Are Americans getting financially dumber? It's hard to say

Financial literacy in this country has steadily declined over the last 12 years, according to a recent study, but the root cause remains elusive.

In 2021, the average respondent correctly answered 2.6 out of 5 financial literacy questions, according to the findings from the FINRA Foundation National Financial Capability Study that surveyed nearly 30,000 U.S. adults, down from 3.0 out of 5 questions in 2009. High financial literacy was considered answering more than 3 correctly.

Why financial literacy is declining, its correlation with smart money behaviors, and how to improve all is vexing experts who hope any connection can ultimately help more folks reach financial security.

“The 14% drop in financial literacy from 2009 to 2021 is certainly notable, but much more surprising is the 21% increase in the number of ‘don’t know’ responses to the financial literacy quiz questions over the same time,” FINRA Research Director Gary Mottola told Yahoo Money. “We do not yet fully understand why so many more people are reporting ‘don’t know’ in recent years. One hypothesis is that the growing complexity of our financial world could indicate that people are increasingly aware of their own knowledge limitations.”

Financial literacy quiz

To evaluate respondents’ financial literacy, the 2021 NFCS used seven quiz questions covering fundamental economics and personal finance.

The questions ran the gamut of asking about compounding interest. For example, “Suppose you had $100 in a savings account and the interest rate was 2% per year. After 5 years, how much do you think you would have in the account if you left the money to grow? The possible answers included: more than $102, exactly $102, less than $102, and don’t know.

Another was: “Imagine that the interest rate on your savings account was 1% per year and inflation was 2% per year. After 1 year, how much would you be able to buy with the money in this account? Answers ranged from more than today, exactly the same, less than today, and don't know.

Another question: do you think the following statement is true or false? Buying a single company stock usually provides a safer return than a stock mutual fund.” See answers below.

The results indicate that those with higher financial literacy are more likely to have taken steps to plan for their long-term financial future, such as calculating retirement savings needs (52%, compared to 29% among those with lower financial literacy), and having a retirement account (70% vs. 43%). They are 23% more likely to spend less than their income, and 26% less likely to use high-cost forms of borrowing than those who display low financial literacy, according to the FINRA survey.

Financial education programs are only one piece of the puzzle

How successful financial literacy efforts truly are is often batted around. “There's no credible evidence that these financial education programs actually give people the tools that they need to protect themselves or to make optimal choices for their own situation and values,” Lauren Willis, associate dean for research and professor of Law at Loyola University, said in a recent financial literacy webinar, hosted by the Financial Access Initiative.

“The market changes so quickly that things that we teach people, even habits, often end up being outdated. If regulators can't keep up with the speed of financial innovation, we can't expect educators to, and we certainly can't expect their students to. Just because you can even calculate compound interest does not save you from a bank who has highly detailed information about your online behavior, figuring out how to micro-target an offer to you that's going to be highly profitable for them and suboptimal for you.”

Mottola is realistic.

“It’s important to note that better financial knowledge is not a panacea,” he said. “Other factors — like income, educational attainment, systemic racism, and lack of access to financial products and services– are tied to indicators of lower financial capability. Such factors need to be addressed by policymakers and advocates who want to improve people’s financial capability.”

The core issue is that while financial savvy is essential, circumstances make it hard to get a grip on some of these challenges for a swath of the population. “Amid these overall gains in financial capability, there are segments that continue to struggle, particularly younger adults, those with lower income and education levels, Black/African Americans, Hispanic/Latino Americans, and those who were laid off or furloughed due to COVID-19,” Mottola said.

“The reality is that many disadvantaged people face hurdles and barriers that many others do not,” he said. “For example, those whose parents were on stronger financial footing are more likely to have learned about money from their families as well as have better financial outcomes later in life themselves. Therefore, these do not reflect a direct link between financial literacy and financial behaviors.”

It takes money to make money

Making good financial choices “mostly comes from having enough money that good financial choices are possible, especially having enough money to make a few mistakes—this is the way all of us really learn how to manage our finances, not by taking a class,” Timothy N. Ogden, managing director of the Financial Access Initiative at New York University's Wagner School of Public Service, told Yahoo Money.

“People with more money have more experience with financial tools and services and therefore have higher financial literacy. Telling someone they should have an emergency fund or save instead of borrowing presumes they are making more than enough money to cover basic expenses and enjoy life on a regular basis,” he said. “People don't borrow from payday lenders because they don't know how compound interest works. They're borrowing because they don't have enough money, and they don't have other cheaper alternatives. Teaching them about the importance of retirement planning isn't going to change the need to pay the rent or the electric bill this month.”

Yet, when results like those from FINRA are released, it’s easy to fall back on the idea that the solution is to ramp up more money classes in schools.

“Financial literacy is perceived to be a panacea because it's so much easier to do something about than the difficult and messy policy problems of ensuring there is affordable housing, affordable medical care, affordable transportation, and good paying jobs,” Ogden said. “You can't fix this problem with boring, mandated financial literacy courses taught by high school gym teachers who would rather be doing anything else. It's crazy that anyone thinks that mandated classes in school are a solution to these issues.”

The FINRA findings are a wake-up call in some respects that more needs to be done to ramp up basic financial skills and will have a lasting impact on the finances of millions of Americans, and, in turn, the economy. But it’s only part of the puzzle.

“I really don’t think it’s the financial literacy community that’s saying that financial education alone will save everything,” Laura Levine, president, and CEO of The Jump$tart Coalition for Personal Financial Literacy, told Yahoo Money. “Financial education is a critical component to achieving financial well-being when coupled with things like suitable products and services, consumer protections, fair and equitable access and opportunities, and clear, reliable information.”

And for those of you checking to see if you had the right responses to FINRA questions: Here you go: More than $102; less than today; false.

Kerry is a Senior Columnist and Senior Reporter at Yahoo Money. Follow her on Twitter @kerryhannon

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