financial literacy research papers

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• Published: 24 January 2019

Financial literacy and the need for financial education: evidence and implications

• Annamaria Lusardi 1  

Swiss Journal of Economics and Statistics volume  155 , Article number:  1 ( 2019 ) Cite this article

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1 Introduction

Throughout their lifetime, individuals today are more responsible for their personal finances than ever before. With life expectancies rising, pension and social welfare systems are being strained. In many countries, employer-sponsored defined benefit (DB) pension plans are swiftly giving way to private defined contribution (DC) plans, shifting the responsibility for retirement saving and investing from employers to employees. Individuals have also experienced changes in labor markets. Skills are becoming more critical, leading to divergence in wages between those with a college education, or higher, and those with lower levels of education. Simultaneously, financial markets are rapidly changing, with developments in technology and new and more complex financial products. From student loans to mortgages, credit cards, mutual funds, and annuities, the range of financial products people have to choose from is very different from what it was in the past, and decisions relating to these financial products have implications for individual well-being. Moreover, the exponential growth in financial technology (fintech) is revolutionizing the way people make payments, decide about their financial investments, and seek financial advice. In this context, it is important to understand how financially knowledgeable people are and to what extent their knowledge of finance affects their financial decision-making.

An essential indicator of people’s ability to make financial decisions is their level of financial literacy. The Organisation for Economic Co-operation and Development (OECD) aptly defines financial literacy as not only the knowledge and understanding of financial concepts and risks but also the skills, motivation, and confidence to apply such knowledge and understanding in order to make effective decisions across a range of financial contexts, to improve the financial well-being of individuals and society, and to enable participation in economic life. Thus, financial literacy refers to both knowledge and financial behavior, and this paper will analyze research on both topics.

As I describe in more detail below, findings around the world are sobering. Financial literacy is low even in advanced economies with well-developed financial markets. On average, about one third of the global population has familiarity with the basic concepts that underlie everyday financial decisions (Lusardi and Mitchell, 2011c ). The average hides gaping vulnerabilities of certain population subgroups and even lower knowledge of specific financial topics. Furthermore, there is evidence of a lack of confidence, particularly among women, and this has implications for how people approach and make financial decisions. In the following sections, I describe how we measure financial literacy, the levels of literacy we find around the world, the implications of those findings for financial decision-making, and how we can improve financial literacy.

2 How financially literate are people?

2.1 measuring financial literacy: the big three.

In the context of rapid changes and constant developments in the financial sector and the broader economy, it is important to understand whether people are equipped to effectively navigate the maze of financial decisions that they face every day. To provide the tools for better financial decision-making, one must assess not only what people know but also what they need to know, and then evaluate the gap between those things. There are a few fundamental concepts at the basis of most financial decision-making. These concepts are universal, applying to every context and economic environment. Three such concepts are (1) numeracy as it relates to the capacity to do interest rate calculations and understand interest compounding; (2) understanding of inflation; and (3) understanding of risk diversification. Translating these concepts into easily measured financial literacy metrics is difficult, but Lusardi and Mitchell ( 2008 , 2011b , 2011c ) have designed a standard set of questions around these concepts and implemented them in numerous surveys in the USA and around the world.

Four principles informed the design of these questions, as described in detail by Lusardi and Mitchell ( 2014 ). The first is simplicity : the questions should measure knowledge of the building blocks fundamental to decision-making in an intertemporal setting. The second is relevance : the questions should relate to concepts pertinent to peoples’ day-to-day financial decisions over the life cycle; moreover, they must capture general rather than context-specific ideas. Third is brevity : the number of questions must be few enough to secure widespread adoption; and fourth is capacity to differentiate , meaning that questions should differentiate financial knowledge in such a way as to permit comparisons across people. Each of these principles is important in the context of face-to-face, telephone, and online surveys.

Three basic questions (since dubbed the “Big Three”) to measure financial literacy have been fielded in many surveys in the USA, including the National Financial Capability Study (NFCS) and, more recently, the Survey of Consumer Finances (SCF), and in many national surveys around the world. They have also become the standard way to measure financial literacy in surveys used by the private sector. For example, the Aegon Center for Longevity and Retirement included the Big Three questions in the 2018 Aegon Retirement Readiness Survey, covering around 16,000 people in 15 countries. Both ING and Allianz, but also investment funds, and pension funds have used the Big Three to measure financial literacy. The exact wording of the questions is provided in Table  1 .

2.2 Cross-country comparison

The first examination of financial literacy using the Big Three was possible due to a special module on financial literacy and retirement planning that Lusardi and Mitchell designed for the 2004 Health and Retirement Study (HRS), which is a survey of Americans over age 50. Astonishingly, the data showed that only half of older Americans—who presumably had made many financial decisions in their lives—could answer the two basic questions measuring understanding of interest rates and inflation (Lusardi and Mitchell, 2011b ). And just one third demonstrated understanding of these two concepts and answered the third question, measuring understanding of risk diversification, correctly. It is sobering that recent US surveys, such as the 2015 NFCS, the 2016 SCF, and the 2017 Survey of Household Economics and Financial Decisionmaking (SHED), show that financial knowledge has remained stubbornly low over time.

