With a GDP greater than $21 trillion, the United States has cemented itself as a global economic power. However, despite being a global economic power, many of its citizens have no grasp of personal finance. Across the country, many citizens lack a basic grasp of financial principles and fundamentals. According to a FINRA report, 19% of American households spend more than their actual income, while 36% break even. In other words, over half of American households spend their entire income or more in a given year. FINRA also estimates that 46% of Americans do not have enough money saved to cover three months’ worth of expenses. This one statistic displays how many Americans fail to properly budget, which is fundamental to having healthy personal finances.
Saying that there is widespread financial illiteracy based on this one statistic may seem like a reach. However, this is not the only statistic that suggests this unfortunate phenomenon. This is just one of many pieces of evidence demonstrating the financial illiteracy of Americans. So, this FINRA statistic is just the tip of the iceberg.
Exploring the Financial Illiteracy Iceberg
Comparing financial illiteracy in the US to an iceberg is not an exaggeration. There is a mountain of evidence published in scholarly journals and news articles demonstrating how significant this issue is.
In the same FINRA report mentioned earlier, roughly two-thirds of Americans were unable to correctly answer more than three questions on a five-question financial literacy quiz. In other words, if asked to take a quiz on personal finance, a majority of Americans would likely fail. Failing to understand the basic concepts of personal finance could prevent individuals from partaking in beneficial financial activities, such as creating an emergency fund, paying off debt, and investing in the stock market.
There is evidence to support that this is the case. According to a Gallup poll, 55% of Americans own stocks in some way, whether it is a personal investment or a retirement plan. As shown in the figure to the right, this is actually a decrease from between 2001 and 2008, when 62% of American adults owned stocks. Unfortunately, a lack of participation in the stock market has been an ongoing phenomenon for decades. Since 1998, the percentage of households not participating in the stock market remained around 40% roughly until 2016, according to the St. Louis Federal Reserve.
Participating in the US financial markets is an effective way to create generational wealth. It strongly correlates with financial security, especially when it comes to retirement. Choosing not to invest, many Americans fail to take advantage of a tremendous financial opportunity right in front of them.
How Financial Literacy Affects Young Americans
Hopefully, I’ve made it clear how significant the issue is at the moment. While financial literacy impacts individuals from all walks of life, I wanted to specifically focus on younger Americans in this article.
Why focus on younger Americans? Well, younger Americans have no advantage when it comes to financial literacy. Based on a financial literacy survey, 47% of college students were unable to answer questions correctly, demonstrating their lack of financial comprehension. When looking at specific sub-groups, such as non-business majors, women, underclassmen, and those with no work experience, the observed performance is actually worse.
This is troubling, as young Americans are in very unique financial situations when compared to their older counterparts. On the surface, it may appear that personal finance impacts mostly older demographics of Americans. But, that would be a misconception. While younger Americans typically have fewer financial responsibilities, it is at these younger stages of life when financial habits and choices can have lifelong impacts. And, if they lack even a basic grasp of personal finances, then their entire financial future could be in ruins before it truly begins.
The Student Loan Crisis
This is most evident in the ongoing student loan crisis in the country. For many soon-to-be high school graduates, college is a very anticipated experience. For the first time, many young students can experience being independent for the first time in their lives. Even for those who are not completely excited about attending college, there is still immense societal pressure to apply to colleges and universities (which is a whole other issue).
Due to these factors, there are over 20 million college students in the United States. On the surface, this appears to be a positive statistic, as many are looking to enhance their education and future career opportunities. However, attending college has a tremendous price tag, which many young students may not understand due to financial illiteracy.
Before the 2000s, selecting a college was a rather straightforward process. Soon-to-be graduates only had to take financially trivial aspects of a university into consideration, such as campus size, extracurriculars, etc. However, there is now a factor today that surpasses all others: tuition. Rising tuition costs have made what was once a simple decision-making process into a financial decision that can have lifelong ramifications.
