.com. It can be as easy as calling local wholesalers and asking if they allow the general public to shop. Sample sales are a great way to buy wholesale. If you have friends who are interior designers, contractors or beauticians who can buy wholesale, offer to buy their lunch if you can go with them next time they shop. And always shop around. Sometimes a torn box is the only reason an item is marked down. Prices lower than wholesale can always be found if you do your detective work.

Employee financial education increases productivity, reduces turnover and generates a substantial return on the investment required. ltdan/Flickr photo.

Employees with poor personal finance habits can affect a company’s profitability. Money problems at home can lead to lower productivity at work, health problems and excessive turnover. A company that promotes financial literacy among its employees can add hundreds of thousands of dollars a year to its bottom line. The weak U.S. economy has taken a toll on employee benefits like health insurance and matching retirement plans. But a company can still provide a safety net for its employees with education in personal finance.

Financial security through employee education

To help its workers achieve financial security, as well as its bottom line, a company can do more than provide a paycheck. The Durango Herald reports that Employees with serious financial problems can waste as many as 20 work hours a month worrying about their finances. The newspaper cites a survey of American workers by creditcards.com that found 57 percent don’t budget and 40 percent spend 110 percent of their household income. The survey also found a correlation between consumer debt and relationship problems. Fighting about financial security was a major reason 50 percent of the workers in the survey were divorced.

Financial literacy and the bottom line

Promoting employee financial education is the mission of the Personal Finance Employee Education Foundation. The PFEEF claims that financial literacy programs contribute hundreds of thousands of dollars each year to a company’s bottom line. Results of employee financial education include improvement in productivity, morale and company loyalty. Higher financial literacy can also reduce absenteeism, turnover and workplace distractions as well as operational risk across a company. The PFEEF provides a return on investment model and an ROI calculator online that a company can use to estimate the benefits of employee financial education. It said employee financial literacy generally has a return ratio of three to one.

Employee financial education in action

Financial literacy is part of the corporate culture at Weyerhaeuser, a Washington state timber company. Business Week reports that Weyerhaeuser is recognized as one of America’s leaders in providing financial education to nearly 14,000 employees. The company has an established a benefits education department that offered more than 40 retirement, benefits and wellness programs to its workers last year. Employees who attended Weyerhaeuser’s financial literacy seminars said that they were better informed about their retirement programs, 99 percent thought that they could now make better retirement choices, and 88 percent said they would change some of their retirement choices. Participants in the program thought the seminars were a valuable employee benefit that enhanced their positive feelings about Weyerhaeuser

Personal financial literacy begins in the home, but a survey shows that most parents give their own financial skills failing grades. Flickr photo.

Who else do kids have but their parents for getting a personal financial education? And what are they learning? A recent survey showed that most people learned their personal finance skills at home, from their parents. But the same survey showed that a great portion of those people gave themselves failing financial grades. Some people say that personal financial literacy needs to be taught in school. Others say that it’s not hard for parents to get up to speed on personal financial literacy so they can pass the knowledge along.

Parents in dire need of financial education

In its 2010 Financial Literacy Survey, the National Foundation for Credit Counseling asked people where they learned the most about personal finance. Most said they learned their personal finance skills from their parents at home. But when people were asked to grade themselves for financial literacy, nearly 25 percent gave themselves a C, D or F. The NFCC concluded that those in charge of the financial education at home are in dire need of financial education themselves.

Reading, writing and personal finance?

In this tough U.S. economy, many parents are drowning in debt, not planning for retirement or saving for college or able to purchase a house. NJ.com reports that these people may have been able to avoid these troubles if they took basic financial literacy courses in school. The NJ article said only 14 percent of teens nationwide take personal finance classes in school. NJ proposed that if the rate of teens taking personal finance classes in school nationwide had been higher in the past, perhaps the U.S. economy would be stronger today.

Kids set up for financial failure?

Last year, Wells Fargo conducted a survey and found out that only 5 percent of people ages 18-21 are confident they will achieve their financial goals. The survey discovered that only 41 percent know what a credit score is; only 28 percent understand annual percentage rates; only 41 percent understand the concept of the 401(K); and only 31 percent understand compound interest.