Over time, the Big Three have been added to other national surveys across countries and Lusardi and Mitchell have coordinated a project called Financial Literacy around the World (FLat World), which is an international comparison of financial literacy (Lusardi and Mitchell, 2011c ).

Findings from the FLat World project, which so far includes data from 15 countries, including Switzerland, highlight the urgent need to improve financial literacy (see Table  2 ). Across countries, financial literacy is at a crisis level, with the average rate of financial literacy, as measured by those answering correctly all three questions, at around 30%. Moreover, only around 50% of respondents in most countries are able to correctly answer the two financial literacy questions on interest rates and inflation correctly. A noteworthy point is that most countries included in the FLat World project have well-developed financial markets, which further highlights the cause for alarm over the demonstrated lack of the financial literacy. The fact that levels of financial literacy are so similar across countries with varying levels of economic development—indicating that in terms of financial knowledge, the world is indeed flat —shows that income levels or ubiquity of complex financial products do not by themselves equate to a more financially literate population.

Other noteworthy findings emerge in Table  2 . For instance, as expected, understanding of the effects of inflation (i.e., of real versus nominal values) among survey respondents is low in countries that have experienced deflation rather than inflation: in Japan, understanding of inflation is at 59%; in other countries, such as Germany, it is at 78% and, in the Netherlands, it is at 77%. Across countries, individuals have the lowest level of knowledge around the concept of risk, and the percentage of correct answers is particularly low when looking at knowledge of risk diversification. Here, we note the prevalence of “do not know” answers. While “do not know” responses hover around 15% on the topic of interest rates and 18% for inflation, about 30% of respondents—in some countries even more—are likely to respond “do not know” to the risk diversification question. In Switzerland, 74% answered the risk diversification question correctly and 13% reported not knowing the answer (compared to 3% and 4% responding “do not know” for the interest rates and inflation questions, respectively).

These findings are supported by many other surveys. For example, the 2014 Standard & Poor’s Global Financial Literacy Survey shows that, around the world, people know the least about risk and risk diversification (Klapper, Lusardi, and Van Oudheusden, 2015 ). Similarly, results from the 2016 Allianz survey, which collected evidence from ten European countries on money, financial literacy, and risk in the digital age, show very low-risk literacy in all countries covered by the survey. In Austria, Germany, and Switzerland, which are the three top-performing nations in term of financial knowledge, less than 20% of respondents can answer three questions related to knowledge of risk and risk diversification (Allianz, 2017 ).

Other surveys show that the findings about financial literacy correlate in an expected way with other data. For example, performance on the mathematics and science sections of the OECD Program for International Student Assessment (PISA) correlates with performance on the Big Three and, specifically, on the question relating to interest rates. Similarly, respondents in Sweden, which has experienced pension privatization, performed better on the risk diversification question (at 68%), than did respondents in Russia and East Germany, where people have had less exposure to the stock market. For researchers studying financial knowledge and its effects, these findings hint to the fact that financial literacy could be the result of choice and not an exogenous variable.

To summarize, financial literacy is low across the world and higher national income levels do not equate to a more financially literate population. The design of the Big Three questions enables a global comparison and allows for a deeper understanding of financial literacy. This enhances the measure’s utility because it helps to identify general and specific vulnerabilities across countries and within population subgroups, as will be explained in the next section.

2.3 Who knows the least?

Low financial literacy on average is exacerbated by patterns of vulnerability among specific population subgroups. For instance, as reported in Lusardi and Mitchell ( 2014 ), even though educational attainment is positively correlated with financial literacy, it is not sufficient. Even well-educated people are not necessarily savvy about money. Financial literacy is also low among the young. In the USA, less than 30% of respondents can correctly answer the Big Three by age 40, even though many consequential financial decisions are made well before that age (see Fig.  1 ). Similarly, in Switzerland, only 45% of those aged 35 or younger are able to correctly answer the Big Three questions. Footnote 1 And if people may learn from making financial decisions, that learning seems limited. As shown in Fig.  1 , many older individuals, who have already made decisions, cannot answer three basic financial literacy questions.

Financial literacy across age in the USA. This figure shows the percentage of respondents who answered correctly all Big Three questions by age group (year 2015). Source: 2015 US National Financial Capability Study

A gender gap in financial literacy is also present across countries. Women are less likely than men to answer questions correctly. The gap is present not only on the overall scale but also within each topic, across countries of different income levels, and at different ages. Women are also disproportionately more likely to indicate that they do not know the answer to specific questions (Fig.  2 ), highlighting overconfidence among men and awareness of lack of knowledge among women. Even in Finland, which is a relatively equal society in terms of gender, 44% of men compared to 27% of women answer all three questions correctly and 18% of women give at least one “do not know” response versus less than 10% of men (Kalmi and Ruuskanen, 2017 ). These figures further reflect the universality of the Big Three questions. As reported in Fig.  2 , “do not know” responses among women are prevalent not only in European countries, for example, Switzerland, but also in North America (represented in the figure by the USA, though similar findings are reported in Canada) and in Asia (represented in the figure by Japan). Those interested in learning more about the differences in financial literacy across demographics and other characteristics can consult Lusardi and Mitchell ( 2011c , 2014 ).