The Price is Only Increasing Too
College is a whole lot of money, and it’s only getting more and more expensive every year. According to the College Board, since 1990, the cost of a private four-year college education in the United States has more than doubled, going from $18,560 to $37,650. In that same time frame, the tuition for public four-year colleges tripled, increasing from $3,800 to $10,560. This has far outpaced the rate at which income increased over this time. From 1990 to 2020, the average household income increased 56% for the upper quartile, while only increasing 21% for the lowest quartile. In addition, it has tripled the rate of inflation over the past twenty years, as reported by US News. This demonstrates just how unaffordable attaining higher education has become for many Americans.
Evidently, the price of a college education in the United States has outgrown the increase in household income by a significant margin. Consequently, in order to afford such expensive tuition, many students have looked to debt as a solution. As of writing this article, there are over 38 million Americans with outstanding debt for an undergraduate degree. This has resulted in total student loan debt reaching unprecedented levels. As of 2020, the Brookings Institute reports that there is $1.5 trillion worth of student loan debt in the United States, which is an increase of 20%, or $25 million, since 2004. It has now reached an all-time high, becoming the second-largest form of debt in the United States behind home mortgages, representing 11% of all US consumer debt.
How Financial Literacy Can Combat This
Student loans are not intrinsically detrimental to one’s financial situation. In fact, they can provide many educational opportunities to individuals who could not otherwise afford them. However, misuse of this debt can create a lifelong burden for individuals financially. Understanding the return on investment of one’s degree should be pivotal in deciding on a university and major. Unfortunately, since so many students have no exposure to personal finance, this is not even a thought crossing their minds. With so many college students lacking basic comprehension of finance, it becomes more and more clear why there is a student loan crisis.
Aspiring college students should look to see what their potential income is as a result of their college education. The degree a student is pursuing should lead to a career that pays a salary that allows them to afford their student loan debt payments. If the student is majoring in a field with a low salary ceiling, then they should not look to take out tremendous amounts of debt (if any at all). Sadly, with so few students grasping this concept, return on investment for college degrees is often ignored. This contributes to the fact that one million graduates default on their student loans annually.
Having such significant amounts of debt can be financially crippling for many young Americans. Many individuals start their careers in their early twenties already at a disadvantage with the amount of debt they owe. While some may argue that these individuals should live with their decisions, it is unfair to punish those who made these financial choices without having the education necessary to understand the consequences.
Instilling Healthy Habits that Compound Over Time
In addition to directly addressing a financial crisis, financial literacy also has more subtle benefits for younger Americans. Exposing personal finance concepts to Americans at very young ages would allow for these ideas to become ingrained into their daily lives and behaviors. In other words, early education would turn proper financial behaviors into habits.
In his book The Power of Habit, Charles Duhigg makes the point that the human brain tries to make any routine into a habit because habits allow the mind to ramp down more often. Forming habits allows for acts to become second nature, where no thought is required.
“When a habit emerges, the brain stops fully participating in decision making. It stops working so hard, or diverts focus to other tasks. So unless you deliberately fight a habit-unless you find new routines-the pattern will unfold automatically.”
Charles Duhigg
Once ingrained into the human brain, habits do not go away. Instead, like with investing, habits can actually compound over time, completely shaping an individual into who they are.
In his book Atomic Habits, James Clear presents the notion that habits, both positive and negative, can compound over time. Because of this, Clear argues that small habits can make a tremendous difference down the line: “Habits are the compound interest of self-improvement.”
Often, individuals think that a major change needs to occur for an individual to realize a significant change in their lives. However, Clear demonstrates that, by simply improving oneself by 1% every day, one would improve oneself by thirty-seven times over in the span of a year. On the other hand, if one’s habits result in them declining 1% daily, then they will finish the year worse than they started.
Between the work of Duhigg and Clear, it is made evident that small habits developed early can integrate these habits into individuals’ everyday lives and allow for the benefits of good habits to compound so self-improvement can be realized. This can be seen in the figure above.
The Education System Fails to Address Financial Illiteracy
Financial illiteracy plagues the United States, and the public school system fails to address it on any front. Despite the financial magnitude that it could have, many teenagers graduate from the public school system with little-to-no exposure to financial education. In many primary schools and high schools, personal finance is not a subject taught to students.
