The role of financial literacy.
What is financial wellness and does financial literacy matter to financial wellness? Financial wellness and financial well-being have become popular topics and we believe it such an important topic it deserved two posts. This is the first in the series.1
Financial wellness fits within a larger conceptualization of life. What are your dreams? How are your relationships? Your health? Is a future independent of financial concern a primary objective? Are you tired of reading from financial writers that you must save, because you do not save, yet feel good about your finances? Sounds like a conundrum. Academics are on it, and numerous academic papers have correlated financial behavior and financial literacy, presupposing that certain financial behaviors are de facto good, and more easily attained if competent. But, of course, some financial behaviors cross into a gray area and judgment mirrors the eye of the writer; correlation isn’t causation. Even with all this debate you may still feel good about your financial life.
The “save more” mantra, repeated robotically by personal finance writers, is a classic. Prescriptively, that may be important for some households, but not others. Savings today is accompanied by a reduction in living standard today; there are costs to savings. A high level of savings as good financial behavior is not a truth. It cannot be for the economics behind savings is that any savings need is a determined amount after first determining the highest, sustainable living standard. Members of a household may feel just peachy today even if they do not save. Being financially well requires digging deeper.
Financial Wellness and Wealth
Financial wellness is a broader measure of financial success than assets or income. It better assesses how households’ feel about their finances and financial decision-making. We are interested in whether financial literacy plays a role in wellness? Are more literate people happier? Interest in wellness comes at a time when local, state, and federal governments have invested resources to promote financial literacy, with a belief that financial education will cause financially sound decisions that benefit households.2 There is a presupposition that households will be better off. While literacy has improved marginally over the years that judgment is based on a test about competence. If you don’t test as financially savvy are you financially well? If you have a high income but pass on your financial affairs to an advisor are you financially well? If you ace the financial literacy test and do not feel financially well, why might that be? These are strikingly complex questions to answer scientifically.
One problem is that the financially sound decision may not be obvious to the outside observer. Examples are numerous. It is well known, for instance, that healthy individuals are better served to wait until age 70 to begin the receipt of their social security retirement benefits, however, the unhealthy 62-year old who doesn’t have enough money to pay for basic food is making their best financial decision by pulling benefits early. Investment advisors will profess the benefits of a portfolio with higher expected returns, but that entails more risk-taking. Any financial decision, whether quantifiable or not, is in the eye of the beholder. Fortunately, many times the best financial behavior is unambiguous, e.g., “avoid incurring late payment penalties on credit cards,” but household or advisory circumspection is important for decisions with a wide swath of gray areas.
A Glimpse at the Financial Well-Being Data
In 2015, the Consumer Financial Protection Bureau (CFPB) developed a measure for financial well-being that gauges how an individual feels about their broader financial condition and future prospects. The CFPB defines financial well-being as “a state of being wherein a person can fully meet current and ongoing financial obligations, can feel secure in their financial future, and is able to make choices that allow them to enjoy life.”3
We looked at two general questions from the collected data generated by the 2018 National Financial Capability Study, which uses the abbreviated version of the Financial Well-Being Scale: “How well does this statement describe you or your situation?,” and “How often does this statement apply to you?”4 Results are summarized below.
For questions Q1-Q3 and Q5, respondents were given a scale from 0 to 4. A 1, 2, and 3 are defined as “Very Well,” “Somewhat,” and “Very Little,” respectively. Results are broken down by broad age categories. Based on averages, there is a more pessimistic tone about finances among the under 60 cohort with a general bias toward living on the financial margin, unable to reach a preferred financial life and with doubt about whether savings will last. More than somewhat do finances control the life of the younger cohort, consistent with the responses to the other questions.
The older age cohort responds to questions phrased toward financial concern nearer the “Very Little” response. Age 62 and up households are likely to a) have fewer dependents and a resulting higher living standard, b) receiving social security benefits, and c) have less uncertainty about the balance of their lives. They have the wisdom from more financial experience which likely tempers expectations about their future.
Financial Well-Being and Income
Distinct from age, we rearranged our perspective, and grouped results by level of income expecting financial concerns were less negative among respondents with a higher annual income at the time of survey. That supposition turns out to be supported, at least based on averages. A positive financial well-being is more likely to be felt with more income, but with an interesting twist. Average values for Q1-Q3 and Q5 do not reflect an overwhelming level of financial wellness, except at the highest income level, those with incomes greater than $150,000. Comfort and well-being actually felt, resides among the highest earners and not at all among those earning less than $25,000 per year. Low-income earners are just getting by, feel they never will have what they want, and expect their money will not last.
