Financial Literacy Is Key Component of Retirement Planning

Older Americans aren’t that literate when it comes to finance, which could have a negative impact on their ability to plan successfully for retirement.

The older Baby Boomers are not particularly financially literate, a study finds—and they’re easily tripped up by wording.

Financial sophistication is a weak spot for older respondents age 55 and older, according to research from the Pension Research Council. While other studies have looked at basic financial literacy, Olivia Mitchell and Annamaria Lusardi examined both financial literacy and financial sophistication among older Americans. 

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In “Financial Sophistication in the Older Population,” Mitchell and Lusardi— the Pension Research Council’s director and a professor of insurance and risk management at The Wharton School, and a professor of economics at Dartmouth College, respectively­—found that many Americans over age 55 lack a basic grasp of asset pricing, risk diversification and investment fees. Specific subgroups among older Americans include women, people over the age of 75 and those who are least educated.

At a time when people are increasingly being asked to take on responsibility for their own retirement security, such lack of knowledge can have serious implications, Mitchell and Lusardi said. Americans are more and more likely to hold individual retirement accounts such as IRAs or 401(k) plans, accumulate privately held assets, and hold debt, meaning that most people will need a certain amount of financial sophistication to be able to manage assets and debts sensibly over their lifetimes.

 

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Consumer financial illiteracy can have important consequences—those who lack literacy are much less likely to plan for retirement; are more likely to end up with little wealth close to retirement; are less likely to invest in stocks; and they tend to use high-cost borrowing channels. More literate individuals, on the other hand, are more likely to choose mutual funds with lower fees.

It’s not just the true-or-false questions themselves, but the way they are worded that is significant, Lusardi and Mitchell found.

While 73% were aware that “Even if one is smart, it is very difficult to pick individual stocks that will have better-than-average returns,”  when the question was reworded to “If you are smart, it is easy to pick individual stocks that will have better-than-average returns,”  only 38% answered correctly.

The findings can be useful in designing financial education programs that help participants save and make informed investment choices. The paper is also helpful in determining which questions (and the way they are phrased) are most important in predicting financial literacy.


 

 

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