Gender differences in the responses to the Big Three questions. Sources: USA—Lusardi and Mitchell, 2011c ; Japan—Sekita, 2011 ; Switzerland—Brown and Graf, 2013

3 Does financial literacy matter?

A growing number of financial instruments have gained importance, including alternative financial services such as payday loans, pawnshops, and rent to own stores that charge very high interest rates. Simultaneously, in the changing economic landscape, people are increasingly responsible for personal financial planning and for investing and spending their resources throughout their lifetime. We have witnessed changes not only in the asset side of household balance sheets but also in the liability side. For example, in the USA, many people arrive close to retirement carrying a lot more debt than previous generations did (Lusardi, Mitchell, and Oggero, 2018 ). Overall, individuals are making substantially more financial decisions over their lifetime, living longer, and gaining access to a range of new financial products. These trends, combined with low financial literacy levels around the world and, particularly, among vulnerable population groups, indicate that elevating financial literacy must become a priority for policy makers.

There is ample evidence of the impact of financial literacy on people’s decisions and financial behavior. For example, financial literacy has been proven to affect both saving and investment behavior and debt management and borrowing practices. Empirically, financially savvy people are more likely to accumulate wealth (Lusardi and Mitchell, 2014 ). There are several explanations for why higher financial literacy translates into greater wealth. Several studies have documented that those who have higher financial literacy are more likely to plan for retirement, probably because they are more likely to appreciate the power of interest compounding and are better able to do calculations. According to the findings of the FLat World project, answering one additional financial question correctly is associated with a 3–4 percentage point greater probability of planning for retirement; this finding is seen in Germany, the USA, Japan, and Sweden. Financial literacy is found to have the strongest impact in the Netherlands, where knowing the right answer to one additional financial literacy question is associated with a 10 percentage point higher probability of planning (Mitchell and Lusardi, 2015 ). Empirically, planning is a very strong predictor of wealth; those who plan arrive close to retirement with two to three times the amount of wealth as those who do not plan (Lusardi and Mitchell, 2011b ).

Financial literacy is also associated with higher returns on investments and investment in more complex assets, such as stocks, which normally offer higher rates of return. This finding has important consequences for wealth; according to the simulation by Lusardi, Michaud, and Mitchell ( 2017 ), in the context of a life-cycle model of saving with many sources of uncertainty, from 30 to 40% of US retirement wealth inequality can be accounted for by differences in financial knowledge. These results show that financial literacy is not a sideshow, but it plays a critical role in saving and wealth accumulation.

Financial literacy is also strongly correlated with a greater ability to cope with emergency expenses and weather income shocks. Those who are financially literate are more likely to report that they can come up with $2000 in 30 days or that they are able to cover an emergency expense of $400 with cash or savings (Hasler, Lusardi, and Oggero, 2018 ).

With regard to debt behavior, those who are more financially literate are less likely to have credit card debt and more likely to pay the full balance of their credit card each month rather than just paying the minimum due (Lusardi and Tufano, 2009 , 2015 ). Individuals with higher financial literacy levels also are more likely to refinance their mortgages when it makes sense to do so, tend not to borrow against their 401(k) plans, and are less likely to use high-cost borrowing methods, e.g., payday loans, pawn shops, auto title loans, and refund anticipation loans (Lusardi and de Bassa Scheresberg, 2013 ).

Several studies have documented poor debt behavior and its link to financial literacy. Moore ( 2003 ) reported that the least financially literate are also more likely to have costly mortgages. Lusardi and Tufano ( 2015 ) showed that the least financially savvy incurred high transaction costs, paying higher fees and using high-cost borrowing methods. In their study, the less knowledgeable also reported excessive debt loads and an inability to judge their debt positions. Similarly, Mottola ( 2013 ) found that those with low financial literacy were more likely to engage in costly credit card behavior, and Utkus and Young ( 2011 ) concluded that the least literate were more likely to borrow against their 401(k) and pension accounts.

Young people also struggle with debt, in particular with student loans. According to Lusardi, de Bassa Scheresberg, and Oggero ( 2016 ), Millennials know little about their student loans and many do not attempt to calculate the payment amounts that will later be associated with the loans they take. When asked what they would do, if given the chance to revisit their student loan borrowing decisions, about half of Millennials indicate that they would make a different decision.

