Simply stated, financial literacy is generally described as the ability to understand finance. More recently, some have begun to focus on financial capability1. Research has shown that people with higher levels of financial literacy approach retirement with much higher levels of wealth. However, a growing body of research also suggests that most Americans have limited knowledge about concepts such as inflation, compound interest, and risk diversification at a time when they face an increasingly complex financial planning process alongside an expanding set of saving, investment, and decumulation options.
Drawing on data from the National Financial Capability Study (NFCS)2, designed by the FINRA Investor Education Foundation (an ASEC member firm), Dr. Banerjee’s report3 noted that the chances of having a bad financial behavior decreases with age, and that the chances of exhibiting a bad financial behavior go down with education and income. Interestingly enough, full-time and part-time workers, homemakers, sick or disabled, and unemployed or laid-off individuals were all more likely to have bad financial behavior than self-employed people.
That said, the report specifically examined the role of where you live – specifically the state in which individuals live – in explaining financial literacy and behavior. It also ranked all U.S. states in terms of financial literacy and financial behavior of its residents.
Financial literacy and financial behavior are strongly associated with an individual’s age, income, education and other demographic characteristics. The study shows that, after controlling for the effect of these individual demographic characteristics, most bottom-ranked states had a statistically significant effect on their residents’ financial literacy and almost all states have a statistically significant effect on their residents’ financial behavior. However, the chance of exhibiting “worse”financial behavior increased as the financial behavior ranking dropped.
According to the report, this suggests that there might be factors shaping individual financial literacy and behavior other than individual demographic characteristics – and they might be influenced by the state in which people live.
- Nevin E. Adams, JD
1 The National Financial Capability Study identifies four key components of financial capability as (1) making ends meet, (2) planning ahead, (3) managing financial products, and (4) financial knowledge and decision-making. See http://www.finrafoundation.org/web/groups/foundation/@foundation/documents/foundation/p120535.pdf2 The National Financial Capability Study is available online at http://www.finrafoundation.org/programs/p123306
3 Banerjee’s paper, including the state rankings, is online at https://custom.cvent.com/09056B0B33C34EC2BECC8C4A235B766F/files/event/51EB0D7B12344774B422F6A615E9B8B9/0c08c7cd98d74c01bf954ad368275ff4.pdfSee also“How Do Financial Literacy and Financial Behavior Vary by State?” in EBRI Notes, November 2011 at http://www.ebri.org/publications/notes/index.cfm?fa=notesDisp&content_id=4936