Annamaria Lusardi is University Professor of Economics and Accountancy at the George Washington University. Moreover, she is the founder and academic director of the Global Financial Literacy Excellence Center (GFLEC), and the co-chair of the G53 Financial Literacy and Personal Finance Research Network (G53 Network). Previously, she was the Joel Z. and Susan Hyatt Professor of Economics at Dartmouth College, where she taught for twenty years.

She holds a Ph.D. in Economics from Princeton University and an honorary degree of Doctor of Science (Economics and Business Administration) from the University of Vaasa in Finland.

Professor Lusardi received numerous research awards. In 2017, 2021, and 2022, she was included in the Clarivate list, which recognizes exceptional research influence. In 2009, she served as a faculty advisor for the Office of Financial Education of the U.S. Treasury. In August 2017, she was appointed Director of the Financial Education Committee in charge of designing the national strategy for financial literacy in Italy.

Gaining financial literacy is critical if you want to thrive in today’s society. And yet, only about a third of the global population can be described as being financially literate. Joining us today to unpack the concept of financial literacy and its impact is Dr. Annamaria Lusardi, Professor of Economics and Accountancy at George Washington University. Dr. Lusardi has taught Economics for over 20 years, and her passion for financial literacy is reflected in everything she does. Her career has been instrumental in furthering the cause of increased global financial literacy, from being the Founder and Academic Director of the Global Financial Literacy Excellence Center, to serving as the co-chair of the G53 Financial Literacy and Personal Finance Research Network. In our conversation, Dr. Lusardi breaks down the definition of financial literacy, how it’s measured by leading experts across the world, along with some of the key differences we see between people in richer and poorer countries. She explains why financial advice isn’t a replacement for financial literacy and provides guidance on what we should be doing to educate various population groups. We also discuss how global trends have created an increased need for financial literacy as an essential skill, especially for young people, and why greater global financial literacy is beneficial to everyone, including governments and wealthier individuals. Tune in as we delve into the many facets of financial literacy and the important role it plays in our collective health, happiness, and success!

Key Points From This Episode:

• Dr. Lusardi defines the concept of financial literacy and the importance of being able to apply it as a skill. (0:04:30)

• How experts measure financial literacy and some of the key challenges involved. (0:07:55)

• The global survey that was conducted on financial literacy in 2014 and its dismal findings. (0:11:44)

• The areas of financial literacy that people struggle with most and why the need for financial literacy has increased over time. (0:15:26)

• The costs and benefits of gaining financial literacy and the concept of optimal financial knowledge. (0:22:42)

• An overview of the type of person who should be investing in financial literacy and why. (0:27:46)

• How the strength of your government’s social safety net affects financial literacy rates. (0:30:15)

• The extent to which financial literacy affects stock market participation and wealth accumulation. (0:31:18)

• Some of the common mistakes that those with low levels of financial literacy tend to make. (0:35:10)

• Why financial literacy’s end goal should be geared towards happiness and living a good life. (0:39:24)

• The impact that financial advice and financial advisors have on economic outcomes. (0:43:18)

• How financial literacy varies across demographic groups and some of the factors that account for disparities in financial literacy. (0:45:42)

• How financial education programs can yield positive results and where this education should take place for it to be optimal. (0:52:13)

• What listeners can do to increase financial literacy for those around them and why there is no alternative to good financial knowledge. (0:58:55)

Read The Transcript:

Ben Felix: This is the Rational Reminder Podcast, a weekly reality check on sensible investing and financial decision-making from two Canadians. We are hosted by me, Benjamin Felix and Cameron Passmore, portfolio managers at PWL Capital.

Cameron Passmore: Welcome to Episode 232. Welcome to the end of, almost the end of 2022. Ben, I must say, this was an absolute blast guest to meet Professor Annamaria Lusardi. Wow, she started us off camera, when we first met her, showing us an award she won last night, which was just to see her excitement and the recognition for her career. It's incredible. The energy that she brings to the topic of financial literacy was absolutely contagious. It was a fantastic interview. We learned a ton. She is so articulate. The experience she has in this and the impact. Some of the notes I took down, Ben, just financial advice is not a replacement for financial literacy. So interesting. Only a third of the world is financially literate. Two-thirds is financially illiterate. Financial literacy is critical, when you ask for the question, in happiness and having a good life.

Ben Felix: Oh, I loved her answer on that. That was great.

Cameron Passmore: It was so interesting. 30% to 40% of the difference in someone's economic net worth is due to financial literacy.

Ben Felix: In retirement wealth equality. Yeah, yeah.

Cameron Passmore: That was just a brilliant conversation.

Ben Felix: I agree. I expected it would be when I found Professor Lusardi’s research, I was blown away by the quality, the influence, the reach of her research. She's authored or co-authored all of the most cited papers on this topic. I said to her before we started recording, she was very humble and told me not to exaggerate. I think it's true. I can't get this out of my head, that she is to financial literacy research, what Gene Fama is to efficient markets. She told me that's an overstatement. I don't know. I don't think it is. Her body of work is absolutely incredible on this topic, and the passion that she brings to it is also incredible.

Cameron Passmore: 100%. She's the Professor of Economics and Accountancy at George Washington University. She's the Founder and Academic Director of the Global Financial Literacy Excellence Center, and the co-chair of the G53 Financial Literacy and Personal Finance Research Network, the G53 Network. Before that, she was Professor of Economics at Dartmouth, where she taught for 20 years and she has a PhD in Economics from Princeton.

Ben Felix: Yeah. An incredible career and incredible body of work, and incredible area of research that's just so directly relevant to people. She articulated this so well, when we talked about happiness and she talked about how when she asks her students, what they think her course on financial literacy, which she teaches at her current university, what they think it's about. They usually think it's about investments, or they think it's about debt. She tells them, no. It's about happiness. Financial literacy is ultimately about happiness, about having the ability to choose in your life. I just thought that was an incredible explanation of what personal finance is and what financial literacy can bring to the table, to somebody's life.