A financial tune-up for parents

It may be awhile before your school district decides to follow the lead of New Jersey, which is running a pilot project requiring financial literacy classes for high school students. But until then you can set a good example for the kids by getting your financial house in order with a mid-year financial tune-up. Boston.com offers five good places to start:

1. Budget and Spending — Take a look at your spending plan from the beginning of the year and compare your cash flow for the first six months. Did you allocate enough to cover expenses, or are you falling behind in certain areas? Start tracking every penny you spend, put a plan in place and stick to it.

2. Savings — Set aside cash for emergencies and short-term goals. Even a small amount can play an important role. The Consumer Federation of America found that with just $500 in the bank, you’ll sleep better and will be more likely to avoid high-cost borrowing and nasty fees for overdrafts.

3. Debt — Carrying high debt loads can have a big effect on your credit score, make monthly budgeting more difficult and leave you more vulnerable in emergencies. The first step toward solving these problems is to stop using plastic and chart a plan for paying off your cards.

4. Taxes —There’s a lot of uncertainty for people who try to plan for taxes this year, because Congress has not yet addressed a number of expired tax laws. But tax rates are expected to go up for all but the lowest income brackets in 2011,so be prepared.

5. Retirement — A retirement plan review starts with your 401(k), but it doesn’t end there. It includes Social Security and company pensions, as well. Figure out how much money you need to provide for yourself, and then to put a plan together.

The Dodd-Frank financial reform bill includes creating the Office of Financial Literacy to offer knowledge and money management tools for consumers. Flickr photo.

The financial reform bill Congress hopes to finally pass by the Fourth of July includes establishing a new Office of Financial Literacy. The new Dodd-Frank financial reform bill also includes a new Consumer Financial Protection Bureau to enforce ethical behavior from banks. But ultimately, consumers will have to educate themselves about  money management to stay out of financial trouble. The Office of Financial Literacy will try to make it easier for them to do that.

A national strategy for financial literacy

The Office of Financial Literacy as written into the Dodd-Frank financial reform bill isn’t the first effort by the government to encourage financial management from consumers. A 2003 law that provided people a free credit report once a year also established the Financial Literacy and Education Commission, which was charged with developing a national strategy for financial literacy. In 2004 the FLEC launched the MyMoney.gov website to provide a central location where consumers can find money management tools and useful government financial information.

The FLEC financial literacy website

Recently the FLEC’s financial literacy website got a new look. The new version of the site creates online access where users can find information about how to plan for life events that have financial implications, such as birth or adoption of a child, home ownership or retirement. There are also answers to questions users may have about a variety of personal or professional situations. MyMoney.gov offers money-management tools including a savings calculator, household budget worksheets and a college prep checklist.

Americans are literally lazy about finances

To promote financial literacy, the government has pushed knowledge more than regulation. The assumption is that the more high-quality information and money management tools consumers have, the better choices they will make. But most Americans are financially lazy. It’s common knowledge that we should spend less, save more and shop around for the best credit card rates. But most of us don’t.

American financial literacy lacking

In a survey of American financial literacy, the Wall Street Journal reports that the Finra Investor Education Foundation — the research arm of the securities industry regulator — found that about half of those 45 or older hadn’t tried to calculate their retirement needs. About half of almost 1,500 people surveyed also admitted to occasionally carrying a credit-card balance and paying interest. And only one in five knew that when interest rates rise, bond prices fall. In addition, the survey found that 57 percent of adults who earn more than $75,000 a year don’t shop around for credit cards, and 46 percent don’t compare prices on auto loans. Plus, most adults don’t check their credit records each year.

Debt-to-income ratio is the key

Debt is the most painful consequence of inadequate financial literacy. Seerpress.com reports that even though the current average debt-to-income ratio of in America is down to 122 percent from 133 percent in 2007, it still should be below 100 percent. In contrast, from 1960 to 1985, the debt-to-income ratio in America stayed well below 70 percent. The government is trying to do its part by imposing stricter policies and offering free advice. But true financial literacy could be as simple as not spending more than you make. That is a personal responsibility.

