Good morning. I am pleased to be here with the Greater Washington chapter of the Jump$tart Coalition for Personal Finance to kick off Financial Literacy Month 2010. And I would like to take this opportunity to applaud each of you here today for your commitment to revitalizing the Washington chapter.
The coalition is a national leader among organizations that work to improve financial education for students from kindergarten through college. Its programs provide students with the knowledge and skills they need to make informed decisions that will have a positive impact on their economic well-being. With a new leadership team and renewed enthusiasm, the Greater Washington, D.C., chapter of the coalition has joined forces with more than 100 individuals, businesses, and not-for-profit educational and government organizations--including the Federal Reserve Board--to increase knowledge about personal finance among students in our region.
The Federal Reserve System is made up of the Board of Governors here in Washington and 12 regional Federal Reserve Banks with branches across the country. Throughout the Federal Reserve System, we work with the Jump$tart Coalition--locally with the Washington, D.C., chapter and through alliances between the Reserve Banks and other state chapters of the coalition--to achieve our shared goals. The partnership between the Federal Reserve and the Jump$tart Coalition is a natural one. Jump$tart's mission to develop a more financially literate population supports the Federal Reserve's goal of a stable and growing economy. In collaboration with partners like you, Jump$tart enables students to make economically sound financial decisions in their personal and business lives. As students individually form households or start businesses, their collective decisions will shape the economy of our future.
I am especially pleased to be able to represent the Federal Reserve in this effort as my personal commitment to financial literacy has spanned more than 30 years. I have been involved with a number of initiatives including some that took me into the classroom to teach students directly and others that provided teachers with tools and training to better prepare them to teach economics and personal finance. The need in this country for financial education is so great that we must continue to tackle it at all levels and with all available resources. We need to imbed financial concepts in every K-12 curriculum in the country. While physical education and even driver education are part of nearly every curriculum, financial education is mandated by only a handful of states as a requirement for graduation. Alongside classes that prepare students to join the workforce we need courses that demonstrate how to use the financial compensation from their work to meet family necessities and build personal wealth in an era of complex financial products. Students will need to identify situations in which it makes sense to borrow and choose among loan products. They need to know how to budget and save and how to select the best investment vehicles for their savings. And as the recent financial turmoil has taught us, they must understand how to prepare for and deal with financial contingencies such as unemployment or unexpected expenses. Jump$tart supports efforts to provide such an education.
The Federal Reserve is working on several fronts to promote financial education that will help prepare young people to take on the responsibilities of market participants and manage the risks that come with the opportunities to spend, save, borrow, and invest. Financial education that begins at a young age and extends through one's life is the most effective preparation for making important financial decisions such as buying a car, purchasing a home, saving for retirement, borrowing for postsecondary education, and even choosing a career. In support of our efforts, the Reserve Banks have developed programming and curriculum to serve the needs of schools, educators, and students. Among them are:
- Katrina's Classroom, a free video-based curriculum developed by the Federal Reserve Bank of Atlanta that uses the stories of victims of Hurricane Katrina to teach middle school and high school students and their parents the importance of being financially prepared;
- Great Minds Think: A Kid's Guide to Money, a publication developed by the Federal Reserve Bank of Cleveland that helps families begin conversations about money; and
- several essay and creative writing contests for students sponsored throughout the Federal Reserve System, designed to promote students' development of savings goals or encouraging them to apply economic thinking to a social problem.
In addition to providing materials for financial education, the Federal Reserve has also begun to assess the effectiveness of the education programs it engages in, so that we can better evaluate the outcomes of our efforts. This research is intended to help us better answer the question, "What works in education?" so that we may allocate our resources in the best possible manner.
While financial education is an important first step in enabling consumers to make informed financial decisions, it is also important that consumers be presented with clear and consistent information about their financial products. The Federal Reserve is the primary government agency charged with writing rules governing consumer financial products. Historically, we have focused on disclosure as the best way to provide consumers with information to choose between products or to make decisions about using financial products. In recent years, we have used extensive consumer testing to gauge consumers' understanding of financial disclosures and to highlight practices that simply cannot be understood by consumers even with the best disclosures. If we identify practices that cannot be adequately explained through disclosure, we now prohibit those practices. Recently, the Federal Reserve has written strong new consumer protection rules for mortgages, credit cards, and overdraft charges. And we have improved our response time for drafting rules to address emerging trends that may pose new risks for consumers.
In closing, I would like to thank the educators here today for your dedication to Washington-area students. Your role is vital to preparing them with the skills they will need to grow into financially successful adults. I am pleased to be a part of this conversation among the private and public sectors, as well as the education community, about how best to empower students with the confidence and savvy to navigate their financial worlds.
In past generations, cash was used for most daily purchases; today, it's rarely flashed – particularly not by younger shoppers. The way we shop has changed as well. Online shopping has become the top choice for many, creating ample opportunities to use and overextend credit – an all-too-easy way to accumulate debt, and fast.
Meanwhile, credit card companies, banks and other financial institutions are inundating consumers with credit opportunities – the ability to apply for credit cards or pay off one card with another – and without the proper knowledge or checks and balances, it is easy to get into financial trouble.