Cameron Passmore: I mean, clearly, we believe this, right? I mean, that's why we do this podcast. At the end, he talks about how taking care of your finances changes your life.

Ben Felix: I think, you know what? We would agree with that, which is one of the reasons we do this podcast. I know this is anecdotal. When you look at the stories that we hear from listeners of this podcast, who have gone on this little journey with us, where they've listened to a bunch of podcast episodes, the stories we've heard about how much it has changed people's lives. I don't think that it's an overstatement to say what she said.

Cameron Passmore: Yeah. Anything else, Ben? I think we've put a pretty high energy intro to this.

Ben Felix: It’s exciting. It was an exciting, high-energy episode. For me, there was a ton of anticipation, because people have heard us in the podcast recently talking about financial literacy, and on a few different occasions. After we did that podcast episode, I was asked to speak about it. I'm actually doing that tomorrow. Anyway, so I've spent a ton of time reading her research, and I think that comes out during the conversation. Yeah, you're right. Let's go ahead to the episode.

Cameron Passmore: Beautiful. Here is our conversation with Professor Annamaria Lusardi.

***

Professor Annamaria Lusardi. Welcome to the Rational Reminder Podcast.

Thank you. Thank you for inviting me.

We're very excited to be talking to you. To start off, Professor Lusardi, what is the definition of financial literacy?

We have to spend a lot of time defining financial literacy. I have to tell you that we spent, I'm not kidding, probably an entire month, or more to come up with a definition. Now, I'm going to read one that we came up with. I'll read the definition first and then I tell you why I think it's so important. Then I tell you, which group was it designed to, even though it's very general. We came up with this definition. Financial literacy is knowledge and understanding of financial concepts and risk, and the skills, motivation and confidence to apply such knowledge and understanding in order to make effective decisions across a range of financial concepts to improve the financial well-being of individuals and society, and to enable participation in economic life.

Granted, this is a long definition, but I think it's important for several reasons. First of all, when it comes to financial literacy, it’s not just a simple concept, but it's also the motivation and the skill to apply such concept. The definition also points to the fact that financial literacy is useful, because it brings better financial decisions. It has that objective. Third, and this is why I thought it was innovative, it's not just for the individual, but for society as well. Something that I would like to discuss, maybe throughout this podcast, why it is so important to have financial literacy, not just for the individual to society.

Finally, we wanted to underline that we said it enabled participation in economic life. Financial literacy is like being a citizen, having that knowledge that allows you to be a citizen. Interestingly, if you think is very general, we came out with this definition, when we had to design questions for 15-years-old. We started with the young, but it is a definition, which I think is appropriate for everybody. If I fail to summarize, it is basically financial literacy is that basic skill, like reading and writing, that we need today to participate to society.

I liked that you had confidence in there, too. I picked that up from some of your papers that a lot of the gender gap in financial literacy is explained by differences in confidence. It's interesting to see that in the definition.

Yeah. Now, we try to be general. Very general. We saw that it is an important factor that you need the knowledge, but also the confidence to apply it. That's particularly important for some group, as you have said, and we saw that as well. Then also, financial literacy is something beyond the simple knowledge of concept. That's what we wanted to make clear. By the way, we have used this definition to then design a set of question, to then measure financial literacy among the young. Frankly, we apply this concept to also measure financial literacy among the old.

My question, which is how do you actually measure financial literacy?

It's not easy. When we started many, many years ago, and was almost by accident, we were told, we only had three questions. You might know about our big three. We started this measurement of financial literacy back in, I think, actually, when we designed this question was 2002. Then they were added to our first survey in 2004. When we actually had to write down the actual questions, we first of all, realized that what we needed to do is look at the most fundamental concept.

This is also something we did when we worked for the OECD in the previous definition I mentioned, because you have to design measure that actually holds true also across countries. When you look at what are basically this concept that everybody needs to have, in order to make decisions, then you have to really go to the most fundamental, in a sense concept. This is why in our, for example, big three, we talked about interest compounding, or calculation that concern interest rate. This is really something of course, universal. We talked about inflation, cyclical important in financial decision-making, because almost every financial decision has to do with time and risk diversification.

These concepts are at the basis of almost every financial decisions, and they are also universal. It's not that inflation is different across country. Inflation is the same thing. Is the increase in prices over time. Also, this diversification is the same concept across countries. Of course, when you have more and more in the PISA definition, we could design 40 questions, then you can of course, be a lot more elaborate.

When you expand to more questions, what other types of topics are tested?

When we expanded to more, this is where you become less and less global, because many of the questions, I think, often have to do with potentially, a specific country. For example, more recently with the TIA Institute, we designed what we call a personal finance index. This is an index that measure knowledge of personal finance. Basically, measure of the concept related to the decision that you make every day. Now, there are 28 question. But in there, we added questions about do you know about 401K's? Do you know about insurance contract? Do you know about specific financial instrument?

Now these become, of course, now, much less global. In a essence, you could come up with a lot of sophisticated question, including, do you know the difference between a bond and a stock? That's actually a pretty universal concept. Do you know about the inverse relation between asset prices and interest rate, which, by the way, is a great way to measure whether people have a sophisticated knowledge. It's not that by reading the Wall Street Journal, you learn about this inverse relationship between bond prices and interest rates. You really have to understand this.

Do you know more sophisticated questions about the working of interest compounding? Can you do some of the calculation about interest compounding, and so on? This is, of course, very important when it comes to planning and also, making some calculation. I always argue, to make sound decision, you have got to do the calculation. It's not that you can just come up with your gut feeling.

How do you describe the current state of financial literacy when you look around the world?

We did a survey, indeed. The global survey of financial literacy. We have data for more than 140 countries. We did that survey back in 2014, with the help of Gallup. I think the way I would describe it is one word, which is dismal. What that data revealed is that only 1/3 of the population in the world is financially literate. 1/3. If you think about this, that's a very low number, in particular, because what we found, and I think that's a surprising result, is that many countries with well, advanced financial markets do not have even half of the population, which is financially literate.