Finally, a recent report on Millennials in the USA (18- to 34-year-olds) noted the impact of financial technology (fintech) on the financial behavior of young individuals. New and rapidly expanding mobile payment options have made transactions easier, quicker, and more convenient. The average user of mobile payments apps and technology in the USA is a high-income, well-educated male who works full time and is likely to belong to an ethnic minority group. Overall, users of mobile payments are busy individuals who are financially active (holding more assets and incurring more debt). However, mobile payment users display expensive financial behaviors, such as spending more than they earn, using alternative financial services, and occasionally overdrawing their checking accounts. Additionally, mobile payment users display lower levels of financial literacy (Lusardi, de Bassa Scheresberg, and Avery, 2018 ). The rapid growth in fintech around the world juxtaposed with expensive financial behavior means that more attention must be paid to the impact of mobile payment use on financial behavior. Fintech is not a substitute for financial literacy.

4 The way forward for financial literacy and what works

Overall, financial literacy affects everything from day-to-day to long-term financial decisions, and this has implications for both individuals and society. Low levels of financial literacy across countries are correlated with ineffective spending and financial planning, and expensive borrowing and debt management. These low levels of financial literacy worldwide and their widespread implications necessitate urgent efforts. Results from various surveys and research show that the Big Three questions are useful not only in assessing aggregate financial literacy but also in identifying vulnerable population subgroups and areas of financial decision-making that need improvement. Thus, these findings are relevant for policy makers and practitioners. Financial illiteracy has implications not only for the decisions that people make for themselves but also for society. The rapid spread of mobile payment technology and alternative financial services combined with lack of financial literacy can exacerbate wealth inequality.

To be effective, financial literacy initiatives need to be large and scalable. Schools, workplaces, and community platforms provide unique opportunities to deliver financial education to large and often diverse segments of the population. Furthermore, stark vulnerabilities across countries make it clear that specific subgroups, such as women and young people, are ideal targets for financial literacy programs. Given women’s awareness of their lack of financial knowledge, as indicated via their “do not know” responses to the Big Three questions, they are likely to be more receptive to financial education.

The near-crisis levels of financial illiteracy, the adverse impact that it has on financial behavior, and the vulnerabilities of certain groups speak of the need for and importance of financial education. Financial education is a crucial foundation for raising financial literacy and informing the next generations of consumers, workers, and citizens. Many countries have seen efforts in recent years to implement and provide financial education in schools, colleges, and workplaces. However, the continuously low levels of financial literacy across the world indicate that a piece of the puzzle is missing. A key lesson is that when it comes to providing financial education, one size does not fit all. In addition to the potential for large-scale implementation, the main components of any financial literacy program should be tailored content, targeted at specific audiences. An effective financial education program efficiently identifies the needs of its audience, accurately targets vulnerable groups, has clear objectives, and relies on rigorous evaluation metrics.

Using measures like the Big Three questions, it is imperative to recognize vulnerable groups and their specific needs in program designs. Upon identification, the next step is to incorporate this knowledge into financial education programs and solutions.

School-based education can be transformational by preparing young people for important financial decisions. The OECD’s Programme for International Student Assessment (PISA), in both 2012 and 2015, found that, on average, only 10% of 15-year-olds achieved maximum proficiency on a five-point financial literacy scale. As of 2015, about one in five of students did not have even basic financial skills (see OECD, 2017 ). Rigorous financial education programs, coupled with teacher training and high school financial education requirements, are found to be correlated with fewer defaults and higher credit scores among young adults in the USA (Urban, Schmeiser, Collins, and Brown, 2018 ). It is important to target students and young adults in schools and colleges to provide them with the necessary tools to make sound financial decisions as they graduate and take on responsibilities, such as buying cars and houses, or starting retirement accounts. Given the rising cost of education and student loan debt and the need of young people to start contributing as early as possible to retirement accounts, the importance of financial education in school cannot be overstated.

There are three compelling reasons for having financial education in school. First, it is important to expose young people to the basic concepts underlying financial decision-making before they make important and consequential financial decisions. As noted in Fig.  1 , financial literacy is very low among the young and it does not seem to increase a lot with age/generations. Second, school provides access to financial literacy to groups who may not be exposed to it (or may not be equally exposed to it), for example, women. Third, it is important to reduce the costs of acquiring financial literacy, if we want to promote higher financial literacy both among individuals and among society.

There are compelling reasons to have personal finance courses in college as well. In the same way in which colleges and university offer courses in corporate finance to teach how to manage the finances of firms, so today individuals need the knowledge to manage their own finances over the lifetime, which in present discounted value often amount to large values and are made larger by private pension accounts.

Financial education can also be efficiently provided in workplaces. An effective financial education program targeted to adults recognizes the socioeconomic context of employees and offers interventions tailored to their specific needs. A case study conducted in 2013 with employees of the US Federal Reserve System showed that completing a financial literacy learning module led to significant changes in retirement planning behavior and better-performing investment portfolios (Clark, Lusardi, and Mitchell, 2017 ). It is also important to note the delivery method of these programs, especially when targeted to adults. For instance, video formats have a significantly higher impact on financial behavior than simple narratives, and instruction is most effective when it is kept brief and relevant (Heinberg et al., 2014 ).