Credit repair is possible, but only if you increase your debt literacy. (Photo: flickr.com)

Do you consider yourself to be financially literate? How about when it comes to debt – is your level of debt literacy high enough that concepts like credit repair are second nature to you? Chances are your opinion of your debt literacy is higher than the reality. This is much in keeping with a trend numerous studies have observed in Americans: their level of debt literacy is less than adequate to deal with a complex financial market where important decisions – even on the average consumer’s level – can make the difference between a lifetime of saving or an endless cycle of debt. One recent study for the National Bureau of Economic Research by Dartmouth Economics Professor Annamaria Lusardi and Harvard Financial Management Professor Peter Tufano entitled “Debt Literacy, Financial Experiences and Overindebtedness” shows us just how far Americans have to go before debt literacy and credit repair become a part of the everyday financial lexicon.

Survey Methodology

Saving, investing and being prepared for retirement are vital elements of financial health and well-being. However, runaway personal debt and a widespread lack of basic debt literacy understanding tend to take the place of the more positive aspects for many Americans. What the authors attempt to do with their study is to examine the connection between financial literacy and debt. As the authors see it, debt literacy amounts to “the ability to make simple decisions regarding debt contracts, in particular how one applies basic knowledge about interest compounding, measured in the context of everyday financial choices.” To measure debt literacy, the authors worked with a market research company to create and conduct a survey that asks a broad consumer sampling three questions designed to assess their understanding of basic debt literacy concepts like compound interest. The questions were intended to be solved via reasoning alone, so they were simple enough that calculators were not needed. Afterward, participants were asked to rate their own knowledge of debt literacy.

What Did They Expect to Find?

If numerous studies on the financial knowledge of the U.S. consumer were any indication, it wasn’t going to be a fairy tale ending. Douglas Bernheim documented Americans’ lack of financial knowledge as early as 1995. They fail to understand basic financial concepts, “particularly those relating to bonds, stocks, and mutual funds,” and are quite fuzzy on such things as terms and conditions on large-scale loans and mortgages. This trend looks to continue on into the future, as a National Council on Economic Education study of high school students shows “a widespread lack of knowledge.”

Is this a uniquely American phenomenon? Sign point toward “No,” as a survey of Health, Aging and Retirement in Europe (SHARE) indicates poor scores on financial numeracy and literacy scales. Even a member of the U.K. Treasury reported that United Kingdom borrowers have “a poor understanding of mortgages and interest rates.” As a whole, studies in America and Europe show that those with a lower level of debt literacy were less than likely to have a well-developed retirement savings plan, accumulated wealth, stock investments or low-fee mutual funds. They were more likely to have more expensive mortgages, however.

Survey Questions and Analysis

Here are the three debt literacy questions utilized in the authors’ study. The first involves compound interest:

Suppose you owe $1,000 on your credit card and the interest rate you are charged is 20 percent per year compounded annually. If you didn’t pay anything off, at this interest rate, how many years would it take for the amount you owe to double?

A)     2 years;

B)      less than 5 years;

C)      5 to 10 years;

D)     more than 10 years;

E)      Do not know;

F)      Refuse to answer.

Ignoring interest compounding would lead to doubling in 5 years; someone who knew about interest on interest might have selected a number less than 5; someone who knows the ―Rule of 72 would know that it would be about 3.6 years (i.e., correct answer (ii) ―less than 5 years.). Answers above five years reflect misunderstanding of the concept of interest accrual.

Fewer than 36 percent of respondents got this one right. Considering how many people carry revolving balances on credit cards, that’s a troubling statistic, but less than surprising. Many consumers have difficulty grasping percentages and fractions, and compound interest deals with these. The authors found a particular problem in this area for respondents aged 65 and older – many can’t do simple interest calculations.

How Long Will it Take to Pay Off Debt?

That’s something else any consumer with credit card debt should know, so the authors posed this as their second of three questions:

You owe $3,000 on your credit card. You pay a minimum payment of $30 each month. At an Annual Percentage Rate of 12 percent (or 1 percent per month), how many years would it take to eliminate your credit card debt if you made no additional new charges?

A)     Less than 5 year;

B)      Between 5 and 10 years;

C)      Between 10 and 15 years;

D)     Never, you will continue to be in debt;

E)      Do not know;

F)      Prefer not to answer.

Slightly more than 35 percent of respondents knew that making the minimum payment amounts to an endless cycle (choice D). That’s it. The remainder show a less than solid grasp of debt literacy on this question. Hopefully they’ll do better with the final question.