That to me was a striking and very, I would say, I just want to put a warning about that finding in today's world. Particularly, I think you look at the fact of the crisis. Now we are back having inflation. People need to have that basic knowledge. By the way, what we did measure is exactly that the most simple knowledge. It's surprising and striking and I would say, dangerous, that such a large part of the population doesn't even have that basic knowledge. That was, I think, the most important message, frankly, of that global survey.

Do you know how financial literacy levels have changed over time? Are we getting better?

We don't know the answer to this question, because even though that survey that we did in 2014 is the most cited survey, by the way, there is no week that goes by without somebody citing that survey. Particularly, they want to talk about financial literacy in a specific country, because for example, other institutions have done surveys. It's always 20 country, or the G7, or the G20, or so on, but not a global survey.

That global survey has not been done yet again. Understand, it is expensive to do a global survey, but I actually think is even more expensive not to have that data. If I look at countries for which we have data, so for example, mostly the US, and I say that because for example, our data collection, I work for the personal finance index, started in 2017. Now, we have six years of data. If I look at other surveys, for example, the one of the regulator in the US, the national financial capability study, we started in 2009. Now, we have more than 10 years of data.

What we see is very little, or no improvement over time, which is actually not surprising to me, because it's not that you increase financial literacy just by watching the world around you. Relatively sophisticated knowledge that it's not that you acquire it, necessarily. In fact, that's also, I think, what we find, when you look at the countries with the well-developed financial markets, they often do not have young people that are more financially literate than countries with less developed financial market. Which again, says, if you're born in a rich country, it's not that you are automatically financially literate. Financial literacy is something that you add to acquire, in essence, in school.

It's like, can you learn your reading and writing just by yourself? I don't think so. Even writing and writing at the end of the day, it's not that simple. Finance is simple, but not that simple that you just learn by watching the world around you.

What areas of financial literacy do people struggle with the most?

Yeah. I would not have been able to answer that question until recently, when we did, for example, this personal finance index. What we did find is that the area in which they struggled the most is basically risk and understanding risk. It is investing and it is insuring. Actually, this might be useful for you, in particular, because that's where probably financial advisor operate the most. In many ways, this is not surprising, because if you think about what risk is, that's a difficult concept, right? It's the second moment of a distribution. It's not something so easy. It's also, I don't think something's so intuitive.

It's also interesting that also, insurance is where we see the lowest amount of knowledge and also investing. By the way, we have tried to come up with the simplest questions about investing. But nevertheless, this is the one – these are the topics that I think people find most difficult. Probably, rightly so, because there is quite a complexity behind that. I always tell my students that, to explain why it's not a good idea to put all of your eggs in one basket, right? Just if I had to do the proof of that simple story, it's actually a long proof. It's not so simple. This is where people struggle the most. I think, this is also very consequential, because risk can really increase a lot in our life, from a macro risk, from climate change, from the pandemic, from health risk, and so on.

More and more part of our life is how to hedge against those risks, how to ensure against those risks. These are important skill for us to develop, because we really do want not to be derailed by sharks happening to us.

Interesting. Do you think that the importance of financial literacy has increased over time?

I do. This is actually one of the reason why we started this project. When I say we, is also with several long-term collaborator, from Olivia Mitchell, to Peter Tufano, to even collaborator in Canada, for example, Professor [inaudible 0:17:54]. Let me at least mention two or three of those reasons, as might be very obvious, and I think some of them are also happening across countries. One, I think, is really to do with the changes in the pension system.

More fundamentally, is basically, the change in demography, right? The fact that we live much longer, and there are less young people, for example, people are having less children. This is putting enormous pressure on the government and all of these social insurance. For example, almost every country has shifted toward the defined contribution type pension. More and more, people will have to at least provide for part of their financial security at retirement. I'm not claiming that these things are not going to go away, but they will be less generous.

That, I think, is one of the fundamental reason why we all need to be financially literate. Even countries like China. I mean, you don't need to be in a sense, the G7 countries for that. Another question, the other reason is we see just the complexity of the financial instrument. Even a mortgage is a very complex financial instrument now, so that complexity of the financial instrument has happened everywhere. I mean, think about of how many mutual funds exist, and how many financial instruments exist with respect to the past.

The third thing, this is also related to the US, but I think is happening in other countries is the change in the cost of education. More and more people, they have to make a decision about a very important investment, which is the investment in education. That education is becoming in some country, much more expensive. If you don't even go to the US, going to college in other countries as well is getting more and more expensive. Maybe you also want to be very deliberate about it. Which type of university do you want to go to?

Well, in the US, an average student is going to come out of college with more than $30,000 in student loan. Young people start their economic life in debt. Think about this. That's a very, very big change. It means that very early on, in fact even when you are 15, before you make that college decision, you need to have at least some basic knowledge. Again, to come back to my definition, to understand the world around you and to participate to society. Making mistakes about some of those decisions can be very consequential, much more than in the past.

When you look at trying to explain the differences in the individual's economic outcomes, is financial literacy distinct from other types of education, like schooling?

Yes, it is. It is, because I think it's very specific. It's a specialized knowledge. The question is, do we need specialized knowledge, right? If I teach more math at school, shouldn’t be people be able to make financial decisions? That's, I think, what some people argue. I actually think not, because by the way, financial literacy doesn't mean only being able to do the calculation. Also, means being able to know where to go and get sources of information. It means, being able to decide whether or not you should consult a financial advisor. It means also, know where are your rights and your obligations, and things like this.

I think what we really see as well, that it is an additional piece of knowledge. In almost all of our empirical work, we have seen that, for example, your level of schooling affects financial decision, but financial literacy affect financial decision above and beyond schooling. Just to give you an example, if you are more financially literate, you are a lot more likely, for example, to invest in stock, you are a lot more likely to invest also in other assets. You are almost more likely, by the way to manage that well. You're also more likely to have precautionary savings. Above and beyond the level of education. It's a specialized knowledge that is particularly helpful in making a decision in that specific area, which is financial decision-making.