The Big Three also show that it is particularly important to make people familiar with the concepts of risk and risk diversification. Programs devoted to teaching risk via, for example, visual tools have shown great promise (Lusardi et al., 2017 ). The complexity of some of these concepts and the costs of providing education in the workplace, coupled with the fact that many older individuals may not work or work in firms that do not offer such education, provide other reasons why financial education in school is so important.

Finally, it is important to provide financial education in the community, in places where people go to learn. A recent example is the International Federation of Finance Museums, an innovative global collaboration that promotes financial knowledge through museum exhibits and the exchange of resources. Museums can be places where to provide financial literacy both among the young and the old.

There are a variety of other ways in which financial education can be offered and also targeted to specific groups. However, there are few evaluations of the effectiveness of such initiatives and this is an area where more research is urgently needed, given the statistics reported in the first part of this paper.

5 Concluding remarks

The lack of financial literacy, even in some of the world’s most well-developed financial markets, is of acute concern and needs immediate attention. The Big Three questions that were designed to measure financial literacy go a long way in identifying aggregate differences in financial knowledge and highlighting vulnerabilities within populations and across topics of interest, thereby facilitating the development of tailored programs. Many such programs to provide financial education in schools and colleges, workplaces, and the larger community have taken existing evidence into account to create rigorous solutions. It is important to continue making strides in promoting financial literacy, by achieving scale and efficiency in future programs as well.

In August 2017, I was appointed Director of the Italian Financial Education Committee, tasked with designing and implementing the national strategy for financial literacy. I will be able to apply my research to policy and program initiatives in Italy to promote financial literacy: it is an essential skill in the twenty-first century, one that individuals need if they are to thrive economically in today’s society. As the research discussed in this paper well documents, financial literacy is like a global passport that allows individuals to make the most of the plethora of financial products available in the market and to make sound financial decisions. Financial literacy should be seen as a fundamental right and universal need, rather than the privilege of the relatively few consumers who have special access to financial knowledge or financial advice. In today’s world, financial literacy should be considered as important as basic literacy, i.e., the ability to read and write. Without it, individuals and societies cannot reach their full potential.

See Brown and Graf ( 2013 ).

Abbreviations

Defined benefit (refers to pension plan)

Defined contribution (refers to pension plan)

Financial Literacy around the World

National Financial Capability Study

Organisation for Economic Co-operation and Development

Programme for International Student Assessment

Survey of Consumer Finances

Survey of Household Economics and Financial Decisionmaking

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Acknowledgements

This paper represents a summary of the keynote address I gave to the 2018 Annual Meeting of the Swiss Society of Economics and Statistics. I would like to thank Monika Butler, Rafael Lalive, anonymous reviewers, and participants of the Annual Meeting for useful discussions and comments, and Raveesha Gupta for editorial support. All errors are my responsibility.

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Lusardi, A. Financial literacy and the need for financial education: evidence and implications. Swiss J Economics Statistics 155 , 1 (2019). https://doi.org/10.1186/s41937-019-0027-5

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Received : 22 October 2018

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Financial Literacy and the Need for Financial Education: Evidence and Implications

Throughout their lifetime, individuals today are more responsible for their personal finances than ever before. With life expectancies rising, pension and social welfare systems are being strained. In many countries, employer-sponsored defined benefit (DB) pension plans are swiftly giving way to private defined contribution (DC) plans, shifting the responsibility for retirement saving and investing from employers to employees. Individuals have also experienced changes in labor markets. Skills are becoming more critical, leading to divergence in wages between those with a college education, or higher, and those with lower levels of education. Simultaneously, financial markets are rapidly changing, with developments in technology and new and more complex financial products. From student loans to mortgages, credit cards, mutual funds, and annuities, the range of financial products people have to choose from is very different from what it was in the past, and decisions relating to these financial products have implications for individual well-being. Moreover, the exponential growth in financial technology (fintech) is revolutionizing the way people make payments, decide about their financial investments, and seek financial advice. In this context, it is important to understand how financially knowledgeable people are and to what extent their knowledge of finance affects their financial decision-making.

An essential indicator of people’s ability to make financial decisions is their level of financial literacy. The Organisation for Economic Co-operation and Development (OECD) aptly defines financial literacy as not only the knowledge and understanding of financial concepts and risks but also the skills, motivation, and confidence to apply such knowledge and understanding in order to make effective decisions across a range of financial contexts, to improve the financial well-being of individuals and society, and to enable participation in economic life. Thus, financial literacy refers to both knowledge and financial behavior, and this paper will analyze research on both topics.

As I describe in more detail below, findings around the world are sobering. Financial literacy is low even in advanced economies with well-developed financial markets. On average, about one third of the global population has familiarity with the basic concepts that underlie everyday financial decisions (Lusardi and Mitchell, 2011c ). The average hides gaping vulnerabilities of certain population subgroups and even lower knowledge of specific financial topics. Furthermore, there is evidence of a lack of confidence, particularly among women, and this has implications for how people approach and make financial decisions. In the following sections, I describe how we measure financial literacy, the levels of literacy we find around the world, the implications of those findings for financial decision-making, and how we can improve financial literacy.

