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April is National Financial Literacy Month in the United States and a time to reflect on the state of financial literacy today and what can be done to improve it. In particular, where should the financial services industry direct its resources in strengthening financial literacy in the United States and throughout the world?
But first, what is financial literacy and where does it stand today?
The State of Financial Literacy
Financial literacy is distinct from financial education and financial capability and refers to a person’s knowledge, understanding, and skills in managing their personal finances and amassing savings. Although improving financial capability — the ability to manage one’s finances — is the ultimate goal, understanding the principles and best practices of money management is a key first step on that long journey.
So what is the state of financial literacy and financial capability in the United States today?
It is dismal.
Absolute levels of financial literacy are low and have declined since 2009, even though financial circumstances among the American public have improved over the last several years. That’s according to the 2016 National Financial Capability Study from the FINRA Investor Education Foundation. The study focused on four key components of financial capability, including managing financial products, and found that only 37% of those surveyed could correctly answer at least four of five basic financial aptitude questions.
The problem is not confined to the United States, either. Only 33% of the global population is financially literate, according to “Financial Literacy Around the World” from Standard & Poor’s Rating Services. The survey measured basic knowledge of four central concepts in financial decision making: interest rates, interest compounding, inflation, and risk diversification.
Financial Literacy and Financial Services
Financial literacy has an obvious influence on the financial services industry: People who know how to manage money well are better consumers of financial products and can make informed choices about saving, borrowing, and investing.
The financial services sector knows this. And it knows that financial and investment decisions consumers today must make are more complex than ever before. Financial services institutions and trade and industry associations play an important role in funding, developing and implementing financial education programs. Many industry organizations, including CFA Institute, view providing financial education as a natural extension of their corporate social responsibility,
Choosing a Target Audience
But where should they focus their resources? That’s a question all organizations that develop or fund financial education programs struggle with.
For this reason, we asked CFA Institute Financial NewsBrief readers what they thought. I expected the results would be fairly balanced as to where those efforts can have the most influence. I was mistaken.
Where should the financial services industry be putting the greatest resources into improving financial literacy?*
* Results do not add up to 100% due to rounding.
Out of the 619 respondents to our unscientific poll, 46% felt that the finance sector should disperse its educational resources among the general public. The next largest cohort (28%) favored focusing on students, and 22% thought that clients should be the target. Only 5%of respondents felt that the industry should not promote financial literacy.
There are good reasons to direct resources at clients, the public, and students, but each of these groups has inherent issues that make educating them difficult.
Common Areas of Focus
Educating clients might seem intuitive. Financial services organizations have a responsibility to determine whether clients have the requisite knowledge to purchase their financial products. The question is: Does the firm educate clients directly or point them to the appropriate resources?
To ensure an unbiased and transparent program, many firms offer financial education through foundations or other vehicles. So it may be easier to simply encourage clients who need additional instruction to avail themselves of external, firm-supported resources.
Institutions that want to develop the next generation of savers and investors need to target students and engage them early in their school careers. These days, young people are no strangers to financial decisions. They finance and insure their smartphones and are bombarded with credit card applications. Many must consider how to pay for their college educations — how much to take out in students loans, when they can start paying it back, etc.
But engaging and teaching students is not easy. Few school systems provide any type of financial curriculum. And there are few teachers with the requisite skills to teach financial literacy. Finally, how can a curriculum’s effectiveness be measured? There is quite a long lead time before there is enough data to determine whether a program works.
Longevity risk and the shift from defined-benefit pension systems to defined-contribution plans, on top of day-to-day financial decisions, mean that individuals today must shoulder more financial risk and confront ever more complex financial dilemma. Not only do they have to be financially literate, they also must master investment management.
Towards a Financially Literate Public
The greatest obstacle to creating broad financial literacy is the public’s lack of motivation. When confronted with a specific financial decision, say one related to a life change — a marriage, divorce, new child, new job, lost job, etc. — people find the advice and education. Without that life-change-related cue, however, the general public will rarely seek out the financial education they need. So firms must meet people where and when they are receptive to learning.
Building a financially literate public will require significant human, technical, and financial resources, as well as considerable coordination among a variety of organizations. The finance sector must change its methodology. Pushing information to the public through online platforms or trying to effect change at just the local level is not enough. Collaboration is critical. Firms must work with one another and with nonprofits, regulators, and government agencies. Together they must develop new strategies to communicate financial principles and best practices and harness innovations in behavioral finance to help people make better decisions
It is all a tall order, but as National Financial Literacy Month kicks off, there is no better time to think about how to accomplish it.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.
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