Yeah, that's so interesting. The financial literacy is a specific form of human capital. Such an interesting concept. I want to ask about one of your papers, which is just an absolutely fascinating paper on optimal financial knowledge and wealth inequality. Can you talk about how you modelled the effect of financial literacy on retirement wealth and equality in that paper?

Yeah. What we try to do in this paper is basically show that financial literacy, like other form of education is a decision that people make. Because, first of all, it is financial literacy brings benefit. The benefit is you are better able, for example, to participate in financial markets. That you’re able to understand what the stock market is and does and how to use it as well. This is, indeed one of the main channel we use in that model to say, well, what are the benefit, frankly, of financial literacy?

Well, you're better able to basically use a more complex financial instrument. Then for us, because this is a sense, a strong model of reality is that it allows people to better invest and participate in the stock market, so to basically get a higher return on your wealth. We recognize that our cost of financial literacy. You have to spend time and effort and often, pay for acquiring financial literacy. What we wanted to show that every other decision, including your investment in education, people make a rational decision on whether or not to go to college and compare the cost and benefit. The same is done in financial literacy.

Recognizing that it's not that we expect one hundred percent of the population to be financially literate, because we recognize that for some, the benefit of being financially literate might be very limited, right? If you feel like, well, I have a good pension. I don't need to save for my pension. I don't have a lot of money. I already won't be able, or even wish for to invest in the stock market. It’s not that I need to be really financially literate.

That model simply recognizes that it is a rational decision. That's why we say, optimal, the word optimal financial knowledge and not by chance, the paper was published in the Journal of Political Economy, where we are really putting that rational spin, which we believe is what people do. They try to do the best in their financial decisions. There is, I think, a really, really striking finding in that paper. It goes beyond what we expected. Because we have a model, now we can see. But how much does financial literacy matter?

I think, I have met a lot of economists that expect, or claim that financial literacy doesn't matter, or that is not really relevant. We put that to task as well. We have a model. We incorporated financial literacy in it in the model that all economists use to model financial decision, for example, saving decisions. Then, we could determine, but how much does financial literacy matter? How much does it account, for example, for wealth, the differences in wealth close to retirement. We found that from 30% to 40% of wealth at retirement is accounted by financial literacy.

Wow.

I have to say, for those who think that financial literacy doesn't matter, think back. Because this is, first of all, a very high number. If you think about this, it's also not surprising. In fact, let's think of this situation. If we already know, the same people, and we might have the same income, we might have the same education. But if I invest in stock, and you don't invest in stock, 20 years later, we might indeed look very different. This is not a simple calculation. We incorporated the life cycle model with shocks and with all the innocent sources of shocks that people could face. What we actually did show is that having access to financial literacy and therefore, better investing in the stock market brings large differences in wealth, close to retirement.

Yeah. I really liked that paper. One of the things that I was thinking about when I read that one was that you're talking about being able to access effectively higher expected returns by being financially literate. In some of your other writing, I also found that I think you talk about how people with lower financial literacy also tend to pay higher fees in general. That that probably contributes to the same effect.

Yeah. In this model, we don't even take that into consideration, and that's why I think if we were to add these other sources, I think probably we can do even more. Here, with only one channel, with the fact that financial literacy allows you, in a sense to get a higher return on the market, and therefore, a higher return on your wealth, you can generate already a much higher amount of wealth for those who invest in financial literacy. That's, I think, a pretty remarkable finding.

Definitely. You touched on this, but can you expand on what determines the optimal level of knowledge, like who shouldn't invest in financial literacy?

Yeah. Here, because our model is very stylized, we model several sources of uncertainty. What the model really says in a sense here is that one of the main reason for people to save is for retirement. This is in a sense, for example, people save also for precautionary reason, right? For precautionary reason, you don't save millions of dollars, right? It wouldn't be optimal to save millions of dollars for precautionary reason. You should probably buy insurance. The really big part of wealth often count for saving for retirement. Particularly now, and also, that's what we model in the people that the replacement rate of Social Security is probably in particularly for a higher income people, be around 50%.

You need to save quite a bit for retirement. If it is the case, then the people who have in a sense, more of an incentive to invest in financial literacy, going back to what I was saying earlier, why we need financial literacy today is that people will have to save quite a bit for their retirement. It's more optimal in a sense for I would say, a high-income person that has to save a lot for retirement to invest in financial literacy, potentially than a low income worker who has a very high replacement rate, and so his saving for retirement is less.

In that sense, we say, part of the differences we see in society, in how much people are financially literate, part of them is also rational, because some people might not need to invest a lot in financial literacy if they don't need, for example, to make certain type of decisions. Having said that, because this is, of course, a very stylized model. I would argue that today, almost everyone need to add at least the basic knowledge. This model is really about more than sophisticated knowledge that allows you to, in a sense, access more sophisticated kind of financial instrument. Now in the same way in which probably some people don't invest in very, very complex financial instrument, because they don't need to. Or they don't have the type of wealth to invest in very complex financial instrument.

When you look at the global data, does the optimal level of financial knowledge show up there? For example, does a country with a stronger social safety net have lower levels of financial literacy?

Yeah. Actually, this is not work we have done, but other people have done. It's very interesting that they show that the country which have the lowest level of financial literacy, for example, are also country with more general pension plans. Interestingly, for example, this might explain a country like Italy, and all my native country, where the level of the government support, or the government insurance has been quite high and the pension have been quite rich in the past. People didn't really have to probably invest a lot in their own financial knowledge for their own retirement. Also, for those country, things are now changing. In a sense, they should also try to adjust to that, because the reality, particularly for the young people, is going to be very different than the reality for their own parents.

That is fascinating. Can you give us the numbers around how financial literacy affects stock market participation?

