People need to understand finance to succeed in the modern economy. However, consumers’ knowledge of personal finance has not kept up with the complexity of financial products. About half of a series of questions measuring knowledge of personal finance topics can be accurately answered by American adults, according to the Personal Finance Index, a long-running assessment of financial literacy. They have a particularly hard time answering questions concerning financial risk management.
According to Annamaria Lusardi, a finance professor (by courtesy) at Stanford Graduate School of Business and one of the developers of the P-Fin Index, insufficient financial literacy is a serious issue since it typically results in lower financial well-being. Individuals with inadequate financial literacy are less likely to have emergency funds and are more likely to struggle to make ends meet. Black and Hispanic Americans, women, and Gen Z members tend to have lower levels of financial literacy.
Lusardi claims that financial literacy is extremely low worldwide, not only in the United States. “Despite having made several financial judgments, people simply lack those fundamentals. We can and ought to look for methods to make it better. The world is too complicated for people to rely just on what they know.
As the director of Stanford GSB’s Initiative for Financial Decision-Making in new window (IFDM), Lusardi has devoted her professional life to investigating treatments that have the potential to reverse financial illiteracy. She has advocated for financial literacy to be taught in schools at all levels as part of her job. “Having a population of young people with student loans who are unaware of interest rates and how interest compounds is extremely dangerous.”
She teaches the well-liked Introduction to Financial Decision-Making course at Stanford. (Student athletes have particularly enjoyed the class. She adds, “They are more and more conscious of how important it is to manage their finances well and realise they can make quite a bit of money right away.” However, older Americans and young individuals who do not complete high school or college may be excluded from financial literacy education, as more institutions offer it.
The good news is that learning new financial information later in life is not impossible. In a recent study, Lusardi collaborated with IFDM research director Andrea Sticha, Chuanhao Lin in new professor of George Washington University, Olivia Mitchello in new professor at the University of Pennsylvania, and Robert Clarkopen, in new professor at North Carolina State University to test a straightforward program that uses storytelling to teach adults fundamental financial concepts. They discovered that participants’ financial literacy increased as a result of this low-cost, readily expandable program.
Two Minutes to Learn the Fundamentals
Customers who have made important financial decisions in their lives but probably had little to no formal financial literacy training were the focus of Lusardi, Sticha, and their colleagues’ study. Over 2,200 American individuals aged 45 and over were included in their study.
Three financial fundamentals—compound interest, inflation, and risk diversification—were the subject of straightforward narratives created by the researchers.
A 25-year-old couple who got $5,000 in cash as wedding presents and had to make a financial decision are the subject of the compound interest narrative. The couple decided to invest the present immediately after talking about the Rule of 72, which is a method for figuring out how long an investment will double at a certain annual rate of return. Lisa, the protagonist of the inflation narrative, discovers how the cost of a lovely plaid blouse has fluctuated over time and decides to increase her savings for the future. Kate and her husband Sam have to decide the money they received from the sale of their car in the risk diversification story. To reduce the danger of losses, they talk about diversifying their portfolio and making long-term stock market investments.
It took two minutes to read each story. Participants were split up into four groups by the researchers: one for each story and a control group that didn’t read any stories. Each participant was given questions to answer after reading the narrative to gauge their understanding of the given subject.
Participants’ understanding of finance was improved by all three stories, but especially by the one about risk diversification. People with lower incomes and educational levels were most affected by the story, and those who read it were 17 to 18 percentage points more likely than the control group to properly answer the relevant questions. Reading the inflation tale increased the likelihood of answering one of the questions correctly by 6 to 8 percentage points, whereas reading the compound interest story increased the likelihood of answering one of the questions correctly by 17 percentage points.
According to Lusardi, “even a simple story can improve knowledge, and it does so quite a bit.” “A tale may simplify the intricacy of finance, which is thought to be complicated. People frequently learn things through stories because they are highly remembered.
Eight months later, the researchers reassessed the participants’ knowledge in a follow-up survey. Nearly half of the short-term knowledge of risk diversification was retained by those who had read the story. For more complex subjects that require more mental calculations, such as compound interest and inflation, the effect was less pronounced. However, those who read the inflation narrative took longer to respond to questions about how inflation affects real income, indicating that the story increased their interest in the subject.
Investing in Financial Literacy Over Time
Lastly, the researchers assessed how the stories affected a financial resilience index and four measures of financial distress: financial fragility, over-indebtedness, financial unhappiness, and difficulty making ends meet. They discovered no change in the way participants reacted to these signs eight months following the original trial. A possible explanation is that insufficient time had elapsed. “Eight months might not be enough to change some of this behaviour,” Lusardi says. Future studies will examine whether reminders can influence people’s behaviour and help them remember important financial concepts.
According to Sticha, the intervention nevertheless exhibits potential as a practical tool that is simple to use. Companies might employ this strategy as part of a corporate financial wellness program, and banks could use similar stories to educate their consumers. Lusardi hopes that the work will contribute to a shift in the social discourse on money, making it less taboo. “We don’t discuss it enough,” she claims. “Finance should be a part of our everyday lives and woven into the fabric of society.”
Her achievements in Italy have given her hope. The Italian-born Lusardi oversaw the nation’s Financial Education Committee from 2017 to 2023, during which time it created a nationwide financial literacy plan. In addition to establishing October as Financial Literacy Month and launching a specialised website for economic education, the group was instrumental in enacting legislation requiring financial education starting in elementary school. By incorporating financial lessons into a well-known Italian soap opera, she even reached a wider audience.
At Stanford, Lusardi has already experienced success. Her students sometimes write to her with updates on their own financial decisions or share lessons with their parents and siblings. The gold standard for financial literacy, according to Sticha, is a demanding course like Stanford’s. However, even without that, a straightforward, inexpensive, narrative-based financial intervention program can still be successful in expanding access to financial literacy.
Lusardi asserts that ignorance is not bliss in the field of money. The lack of basic knowledge is a major issue, and we will feel the consequences of financial illiteracy. All we need to do is choose how. Which would we prefer: paying for prevention or the cure?