Current Financial Education is Poorly Executed
As of 2021, the New York Times reports that there are twenty-one states in the United States that require students to take a personal finance-related course prior to their high school graduation. In other words, less than half of the states in the country understand the importance of teaching basic concepts of finance to the country’s youth. Even in the states that do implement personal finance, it is not done so in a manner where students can learn most effectively.
According to Next Gen Personal Finance, of the 21 states that implement personal finance in their curriculums, only 6 states offer standalone courses. The other 15 states either have their students exposed to personal finance through other courses, such as economics and mathematics, or teach personal finance through a one-time program. In either scenario, school systems are not attempting to prioritize teaching personal finance to their students. Rather, it appears as if they are going through the motions so they can say they taught the subject.
Exposing students to personal finance through other courses does not provide students with an in-depth financial education. Further, a one-time workshop does not give instructors the time needed to properly instruct these topics thoroughly. Many personal finance topics are not necessarily straightforward. So, a standalone course would be the ideal way to teach this material. Thus, although 21 states are instructing financial literacy to their students, only six are actually doing so effectively, and studies demonstrate that.
Setting Students Up for Failure
According to a 2016 Bank of America report, only 31% of young Americans believed that their high school properly taught them good financial habits, while 41% of college graduates believed that their college did so. Over two-thirds of students believe that their high school does not prepare them for their financial future, while slightly fewer believe the same about their college or university. This just demonstrates that, even though some schools do have some financial literacy courses in their curriculum, the majority do not have courses or programs that are effective in actually educating their students about financial literacy.
This serves as a disadvantage to these students upon graduation for various reasons, and the college selection process demonstrates that best. Ultimately, high school graduates are set up for financial failure, urged to take on tremendous amounts of debt with no certainty that they will be able to afford it. Society puts the responsibility of deciding whether or not to take out a six-figure student loan on the shoulders of teenagers that have no understanding of finances. To prevent this and other financial issues from occurring in the future, financial education must become a staple in school curriculums.
Personal Finance Needs to Be Implemented in School Curriculums
Studies have shown that improved financial literacy can have profound effects on students’ financial behaviors. According to a 2010 study, students who scored higher on a financial literacy test were more likely to engage in saving behaviors and experience fewer financial issues in their lives. Another study found that students who receive financial education in high school are more likely to utilize low-cost financing to attend college. Students who understand financial concepts more profoundly may rely upon scholarships and financial aid more so than those who do not have a grasp of the material.
Further, there is research that demonstrates the effectiveness of formal financial education. According to the Federal Reserve, students graduating from high schools with mandatory financial literacy programs had better credit scores and lower delinquency rates than those that didn’t. The report even concludes that: “If the goal of policymakers is to influence debt repayment behavior, and the opportunity costs of providing this form of education are relatively low, then mandating financial education may prove to be a reasonable strategy.”
Additionally, a 2014 study found that a thorough personal finance course led by instructors who were educated on the material significantly improved the “average personal finance knowledge” when tested. As alluded to earlier, the program in this study required instructors to take a thirty-hour course to ensure their mastery of the material before teaching. Roughly 1,000 students took this course for a semester, with the majority seeing an improvement in their financial literacy comprehension skills. The researchers of this study make two key conclusions that validate the need for implementing personal finance into school curriculums.
The first conclusion of their research is that “a well-designed personal finance course” is an effective measure to promote the understanding of personal finance. It is worth reiterating that many schools that have mandated financial literacy courses do not have programs that are well-designed or thorough. Secondly, the researchers concluded that it is also important for instructors to be “properly trained” for a personal finance course to be effective. This is important, as many schools choose to teach financial literacy through other somewhat related courses. A teaching approach like this does not suggest that the instructor is well-educated on the topics of personal finance. Rather, they are properly educated in the primary course that they teach, like mathematics or economics.
Ultimately, the researchers make the following assertion: “Based on the interest worldwide in helping today’s youth understand financial issues, [a formal financial education] curriculum offers one effective alternative for changing student personal finance outcomes.” It’s rather safe to conclude that having a thorough personal finance course in school curriculums would effectively promote financial literacy amongst students.