Sure. Of course, the number really change a lot, depending on which country you look at. We were able to look at this evidence, for example, for the Netherlands. The reason is, we have worked a lot with the Dutch Central Bank. We have been able to estimate, for example, the relationship between financial literacy and participation in the stock market. We have done several studies, as well in the US as well. What I can argue is that financial literacy is an important determinant of stock market participation. I cannot now pin down the very precise number, because we have done many studies and across all the countries, but it's not a sideshow. People who are financially literate are indeed a lot more likely to participate in the stock market. In other words, knowledge is a very important factor for what relate participation in financial markets.

This is why I know that, for example, a lot of people are pushing for financial inclusion, they feel like, well, if we have a good market, if we open markets, or if we have a good financial system, people will participate to it. I feel like, well, think back, because in particularly when it comes to complex financial instrument, I can tell you that a lot of people don't even know, it cannot define what the stock is. You can open all the market you want, but you need to have people to have that knowledge in order to participate to the market. This is why, and I want to repeat it strongly, if you want to promote financial inclusion, you have got to promote financial literacy. Market and financial instruments, offering people financial instrument is not enough.

Can you talk about the empirical side? You talked about your model on retirement wealth accumulation. Empirically, how is financial literacy related to wealth accumulation?

Many, many ways. For example, from the theoretical model, we even can pin down a number. We see that financial literacy can explain from 30% to 40% of wealth accumulation at retirement, and we think is via the investment channel. In other words, financial literacy allows you to invest better. Therefore, to earn higher return. To basically take advantage of the equity premium puzzle, to say it in finance.

I think, there is another channel, and that we have found in other study, which is that financial literacy allows people to plan more for retirement. I think that planning can influence wealth accumulation in other ways. Meaning, it can also influence how much you save, not just how you invest your wealth. I think, you know, what could potentially happen is, when you start planning and you start setting objectives, then your consumption pattern might change.

You might indeed, by creating an objective, for example, maybe reduce your consumption, or I would say, start saving early. In many ways, that's actually the biggest suggestion, frankly, coming for personal finance, which is that if people were to start as early as possible, and I would say, even well before you start college, or you start your education, if maybe parents, or grandparents would start even putting money aside for their children. When early on, I mean, the power of interest compounding is very powerful and wealth can grow very, very fast and high if you start, let's say, at age 15, or if you start as soon as you start working. That's why, I think, financial literacy is so essential for wealth accumulation.

Can you talk about some of the common mistakes that financially ignorant people tend to make?

Yeah. As you know, mistakes are in the eye of the beholder. As an economist, I always think that there are lots of the many reason why people don't do what we predict them to do. I think, probably one of the many things that we see today, I think, potential mistakes happen, I would say, on the debt side. The reason is, there is so much innovation in that. We have given people so many opportunity to borrow, almost against everything. You can borrow against your human capital. We have student loans. You can even borrow against your future paycheck, going to pay the lender.

You can borrow against your 401K. You can borrow against anything. I think, because of that really huge supply and because it's often shifted to individual, to make those decisions, I think that's where potentially people make mistakes. I would say, in particularly in a country like the US that what people should be doing, and perhaps they don't do enough, is take care of their credit score. Because the credit score is almost a grade on your decisions. It affects the interest rate you're going to get, things like mortgage. Even a 50 basis point difference on your mortgage is going to make a huge difference on the interest you're going to pay for that.

It’s going to even affect whether you're able to rent an apartment and your employer will look at your credit score. That really knowing and taking care of your credit score, I think could be something very important on the debt side. The other things and is related to what I was saying before, is that probably, people don't start saving and planning for the future early enough. That's one of the things I always tell my students, because people feel like, “Retirement. What is retirement?” In fact, time, which by the way, is the asset that all young people have. All young people are endowed with an amazing asset, which is time. Use time on your side, on your favor.

People say, “I cannot save.” But everybody can save. Even poor people, very poor people in poor countries are saving. Saving early can be quite important and quite useful. You can take advantage of that. I think, there are lots of opportunities that perhaps, people are passing on. For example, taking advantage of employer benefits, taking advantage of tax favored asset, taking advantage of financial markets. I would like to see, and probably people have done it, and people have done some of the study that when interest rates go down, it's really time to refinance mortgages. It's really time to take advantage of all of the opportunities of the markets.

In my view is also, if we look at the financial crisis, I think we have seen at least two or three other mistakes that in my view that people have made. From the, I think, the 2008 financial crisis, we did see that people engage in mortgages they could not afford. It's probably, because this mortgage got incredibly complex. Much more complex that people were able to understand. They took convertible, adjustable rate mortgages with very low teaser rates, and so on, not understanding that these things would change very quickly. Then they couldn't bat, or really on the housing market hold was going up.

The second thing that we have seen is, people don't put aside precautionary savings for enough. 1/3 of the population, according to our study, wouldn't be able to face a $2,000 shock in a month time. Let alone, the shutdown of the economy. This is actually not a small proportion. Crisis, I think, also reveal that when it comes to our personal finances, I think we can do much better.

The paper you just mentioned is on financial fragility. I read that one, too. Canada actually has a social survey that the government's been doing, where they look at financial fragility as a predictor of other factors, like wellbeing and happiness. What role do you think financial literacy plays in happiness, broadly speaking, and living a good life?

I think, a critical role. I always tell my students that this is the role of financial literacy. That's the role of finance in general. It’s not that we should think of financial literacy and of finance to save more and borrow less. What we do and our final objective is to be financially secure, to live a happier life, a life where we are free to choose. That's the really fundamental role of financial literacy. That's the fundamental role of making good financial decision, because that's the objective.

I want to tell you an anecdote. I've been teaching personal finance since 2013. The first question I ask my students in the first class is, what do you think this course is about? Because this course was used to be called personal finance, okay. I can tell you that almost all of my students thought that the course was about investing. Investing in the stock market. This is what they identify personal finance with. Investing in the stock market. More recently, some people have said, “I hope, it’s also about student loan.” Mostly, student identify as many people, personal finance with investing, or debt. What I tell them, it’s like, no. This is a happiness project. This is a course about learning the skills and the knowledge that allows you to be happier, to be more financially secure, to make the decision you really want to make.