Financial Well-Being and Financial Literacy
We know higher levels of income are associated with higher levels of education and have written on that topic in a prior post. But, what about education focused on financial literacy? The 2018 NFCS survey includes not only the financial well-being questions but also the questions about financial literacy, which is in our interest. Would more financial literacy matter to financial wellness while controlling for other factors (socioeconomic traits, etc.)? We are at the initial stages of a larger research project on the topic and report some descriptive statistics in the chart below.
A brief explanation of the vertical axis is necessary. An aggregate financial wellness score is calculated for each respondent based on their answers to the five wellness questions following the CFPB scoring methodology. Total scores range between 20 and 90 with higher values noting higher levels of financial well-being. The horizontal axis takes the values of the correct number of questions answered to the standard set of six (6) financial literacy questions used by academicians to assess financial literacy. See a prior post on the topic and take the test if you are inclined.
In the boxplot above, the median financial well-being score is reported by the thick black line within each box and the variability of the score among respondents who answered a certain number of questions correctly is captured by the height of the gray area within the box. The gray area captures the interquartile range from 25% to 75% of respondents. It is clear there is an upward trend in median financial well-being among those with more financial literacy which is expected. A stipulation: it is hard to know anything about whether higher financial literacy causes a higher level of financial well-being. There are many potential effects, not captured in these two dimensions. Those with a higher general education and higher annual incomes may feel better about their finances, but have low literacy IQ because they pass off decisions to an advisor. Or, those with higher general education levels and higher incomes with innate brain talents, may do just fine on a financial literacy exam and feel great about their financial well-being.
The point: medians are fine but accurate inferences from a cursory analysis are complicated. To see this visually, the boxplot gray area among those who scored 5 and 6 in the financial literacy exam drifts into the same horizontal space as those who scored 0 or 1; medians may be indications but don’t tell the entire story.
Well-Being and Literacy: We Need to Know More
Peer-reviewed academic research has been underway over the past decade and we will share some of the results of this work in our second post. We wanted to setup the concept in this post and share very basic information about what we know thus far. It is fair to ask, “why does this matter?” We have a couple of responses. First, public policy and tax dollars are at stake. Mandates for financial education take resources away from other initiatives. Second, a higher level of financial well-being is simply a better way to live, and if there are some obvious paths, then we should know them. It is a prickly endeavor, however.
Should the goal of higher financial literacy be the important outcome of financial education? If households’ feel financially well regardless of financial education, then should that be the measure of success? If financial education turns out to be statistically important in its effect on financial literacy, then is the financial outcome sufficient to justify all the associated costs of education and compliance? As we suggested, complex questions that require new knowledge to be informative to policy prescriptions.
Fortunately, there is data generated by the CFPB, the FINRA Foundation, and others that will help provide researchers with the raw materials needed to better understand financial wellness among the population.
A note to readers: I invited Myeongrok Doh to coauthor two pieces on financial wellness. It is an important topic today and one in which we have a research interest. “Doh” is a Business Honors student at UT Austin who is a research partner, a finance major, and an economics minor. Doh is a research assistant at the Salem Center for Policy at UT, and held a FinTech internship at the International Organization of Securities Commissions (IOSCO).
It is supported by the mission and vision of the Financial Literacy and Education Commission under the Department of the Treasury. The Commission’s mission statement is as follows: “The Commission’s vision is of sustained financial well-being for all individuals and families in the U.S. In furtherance of this vision, the Commission sets strategic direction for policy, education, practice, research, and coordination so that all Americans make informed financial decisions.”
See Consumer Financial Protection Bureau (CFPB), “CFPB Financial Well-Being Scale: Scale development technical report,” p. 6.
After the score is calculated by the answers to the questions in the first two parts, there is an assignment of point values by age (either ages 18-61 or 62+) and the method of the survey (either self-administered or administered by someone else). The result is converted to a well-being score on a scale from 0 to 100. Some surveys and academic work in financial wellness use these questions and the 2018 National Financial Capability Study (NFCS) is one of them. More can be found here.