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Financial literacy, financial advice, and financial behavior

• Original Paper
• Open access
• Published: 04 March 2017
• Volume 87 , pages 581–643, ( 2017 )

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• Oscar A. Stolper 1 &
• Andreas Walter 2  

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In this survey, we review the voluminous body of literature on the measurement and the determinants of financial literacy. Wherever possible, we supplement existing findings with recent descriptive evidence of German households’ financial literacy levels based on the novel Panel on Household Finances dataset, a large-scale survey administered by the Deutsche Bundesbank and representative of the financial situation of households in Germany. Prior research not only documents generally low levels of financial literacy but also finds large heterogeneity in financial literacy across the population, suggesting that economically vulnerable groups are placed at further disadvantage by their lack of financial knowledge. In addition, we assess the literature evaluating financial education as a means to improve financial literacy and financial behavior. Our survey suggests that the evidence with respect to the effectiveness of the programs is rather disappointing. We also review the role of individuals’ financial literacy for the use of professional financial advice and assess whether expert intervention can serve as a substitute to financial literacy. We conclude by discussing several directions for future research.

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1 Introduction

In recent years, consumers across the globe have taken on greater responsibility with regards to their personal financial well-being. Sweeping changes in the pension landscape have marked the principal catalyst for this increased autonomy of consumers by passing financial decisions including saving, investing, and decumulating wealth to employees and retirees. Where in the past, employees in many countries relied on social security and employer-sponsored defined benefit pension plans, with the increasing shift to defined-contribution pension plans, households are now being given greater control and responsibility over the long-term investments funding their retirement. At the same time, consumers have to find their bearings in a market characterized by a growing complexity which requires both a firm understanding of increasingly sophisticated products and the ability to judge the quality of guidance received about these products.

In Germany, this trend towards consumer autonomy has been further accelerated by two developments. First, the 2001 reform of the public pension system transformed a statutory pension scheme established at the foundation of the Federal Republic of Germany which had provided generations of retirees with sufficient funds into a system featuring multiple pillars of old-age provision. Specifically, this shift involved a substantial reduction of state-granted benefits and ever since requires employees to participate in state-subsidized pension plans (most prominently the so-called Riester plan) as well as occupational and private pension plans in order to fill the gap in retirement income. The second aspect relates to how German households have traditionally accumulated wealth: large parts of the population predominantly rely on savings deposits and thus forego excess returns of equity investments. While this extreme risk aversion has always been a challenge to profitable asset management, the ongoing period of interest rates next to zero renders established savings patterns entirely ineffective and urges for new investment strategies to provide for retirement. Taken together, these developments turn millions of German households into financial market participants, even though the vast majority have below-average experience as compared to individual investors in other economies like, e.g., the U.S. with a long-term equity culture.

Against this background, a natural question to ask is whether today’s households are well-equipped to successfully manage their personal financial affairs. In this review, we address this question and thereby focus on consumers’ financial literacy, i.e. their knowledge of key financial concepts as well as their ability to apply this knowledge to make informed financial decisions. Footnote 1

To preview the evidence provided by some of the studies we survey in greater detail in subsequent sections of the paper, research not only documents generally low levels of financial literacy but also finds large heterogeneity in financial literacy across the population. For example, Bucher-Koenen and Lusardi ( 2011 ) assess financial literacy in Germany and provide evidence that knowledge of basic financial concepts is particularly low among women, the less educated, and those living in East Germany, hence suggesting that economically vulnerable groups are placed at further disadvantage by their lack of financial knowledge.

Moreover, low levels of financial literacy have been linked to suboptimal financial behavior likely to have long-term consequences. Hilgert et al. ( 2003 ) find that low literate individuals are generally less likely to engage in a wide range of recommended financial practices. More specifically, Bucher-Koenen ( 2011 ) finds that Riester participation is disproportionately low among those German households with the lowest levels of financial literacy, although this group is eligible for the relatively highest government subsidies (see, e.g., Coppola and Gasche 2011 ). In the U.S., Choi et al. ( 2011 ) investigate contributions to 401(k) plans by employees who are eligible for an employer match and find that a large fraction of these employees either do not participate at all or contribute less than the amount required to be granted the full employer match, thus foregoing matching contributions which cumulate to substantial losses over time. These and other findings in the literature have sparked public discussion pointing to a need for financial literacy in a world in which individuals now shoulder greater personal financial responsibility. Accordingly, the assessment of consumers’ financial competence as well as the effect of financial education initiatives on economic outcomes has attracted considerable attention in recent years and the academic literature on financial literacy is rapidly evolving.

We conducted an ad-hoc query using the Web of Science Footnote 2 and searched for the terms ‘financial literacy’ or ‘financial knowledge’ in the publication titles. Figure  1 reports the rapid increase in publications on the topic as of March 2016. Specifically, the first 3-year period from 2002 to 2004 featured an average of one publication per year whereas roughly 26 papers per year were published between 2013 and 2015. As can be also inferred from Fig.  1 , the increasing relevance of financial literacy becomes even more obvious when using citations generated by financial literacy publications as a benchmark. From 2004 to 2006, the Web of Science database counts no more than two citations per year while in the most recent 3-year period, i.e. 2013–2015, this number jumps to an annual average of 346 citations.