I love it. That's such a important and strong point to make. A question that I had, and I know you've got some reading on this, too, but a question that I think anybody would have going through a lot of your research is, how do we know which way the causal relationship goes? We can see that there's a relationship between financial literacy and economic outcomes. How do we know which way? Yeah.

Yeah. Oh, absolutely. That's a very fundamental question. This is why, in particular, when we look at the effectiveness of financial education, now we have to turn to experiment, to randomized controlled trial. Because of the paper that we just discussed that financial literacy is a choice, and so it's endogenous itself, right? It's very hard to take a variable as exogenous. What we do in order to assess this, we can do experiments, where we take two different groups, and we expose one group, for example, we give them more financial knowledge. Then we study how this group, which is very similar to another group, to which we do something else, behave later on. Like doctors do when they try out different medicines.

This is, by the way, what we have also, many, many people do ourselves have also been doing, and I think we need that to also assess not just whether financial literacy works and in which direction, but also, to find good way to make it really effective and work well for also different groups, and so on. We did, in fact, recently a meta-analysis trying to assess whether, indeed, financial literacy and education works. Because first of all, we need to understand if there is a causal effect and how much financial literacy matter. It is possible, in other words, to assess that causal relationship.

What role do you think financial advice, and I guess financial advisors play in helping people make better financial decisions?

It's a very difficult decision here, because I think the literature is not very clear on that. I think, there is quite a bit of evidence that shows that financial advisor do not necessarily bring better outcome for individuals. What I can say from the research on financial literacy is that if you think that financial advice is a substitute for financial literacy, it’s actually the opposite. It is a complement. In other words, it's the people who have high financial literacy who consult financial advisor. I would argue that it's the people who have higher financial literacy that can better use financial advisor. I always refer, there is a survey done many, many years ago. I think, it was a survey done by IBRI, or a survey within the consumer, some survey that looking at worker in firms.

The question was basically, whether if they were offering advice for free, whether they would take it. Interestingly, many worker said, they wouldn't. They wouldn't even use a free financial advice. Another that would use that advice argue, “Yes, I would use the advice if it conforms with my sort and my view on that.” In other words, I think in particularly people who are not financially literate might be very afraid of consulting a financial advisor, because they are consulting on something they really don't know. Perhaps, they might not fully understand, or appreciate. It might also say, and this is why sometimes financial advice doesn't work, is because when people go to an advisor, they're not really looking for advice. They're looking for somebody saying yes to their own, maybe prior.

In other words, if you're wrong, and your financial advisor doesn't take you away from that wrong decision, then it doesn't help you. If you are really wanting to confirm your bias, then there is no help.

Yeah, there's been some super interesting research on – the paper was The Misguided Beliefs of Financial Advisors, or something like that. I want to move on to demographic groups and their relationship to financial literacy. How does financial literacy vary across groups, like age, gender and then even race?

Yeah. It varies a lot. Interestingly, it varies in very similar way across countries. I want to start with a difference. We have studied a lot, and it's very pervasive, and I'm talking about gender differences in financial literacy. Our global survey basically tells us there is a gender difference in financial literacy around the world. That is in other words, women, when we look at their financial literacy, almost everywhere, no less than men and in the places where there is no gender difference, normally is because the level of literacy is so low, also among men, that there is no difference between men and women.

It was striking to see that if you ask this question, you get the same answer, irrespective if you ask it in a G7 country, or in a BRICS country, or in the G20, and so on. What we do see, and I want to come back to the definition we started with, is that women disproportionately answer the financial literacy questions with, I do not know. It's not that in other word, women are always wrong on the question, that's why they are less financially literate, but the answer with, I do not know. They do not know doesn't mean that they are wrong. They mean that they are perhaps more willing to say, “I actually, I'm not sure 100% about the answer to this question.” This is something we investigated in one of our work, and we were able to indeed pin down the fact that women are less confident than men in their answer.

In other words, even men do not know, but they are more willing to, in a sense, choose at random. What we found is as much as one third of that gender difference in financial literacy is actually explain the difference in confidence. This is important to say, because this is another way in which perhaps, we can make, or design financial education programs, which are more effective by fostering not just knowledge, but also, confidence. That's, for example, what I do in my class, how I, for example, teach some of the courses.

There is also a big gender difference across race. We see that, for example, if you look at the US, where we do see a lot of racial differences, financial literacy is particularly low, for example, among African-American. It's also particularly low among Hispanics. If you look within Hispanics, for example, it's much lower for Hispanic, which have been born abroad, versus Hispanics, which have been born in the US. The differences are very nuanced, and I think is important to recognize them. There is a big difference, of course, between young and old. Some is simply age. I mean, you are young, and therefore, you don't know.

Some is also related to the fact that the experience is very different across countries. It's very interesting that if you look at the global survey, what you see in some countries is that financial literacy is much higher among the young than the old, because the young today in some of the country might have better access, also via technology to knowledge than that older generation, might also mean that that older generation didn't even have to be literate. In some of the country, that financial literacy potentially was very low. Not to mention, literacy itself was very low. This is different for the young.

There is a big divide between, for example, emerging country and richer country when it comes to the young. I think, it is worrisome, and let me say the word worrisome that financial literacy is so low among the young, because the young today have to make a lot of financial decision at a very early age. I think, we need to make sure that the young today are better equipped than older generation were to deal with a very different economic environment.

Other than confidence, does anything else explain the gender gap?

Yes. I think, there have to be a lot of factors, right? Because I mean, the confidence only is explains one-third. We think, in some of the study we have done is almost something about related to culture, or related to the fact that women in very traditional society might not be asked to make some of these financial decisions. That finance is also considered a field, where this is not a field, or where there are lots of women, or women make some of those decisions. I think here, there is a basic confusion, because a lot of people say, but in many families, it’s the woman that makes financial decision. I think this has to be qualified.