Interest, Time and Money

You purchase an appliance which costs $1,000. To pay for this appliance, you are given the following two options: a) Pay 12 monthly installments of $100 each; b) Borrow at a 20 percent annual interest rate and pay back $1,200 a year from now. Which is the more advantageous offer?

A)     Option (a);

B)      Option (b);

C)      They are the same;

D)     Do not know;

E)      Prefer not to answer.

Only seven percent got this question correct. “Most chose a) even though the stream of payments to finance the purchase of an appliance at $100 per month in (a) has an APR of about 35 percent versus the 20 percent in option (b),” write the authors. Personally, this question threw me. As I read it, no interest is implied by choice a). But perhaps I’m missing something.

Demographics of the Debt Illiterate

The study authors found that debt illiteracy is indeed widespread. Respondents 65 and over showed the least debt literacy on the first question, while younger subjects (under 30 years of age) tended to get the first question correct but miss the final two. Gender and race divisions emerged, as did those between married respondents and unmarried. Among the unmarried, it is interesting to note that those who list as being divorced, separated or widowed performed at a lower level than those who had never been married. Surprising no one, respondents with higher income (particularly those earning $75,000 per year or more) scored higher than those in lower income tax brackets.

But Who Thinks They’re Literate?

On a scale from 1 to 7, where 1 means “very low” and 7 means “very high,” the study authors asked respondents to rate their financial knowledge. The average overall score was 4.88, and most considered themselves to be at least above average. Over half of those surveyed marked themselves as a 5 or 6, while only a wink over 10 percent actually chose 4 or lower. Rankings tended to mirror the demographic groups found in the three-question knowledge portion of the survey, but there were two notable differences. In particular, the over 65 age group rated themselves highly but scored lower at an average of 5.3, while the divorced/separated/widowed did the same but clocked in at only 4.79. Again – surprising no one – those who rated themselves high on average had higher incomes and accumulated wealth.

Four Clusters, Four Levels of Debt Literacy

The authors identified four distinct groups among the survey respondents. On one end of the scale are the “in control” group, comprising 26 percent of the sample. They are “firmly engaged in the traditional financial system. These individuals all have credit cards, but do not carry any revolving balances. They have relatively high (but not the highest) levels of experience with mutual funds, stocks, and bonds. They also had the highest incomes. On the other end are “fringe” users who partake of alternative financial services more often, such as payday loans, tax refund loans and pawn shops. Their likelihood of having ever invested in a stock, bond or a mutual fund—or held a mortgage—is about one fifth that of the “in-control” sample.

The middle groups make up what the authors claim to be 43 percent of Americans. The “borrower/saver” group (12 percent) has “the highest level of experience with savings and investments of any of the four clusters, with 98 percent having experience with savings or CD products, 83 percent owning mutual funds, 83 percent owning stocks, and 65 percent owning bonds or savings bonds. They are more extended than the “in control” group in that 95 percent carry revolving credit balances. The final 31 percent are the “overextended” group, who have “less experience with savings and more markers of extended credit.” They typically only pay the minimum on credit cards and have much more experience with penalty fees and much less with stocks and bonds. The authors consider this group to represent the “average American.”

Know Your Debt Level

This is the final question the authors asked participants:

Which of the following best describes your current debt position?

A)     I have too much debt right now and I have or may have difficulty paying it off;

B)      I have about the right amount of debt right now and I face no problems with it;

C)      I have too little debt right now. I wish I could get more;

D)     I just don’t know.

In November 2007 when the data was initially collected – barely predating the recession – around 40 percent of respondents had a negative relationship with debt. It seems likely that the numbers would skew even higher.

Lack of Education Will Cost You

That’s exactly what is found with Americans in credit card debt. Those who the authors found to be less financially knowledgeable tended to pay higher fees and finance charges. In fact, the authors estimate that a third of the costs such consumers pay on credit cards are a direct result of a paucity of debt literacy. In total, credit card holders paid $26.8 billion in penalties. Those less educated financially educated make up about 28.7 percent of the cardholder population, but account for a whopping 42 percent of those charges.

Richness of financial experience and a healthy amount of financial and debt literacy are the true recipe for accumulating wealth and approaching credit repair. Considering what Lusardi and Tufano found in their study, this “widespread lack of financial skills” is something America should be concerned about. Making financial education a mandatory part of school curriculums everywhere would be a good start, because what you know is more than worth its weight in gold.

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