Number of and citations triggered by publications on financial literacy and financial knowledge, per year. Notes : This figure plots the number of studies with the terms “financial literacy” and “financial knowledge” in the title. Numbers stem from search quieries using the scientific citation index “Web of Science” which provides access to multiple databases that reference cross-disciplinary research. See Sect.  1 for further details

Table  1 lists the 20 most frequently cited publications we obtained from our Web of Science query. Interestingly, these top-cited papers are published in journals covering a broad array of disciplines in economics and business administration, including accounting, economics, economic psychology, finance, and marketing. The most important publication outlet is the Journal of Consumer Affairs , i.e. a marketing-related journal, which accounts for a total of eight publications in the top 20. Economics journals come second and the remaining disciplines close behind.

In this survey, we offer an assessment of the voluminous body of literature on the measurement and the determinants of financial literacy. In addition, we assess the literature dealing with the effectiveness of financial education when it comes to improving financial literacy and financial behavior. At this, we complement the excellent reviews provided by Hastings et al. ( 2013 ) and Lusardi and Mitchell ( 2014 ) along at least three different lines. First, while these surveys focus on U.S.-based evidence, we adopt a different perspective and instead put emphasis on what is known about financial literacy in Germany, since German consumers face financial decisions substantially different from those of U.S. their counterparts. Wherever possible, we supplement existing findings with recent descriptive evidence of German households’ financial literacy levels based on the novel Panel on Household Finances  (PHF) dataset, a large-scale survey administered by the Deutsche Bundesbank and representative of the financial situation of households in Germany. Footnote 3

Second, we review the role of individuals’ financial literacy for the use of professional financial advice. Recently, a lot of contributions have addressed the question whether financial advice may substitute for financial capabilities or if the two approaches to improve consumer financial decision making instead should rather be considered complements. One goal of this paper is to present a comprehensive survey of the literature contributions discussing this question which seeks to inform policymakers about the effectiveness of interventions regulating the supply side of financial products and services on the one hand versus enabling the demand side by means of financial education initiatives on the other hand.

Third, we aim at providing the reader with some of the tools necessary to contribute to the research on financial literacy. To this end, we describe different methodological approaches to proxy for individuals’ financial capabilities absent a direct measure of financial literacy. Moreover, we highlight potential endogeneity concerns when it comes to establishing cause-and-effect relationships as well as methodological approaches to address endogeneity in the context of financial literacy research. Finally, we supplement the literature review with a number of useful overviews over the host of different sources providing the raw data necessary to address relevant research questions.

While this review focuses on the empirics of financial literacy research, the body of literature on individuals’ financial knowledge and abilities also comprises important theoretical work (e.g. Delavande et al. 2008 ; Jappelli and Padula 2013 , 2015 ; Lusardi et al. 2013 ). Most of the theoretical contributions develop intertemporal consumption frameworks to model individuals’ decision to invest in financial literacy as well as its effect on households’ general savings and investment decisions, i.e. endogenizing their decision to invest in financial knowledge. Footnote 4

The remainder of the paper is structured as follows. Section  2 discusses conceptualizations of financial literacy and describes and assesses different approaches to measure it. In Sect.  3 , we review the evidence on financial literacy levels for various different economies around the world, while Sect.  4 surveys the literature on the determinants of financial literacy. Section  5 discusses the voluminous body of literature contributions investigating the link between financial literacy and financial behavior and addresses endogeneity concerns arising when capturing this connection. Section  6 reviews alternative approaches proposed to improve consumers’ financial behavior as well as an evaluation of their effectiveness. Section  7 concludes, draws policy implications, and suggests avenues for further research.

2 Measuring financial literacy

2.1 conceptual definitions.

How do consumers perform when it comes to managing their personal finances? Clearly, assessing the role of financial literacy as an input to effective financial decision making first of all requires a clear definition of financial literacy as well as a universal understanding of how it is conceptualized.