In a lot of families, indeed, women make the financial decision making, but mostly the day-to-day, or the short-term financial decision-making, while decisions, like investing, buying a house and so on, are often maybe shifted, or done by the – if there is a married couple, potentially, by the male spouse, and things like that. I think when it comes, perhaps to the – in a world of finance, we also need to fight stereotypes, for the fact that this is a field where women feel uncomfortable, or they don't make this decision, and they shouldn't be in charge of making these decisions.

By the way, this doesn't explain everything, because we still see a gender difference among, for example, young people, also non-married people. If you look at the single women versus single men, there is still that gender difference. I think, it has deep roots and that's why I think, to me, the best way to address this gender difference is to have financial literacy in school. Give access to everybody, because otherwise, I think this typical role of women in society are going to in essence, perpetuating self and continue to perpetuate also a gender gap in financial literacy.

I want to go more into that financial education. Can you talk about the evidence that financial education programs actually help improve outcomes?

Yes. Now I can, because we did a meta-analysis looking at evidence of financial education in 33 countries, and looking only at the more rigorous studies, the one I was mentioning earlier, which are basically randomized control trials. In other words, really program in which we could assess causality, and in which we can say, these are the gold standard in a sense of evaluation. I think, that meta-analysis was very clear in indicating that financial education works.

Interestingly, we found that it works across age group. We were thinking that it would be more effective among the young. In fact, we find and effectively, also among the old population, we were thinking, it would affect mostly the richer countries, because in the no less rich country, there are less resources, and we found it is effective there as well. I could argue, given that study that there is, I think, a lot of evidence that financial education work. This was contrary to earlier work.

I think if you look at that earlier work, what was there was a very, very limited set of studies. Now, we have so much more evidence. Also, I think, often, the financial education was very limited. If, as I've mentioned, there is such a high level of financial illiteracy, and you give a one-hour seminar, or you give a very small intervention, a very limited intervention. Of course, it doesn't work. I mean, if you give aspirin who has poor pneumonia, the fact it doesn't get better doesn't mean that traditional medicine is not effective. It means that the medicine was not adequate to the disease. This is, I think, what's happening today. Now, we can't expect financial literacy to increase by itself. This is a suggestion to government, policymaker, an employer. We need intervention to make a difference, to improve the level of financial literacy. It’s not going to improve by itself, but it is clear that it works. In our study, we also find it is cost effective. For those who think it's expensive, I would say, it's expensive not to do it.

Where should that education take place to be optimal?

I like what you said, to be optimal. I think there are two places, which are ideal conduit of financial education. One, clearly, is the school. It is the school, because this is how you can reach all of the young. And in particular, you can reach the group who need it most, which are the most vulnerable group, and which are the one who will not get it at home. If you look now, or with financially literate in almost all country is a disproportionate group, which is very small. It's mostly composed, if you look at the PISA data, for example, of 15-years-old, these are basically, male student from college educated family, or rich parents.

People learn financial literacy at the dinner table. Many, many young people are not exposed to parents who have that financial knowledge. We need to put it in the school, because that's where everybody is and that's where, I think, everybody can access to education. If you tell me, curriculum are too crowded, well, we can actually add financial literacy in some of the topic, in math, in history, in social sciences, citizenship. I would add it, I think, is very helpful to add it as a separate course and many states in the US are doing so.

I would actually argue that the prime minister in a country actually should call the education minister, because I tell you, the cost of that financial illiteracy is going to weigh very high on the budget. Think of the cost of financial crisis. It has been enormous with respect to doing prevention. The second place where I think it's ideal to have it is the workplace, because that's where the adults are. Many of the adults are at work. You might argue, why the employer should do financial education. We did a survey recently, in our personal finance index, we asked people, how many hours they spend per week, dealing with and worrying about their personal finance issues? How many of those hours are at work, spent at work?

The number were quite high, given that this was a self-reported measure. On average, American spends seven hours per week dealing with their personal finances. This actually tells you about potentially, the advantage of consulting a financial advisor. If you spend seven hours, multiply that by your wage, it seems a very inexpensive way to spend your time. Three of those hours are at work per week, okay. Multiply this by the minimum wage. Let's take the minimum wage at 15. If you're an employer, it costs less than $45 per week to do a personal finance program, which I can assure you, there are many programs that cost less than that. I think it would be advantageous for an employer to also do financial education.

I think again, there would be an advantage. I have to say, I have written a paper that argues, we should mandate financial education in the workplace. Believe me, as an economist, the word mandate is like, I am proud to say mandate, because when it comes to financial education, coming back to my previous point, if there is a crisis, as a taxpayer, I'm asked to pay for it. I prefer to pay less. I prefer to have wider access to everybody, so we can all have some of that basic knowledge that allows us to at least not go into deep financial troubles, so deep that even the taxpayer are asked to do that. There are some fields in which mandate are not so bad, after all.

You talked about some policy level initiatives and workplace initiatives just now. What about at the individual level, what can people who are listening to this podcast, who will probably by nature of being listeners to our podcasts be more financially literate than average, what can they be doing to increase the financial literacy of people around them?

First of all, I have some suggestion for them as well. Then for doing something for someone around them. My big suggestion to everybody is take good care of your finances, in the same way in which you take care of your health, take care of your finances. Because they don't take care of by itself. We live in a world in which we spend a lot of money to actually induce people to consume.

As I tell my students, when they go out from their classroom, in the two blocks, or three blocks to reach their dorms, they have lots of incentives to buy, but nobody's telling them to save. Nobody's telling them sometimes to take good care of their finances. This is a suggestion for everybody. Take good care of your finances. Spend a little bit of time each week, probably not seven hours. It seems a lot of hours to me, but spend at least maybe an hour a week to actually take care of your finances, which means, think of your financial situation, think of your objective. Set your objective of what you'd like to do, and then try to follow up. I think, it's also helpful to look at your financial situation, understand where you are, and whether this is a good place, where to be. From there, make some of those decisions, which are very helpful.

