With all the talk of inequality in this country, a vital cause is being neglected. The decisions made by the financially illiterate among us are devastating to their economic health. Take a look at what happens when schools worry more about students understanding the area of a rhombus than the value of compound interest.
In a recent paper for the National Bureau of Economic Research, Lusardi and Mitchell reviewed the growing research evidence of how low levels of consumer financial literacy lead to money-losing decisions. Here is a “hit parade” of sorts of how we shortchange ourselves:
1. Those who are more financially literate are also more likely to undertake retirement planning, and those who plan also accumulate more wealth.
2. More financially literate individuals are more likely to choose pension accounts with lower administrative fees.
3. More financially sophisticated individuals are less affected by the choices of peers in their financial decisions.
4. Even just learning about the concept of compound interest produces a sizeable increase in pension contributions.
5. Those with lower incomes and less education (characteristics strongly related to financial illiteracy) are less likely to refinance their mortgages during a period of falling interest rates. The cost of such inaction is $50 billion to $100 billion a year in higher mortgage interest payments.
6. Those unable to correctly calculate interest rates end up borrowing more and accumulating less wealth.
7. The least financially savvy incur high transaction costs, pay more for products, services and related fees.
8. The least literate are also more likely to borrow against their 401(k) and pension accounts.
9. Those who are less financially literate are substantially more likely to use high-cost methods of borrowing, such as payday loans, pawn shops, auto title loans, refund anticipation loans, and rent-to-own shops.
10. Financial literacy can explain more than half the wealth inequality observed in U.S. data.
11. In a Dutch study, being in the 75th versus the 25th percentile of a financial literacy index was equal to about 3.5 times the annual net disposable income of a median Dutch household.
12. The least financially literate are more likely to pay higher investment fees and expenses.
13. Of course, the least financially literate also left the stock market and have stayed away, costing them about 4 percent of their wealth as market values recovered from the recession.
14. Failing to have a diversified investment portfolio costs financially inexperienced investors a substantial amount of investment income.
15. The average credit-card fees paid by those with low knowledge are 50 percent higher than those paid by the average cardholder.
The decision-making landscape to prepare for retirement is particularly challenging, according to Lusardi and Mitchell. “Retirees must look ahead to a future of uncertainty when making irrevocable choices with