Many consumers have had very little understanding of finances, how credit works and the potential impact on their financial well-being for many, many years. In fact, the lack of financial understanding has been signaled as one of the main reasons behind savings and investing problems faced by many Americans.
What Is Financial Literacy?
Financial literacy is the confluence of financial, credit and debt management and the knowledge that is necessary to make financially responsible decisions – decisions that are integral to our everyday lives. Financial literacy includes understanding how a checking account works, what using a credit card really means, and how to avoid debt. In sum, financial literacy impacts the daily isues an average family makes when trying to balance a budget, buy a home, fund the children’s education and ensure an income at retirement. (For more, see series: Teaching Financial Literacy.)
A lack of financial literacy is not a problem only in emerging or developing economies. Consumers in developed or advanced economies also fail to demonstrate a strong grasp of financial principles in order to understand and negotiate the financial landscape, manage financial risks effectively and avoid financial pitfalls. Nations globally, from Korea to Australia to Germany, are faced with populations who do not understand financial basics. (The U.S. Ranks 14th In Financial Literacy, by the way).
The level of financial literacy varies according to education and income levels, but evidence shows that highly educated consumers with high incomes can be just as ignorant about financial issues as less-educated, lower-income consumers (though in general, the later do tend to be less financially literate). And it seems consumers are hesitant to learn. The Organization for Economic Co-operation and Development (OECD) cited a survey conducted in Canada that found that choosing the right investment for a retirement savings plan was more stressful than a visit to the dentist.
Trends Making Financial Literacy More Important
Compounding the problems associated with financial illiteracy, it appears financial decision-making is also getting more onerous for consumers. Five trends are converging that demonstrate the importance of making thoughtful and informed decisions about finances:
- Consumers are shouldering more of the financial decisions:Retirement planning is one example of this shift. Past generations depended on pension plans to fund the bulk of their retirement lives. Pension funds, managed by professionals, put the financial burden on the companies or governments that sponsored them. Consumers were not involved with the decision-making, typically did not even contribute their own funds, and they were rarely made aware of the funding status or investments held by the pension. Today, pensions are more a rarity than the norm, especially for new workers. Instead, employees are being offered the ability to participate in 401(k) plans, in which they need to make investment decisions and decide how much to contribute.
- Complex options: Consumers are also being asked to choose among various investment and savings products. These products are more sophisticated than in the past, asking consumers to choose among different options offering varying interest rates and maturities, decisions they are not adequately educated to make. Deciding on complex financial instruments with a large range of options can impact the consumer’s ability to buy a home, finance an education or save for retirement, adding to the decision-making pressure.
- Lack of government aid: A major source of retirement income for past generations was Social Security. But the amount paid by Social Security is not enough, and it may not be available at all in the future. The Social Security Board of Trustees reported that by 2033 the Social Security trust fund may be depleted, a scary prospect for many. So now, Social Security acts more like a safety net that barely provides enough for basic survival. (For more, see: A Social Security Reality Check.)
- Longer life spans: We are living longer. This means we need more money for retirement than prior generations did.
- Changing environment: The financial landscape is very dynamic. Now a global marketplace, there are many more participants in the market and many more factors that can influence it. The quickly changing environment created by technological advances such as electronic trading make the financial markets even swifter and more volatile. Taken together, these factors can cause conflicting views and difficultly in creating, implementing and following a financial roadmap.
- Too many choices: Banks, credit unions, brokerage firms, insurance firms, credit card companies, mortgage companies, financial planners and other financial service companies are all vying for assets creating confusion for the consumer.
Why It Matters
Financial literacy is crucial to help consumers save enough to provide adequate income in retirement, while avoiding high levels of debt that might result in bankruptcy, defaults and foreclosures. A few years ago, a study from financial services company TIAA-CREF showed that those with high financial literacy plan for retirement and, in essence, have double the wealth of people who do not plan for retirement. Conversely, those with low financial literacy borrow more, have less wealth and end up paying unnecessary fees for financial products. In other words, those with lower financial literacy tend to buy on credit, and are unable to pay their full balance each month and end up spending more in interest. This group also does not invest, has trouble with debt and a poor understanding of the terms of their mortgages or loans. Even more worrisome, many consumers believe that they are far more financially literate than they really are.
And while this may seem like an individual problem, it is broader in nature and more influential on the entire population than previously believed. All one needs to do is look at the financial crisis of 2008 to see the financial impact on the entire economy that arose from a lack of understanding of mortgage products. (For more, see: The 2007-08 Financial Crisis in Review.) Financial literacy is an issue with broad implications for economic health and an improvement can lead the way to a global economy that is competitive and strong.
The Bottom Line
Any improvement in financial literacy will have a profound impact on consumers and their ability to provide for their future. Recent trends are making it all the more imperative that consumers understand basic finances, because they are being asked to shoulder more of the burden of investment decisions in their retirement accounts – all while having to decipher more complex financial products and options.
Learning how to read financially is not easy, but once mastered, it can ease life's burdens tremendously.