By the way, I always say that these type of things, save people money. You might realize that you might keeping your money into an allocation, which is not good for you. You might actually be not even using well your checking account. There might be a lot of ways to save and get more money and do better in your financial decisions. There might be subscription you don't really need. If you're not going to the gym, and your gym costs $200 a week, think about it. All of those things, right? I mean, there is really a lot – yeah, I always say financial literacy puts money into your pockets. Take advantage of that.

I love what you're saying, we also need to look at our community, because I can assure you that we are not provided that financial education that we need. I think all of us, for example, can advocate for financial literacy in our local school. Take that initiative. Often, in several places, there are this opportunity to do that. If it is not offered at the school, can it be offered in your community? There are a lot a lot of community center. This could be a way in which we can help our community do better. Because I, and I tell you this, because I am convinced, and I've seen it in my students, I've seen it in our studies, that financial literacy changes people lives. That it is that consequential. That it is that helpful.

If we have a healthier, more financially secure community, we can all do better. It's a win-win for everybody. We don't have to pay even the cost that derive for our potential financial crisis, or for people around us not doing as well. There is a role for us as well to take in making sure that we can add people around us.

What do you think about the argument that this is not a problem that should be solved with financial literacy education, but instead with financial product design?

I have heard this comment for 20 years. It’s what people argue all the time. Let me start with the combustion engine analogy. We are not asking people to become financial expert. That's the point. It's not we are asking people to become Warren Buffett. We are asking people, when I mean financial knowledge, is to have that basic knowledge that allows you to understand what a stock is, how the credit card work, what the FICO score is. I can assure you, in finance, ignorance is not bliss.

All of the study shows that financial literacy is very consequential, is very consequential not just for rich people, but for poor people as well. Because, again, if you don't have that knowledge, the next thing you do is to go to the payday lender, or not to end up potentially in even more financial difficulties. I think, the financial crisis have told us about the huge, huge cost that individual and society have to pay for financial literacy. I would say, push these people to look at what has happened and don't tell me that that has not been a huge cost. Number one.

I think, number two, I really don't think that there is an alternative to financial knowledge. You cannot solve the problem of financial decision-making by offering good product, or choice architecture. You can solve a financial, one specific financial decision, but financial decision are interrelated. You might make people to save for retirement by automatically enrolling people into pension. At a certain point, for example, these people have to know how to accumulate the wealth. We might find solution for that as well. In the meantime, they might have taken the wrong mortgage, so their financial situation is actually not well.

Actually, particularly want to mention, particularly in the world, for example of retirement saving, we have thought what a great solution to automatically enroll people into pension. We can solve the pension. Look what has happened. First of all, people often stick at the very low rate at which they are automatically enroll into. People are borrowing against their 401K. There is an enormous leakage in those accounts when people leave their job, then they withdraw their retirement savings.

Yet again, it doesn't look like that there is – that financial instrument are so clever that people are doing the right things. The reason fundamentally, is because we are all very different when it comes to financial decisions. There is not this one-size-fits-all. There is not that financial instrument that makes my life better off. I'll have to make those decisions and those decisions are very specific and individual. For me to make a good decision, I need to have some basic knowledge. Particularly today.

I don't need to know and I don't need to price convertible bonds. I don't need to know the Black Scholes formula, but I need to know what an interest rate is, and what a FICO score is. I need to have that basic knowledge. Otherwise, I don't think I'm going to do well. I think, the crisis has told us that financial knowledge is very important for individuals and for society as well.

Great perspective.

Our final question for you, Professor, how do you define success in your life?

Everybody has their own definition. For me, success is to be free to choose. To have that capacity to make the choices I want. If I have to say something about myself, because at the end, personal finance is personal. Because I am studying this topic, I made two investment, which were very important to me, and I made them in a very consequential way. I thought it was something that I thought was an important thing to do, one. I think the investment that has brought to me the higher return was the investment in education.

I don't think, I would have, for example, this lifestyle, and probably the satisfaction in my life, if I had not invested in my PhD in economics. That was a very deliberate decision to first of all, pursue a really good education. As you know, I was born in Italy, in case you thought my accent was from Boston. I deliberately chose to come to the US and I deliberately worked very hard and studied very hard, to apply to some of the best university in the US. I've stayed in the US, because I thought that was the best job market and environment to have a good career.

My investment in education, I think, has paid a good rate of interest. I've also got a good rate of interest for my financial investment. Then I think I've been able to make those financial investment deliberately, because I add to knowledge. Because I add, I was an economist studying economics, and then I pursue an interest as well in personal finance. Without that knowledge, it's not obvious to me that I would have achieved the type of financial comfort that I can afford now.

These are, if I can give a suggestion at the end, you have to invest. Certainly, you have to grow your wealth over time, particularly now with this higher rate of inflation. Think of those two investments. One is the best investment that fits your need and specific circumstances. I invest very early on, so I could really take risk. I was very concerned about fees, commissions and so on, but also invest in education as well, because it can also bring a good rate of return. It certainly did for me.

Professor, this has been a wonderful hour. Thank you so much.

Thank you.

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'Financial literacy and financial resilience: Evidence from around the world' — https://onlinelibrary.wiley.com/doi/abs/10.1111/fima.12283

'The Economic Importance of Financial Literacy: Theory and Evidence' — https://gflec.org/wp-content/uploads/2014/12/economic-importance-financial-literacy-theory-evidence.pdf

'Optimal Financial Knowledge and Wealth Inequality' — https://www.journals.uchicago.edu/doi/10.1086/690950

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'Employee Financial Literacy and Retirement Plan Behavior: A Case Study' — https://onlinelibrary.wiley.com/doi/abs/10.1111/ecin.12389

'Skating on thin ice: New evidence on financial fragility' — https://www.dnb.nl/media/uxldldkl/working-paper-no-670_tcm47.pdf

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'Fearless Woman: Financial Literacy and Stock Market Participation' — https://gflec.org/wp-content/uploads/2021/03/Fearless-Woman-Research-Final.pdf?x53868

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