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How Everyday Decisions Affect Your Wealth, According to an Economist

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Annamaria Lusardi found that people with similar salaries throughout their careers retired with different levels of wealth.


When Annamaria Lusardi was a doctorate student studying savings behavior in the early 1990s, she noticed something curious: People who had similar salaries during their careers would end up with vastly different wealth levels at retirement.

The difference, she decided, was the financial decisions they had made. 

That student is now a 59-year-old economics and accounting professor at George Washington University who has made improving financial literacy her mission. Along with economist Olivia Mitchell of the University of Pennsylvania, Lusardi designed three questions to measure financial literacy that have been included in national surveys around the world. A majority of people in most countries are unable to correctly answer all three.  

Lusardi’s drive to improve financial literacy comes at a time when everyday people are making consequential decisions that professional pension managers would have made in the past. Unless Americans can improve their financial decision making, she says, inequality in society will grow. 

Born near Milan, Italy, Lusardi received a Ph.D. in economics from Princeton University and has spent most of her career there. We reached Lusardi by phone in Italy where she is guiding a national financial literacy campaign. An edited version of our conversation follows.

Barron’s: What is financial literacy?

Annamaria Lusardi: I’m really thinking of the ABCs of personal finance. It’s about knowing things like interest compounding, inflation, risk diversification. 

Why is it so important to master these concepts?

Much more than in the past we are in charge of making consequential financial decisions. We live in a world of 401(k)s, not defined-benefits pensions, so we have to take care of our own saving for retirement. A young person today at the age of 15 is going to make a very important and consequential financial decision, which is whether or not he or she will go to college and how to finance that.

Why are Americans so bad at financial literacy?

It is not because we are stupid. What is really happening is that the world is changing fast and we are not catching up. We aren’t teaching young people this topic. This isn’t a topic that people can learn by themselves.

Are some countries better at financial literacy?

Yes. The Nordic countries and other countries, including Canada, Australia, and New Zealand, are shifting more pension responsibilities onto individuals, and there is more interest in financial literacy.

The U.S. began shifting pension responsibilities onto individuals with 401(k)s in the early 1980s.  

If you look at the 401(k) in the U.S., it’s not for the whole population. It’s really for a small group of the population with good jobs that offer good benefits. 

When I look at other segments of the U.S. population, they often don’t have good jobs and good benefits, and their financial decisions might be different. 

What is the best way to make people more financially literate? High school courses? College courses?

I would start even earlier than high school. And it should continue in college.

Another place we can have financial education is in the workplace. Workers make financial decisions now, and it’s important to have education for them.

You grew up in Italy. Is it any better there?

Interestingly, Italy is worse. Italy is a country where pensions until now have been very generous so people didn’t have to save for their own retirements. Older Italians saved anyway.

Italians are now facing a different world. Younger Italians do need to save for their retirement. And that’s why the Italian government is thinking about how to change the financial knowledge of the Italian population. 

You’re involved in that, right?

Yes. The Italian government four years ago decided to put together a national committee to design a national strategy for financial literacy, and I am in charge of it.

Why did you become interested in financial literacy?

I was studying saving behavior while doing my thesis. Think of the two of us. If you put your money in stocks and I leave mine in a checking or savings account, 25 years or 30 years later, we’re going to look very different even though our income might have been very similar. 

Why would people make such obvious mistakes?

I thought perhaps it was the level of knowledge or the comfort in dealing with money. When I looked across education groups, I saw vast differences. For example, in the stock market, it’s disproportionately people who have a college degree who participate in the market. 

What did you do next?

I really wanted to know all about financial literacy, and it seemed the data wasn’t there. Together with economist Olivia Mitchell, we designed three simple questions to measure financial literacy.

What does each of the three questions measure?

We measure the capacity to do calculations in interest rates. We measure inflation and knowledge of inflation. A lot of financial decisions are about transferring resources over time and you have to be knowledgeable about how prices change. If you don’t keep your money growing at the rate of inflation, you are becoming poorer. And the third topic is risk diversification. 

Has anything changed because of them in the U.S.?

I think so. Because of the striking result that so few people are financially literate in the U.S., there are more financial education initiatives. Twenty-one states have made financial literacy mandatory in high school.

Were your parents financially literate?

They were more financially literate because they were entrepreneurs. I was probably exposed to or told about money more than certainly an average kid, and in particular, an average daughter. 

Your data show that women are worse than men at financial literacy. Why?

It’s true in almost every country around the world. When we look at financial literacy, we see that women know much less than men. One of the answer choices in our financial literacy questions is “I don’t know.” Women disproportionately say that. 

It surprised me when I saw that finding because women can be more responsible than men when it comes to money. 

Women manage the day-to-day financial decisions. Too often, they don’t invest for retirement. They aren’t the ones making a decision about buying a house, buying a car. We have to improve the financial literacy of women. Otherwise, they aren’t making some of the more important financial decisions, and maybe when their spouse dies or they divorce they might be left with decisions that they don’t feel comfortable making. 

How do you have your own money invested?

I follow the recommendation of the academics. I invest in index funds so I diversify my risk, and in funds that charge the lowest fees. Because there is very little evidence that managed funds outperform index funds. 

Have you ever made a poor financial decision?

Yes, of course. I should have invested when I was in college and not waited. Time is the best asset. This is the secret of becoming rich. Use it wisely.

Knowing what you know about financial literacy, should the government play a stronger role in regulating financial products?

Yes. But it should also play a bigger role in educating people. Education is a form of protection. I can protect you against being cheated, but I can’t protect you against not knowing. The government should definitely protect people more because people know so little. They are very vulnerable. But people should also be empowered to make good financial decisions.

What’s an example of a bad decision?

Young people think they should invest in individual stocks. You’re kidding me! This is not a good practice. Young people think they shouldn’t look at the fundamentals of stocks but instead should play a game against hedge-fund managers. The stock market is not a game.

With a 401(k), we essentially become our own pension manager. Is this problematic?

Yes and no. A pay-as-you-go system is going to eventually pay a return that is lower than the market return. People are living longer and having fewer children. If this is the case, Social Security will run out of money and our benefits will be cut. With a 401(k), we can live a more secure life because we are making decisions that depend on us rather than political will. 

The U.S. is becoming a more unequal society in terms of wealth. Is there a role for financial literacy to close those gaps?

Yes, financial literacy might have the capacity to decrease some of the wealth inequality. In one paper, I look at wealth inequality of people close to retirement. I found about one-third of wealth inequality is explained by financial literacy.

Thank you, Annamaria.

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