2.1.1 Definitions of financial literacy

The term financial literacy was introduced in the U.S. by the Jump$tart Coalition for Personal Financial Literacy in 1997, defining the concept as “the ability to use knowledge and skills to manage one’s financial resources effectively for lifetime financial security” . Later, also in the U.S., this characterization was adopted in a universal definition provided by the President’s Advisory Council on Financial Literacy (PACFL 2008 ). However, Hung et al. ( 2009 ), in their review of competing financial literacy concepts, find that the literature has proposed several definitions and lacks a universally accepted notion of what financial literacy really means. They document a large variety of conceptual definitions and show that each of them stresses different dimensions of financial literacy, i.e. actual and perceived knowledge of financial matters as well as the ability to apply that knowledge, but also individual financial experience and even sound financial behavior. In another extensive review of financial literacy operationalizations, Huston ( 2010 ) surveys 71 studies using 52 different data sets and corroborates that there is no such thing as a standardized conceptualization of financial literacy. 72% of studies did not even include an explicit definition. Moreover, there was no universally accepted meaning of financial literacy among those studies which did propose financial literacy definitions. Finally, the terms financial literacy and financial knowledge were used interchangeably by almost half of all studies under review. Like other standardized concepts of literacy such as computer literacy or health literacy, however, Huston ( 2010 ) stresses that “financial literacy should be conceptualized as having two dimensions — understanding (personal finance knowledge) and use (personal finance application)” (p. 306). A similar understanding is given in Hung et al. ( 2009 ), who consolidate the various definitions they review and propose an overarching conceptualization specifying financial literacy as the “knowledge of basic economic and financial concepts, as well as the ability to use that knowledge and other financial skills to manage financial resources effectively for a lifetime of financial well - being” (p. 12). A recent definition employed in the 2012 Program for International Student Assessment (PISA) has been provided by the Organization for Economic Cooperation and Development (OECD 2014 ) and includes both the knowledge and the application domain: “Financial literacy is knowledge and understanding of financial concepts and risks, and the skills, motivation and confidence to apply such knowledge and understanding in order to make effective decisions across a range of financial contexts, to improve the financial well - being of individuals and society, and to enable participation in economic life” (p. 33).

2.1.2 Cognitive abilities versus financial literacy

There is an ongoing debate as to how financial literacy is distinct from related concepts like numeracy and cognitive abilities. Hastings et al. ( 2013 ) document that respondents with higher cognitive abilities and more comfortable with numerical calculations on average exhibit higher levels of financial literacy. They also review a number of studies which find a positive relationship between cognitive abilities and numeracy on the one hand and sound financial behavior on the other hand (e.g., Banks and Oldfield 2007 ; Grinblatt et al. 2009 ; Christelis et al. 2010 ). Thus, Hung et al. ( 2009 ) argue that, for designing effective programs to improve financial literacy, it is important to differentiate general cognitive abilities from core aspects of financial literacy. Footnote 5 Lusardi et al. ( 2010 ) address this point of criticism by analyzing both a measure of financial literacy and a proxy for cognitive ability obtained from the National Longitudinal Survey of Youth (NLSY). On the one hand, the authors confirm a positive correlation between financial literacy and cognitive ability. However, they also show that cognitive factors cannot account for the entire variation in measured financial literacy levels, thereby leaving room for other dimensions of financial literacy.

2.2 Test-based measures of financial literacy

In their review of financial literacy measures used in 18 different studies, Hung et al. ( 2009 ) document that test-based or performance-based approaches have become prevalent in order to capture financial literacy. Test questions are usually drawn from household surveys and refer to knowledge of financial products (e.g., knowledge of stocks, bonds, mutual funds, or mortgages), knowledge of financial concepts (e.g., inflation, risk diversification, or the time value of money), and to general mathematical and numerical skills. The individual level of financial literacy of a given survey respondent is then obtained using different means of aggregating these questions. While some studies measure financial literacy using simple indicator variables (Jappelli 2010 ; Gathergood 2012 ), several other authors rely on more advanced techniques such as principal component analysis (e.g. Behrmann et al. 2012 ; Klapper et al. 2013 ; Lusardi et al. 2014 ), iterated principal factor analysis (e.g. van Rooij et al. 2011b ), or cluster analysis (e.g. Lusardi and Tufano 2015 ). Yet, results regarding the relationship of financial literacy with financial behavior have been shown to be largely robust to the technique applied to condense the underlying questions.

2.2.1 The Big Three

Hung et al. ( 2009 ) show that the various test-based measures they review are generally highly correlated with each other and when the questions are worded identically, answers feature high test–retest reliability across different survey waves. Thus, in the following, we will focus on three specific test questions introduced by Lusardi and Mitchell ( 2008 ) in a special module of the 2004 Health and Retirement Study (HRS). Footnote 6 These questions have been widely adopted in the U.S. and elsewhere and have become known as the Big Three . Footnote 7 The first one of this parsimonious set of questions addresses individuals’ numeracy and their ability to do simple calculations and is worded as follows Footnote 8 :

Suppose you had $100 in a savings account and the interest rate was 2% per year. After 5   years, how much do you think you would have in the account if you left the money to grow: [ more than $102 ; exactly $102; less than $102; do not know; refuse to answer.]

The second question refers to inflation and money illusion:

Imagine that the interest rate on your savings account was 1% per year and inflation was 2%   per year. After 1   year, would you be able to buy: [more than, exactly the same as, or less than today with the money in this account; do not know; refuse to answer.]

Finally, the third question tests if respondents are familiar with the concept of risk diversification:

Do you think that the following statement is true or false? ‘Buying a single company stock usually provides a safer return than a stock mutual fund.’ [true; false ; do not know; refuse to answer.]

Although the Big Three generally do not demand advanced financial knowledge, only 34% of respondents in the original survey were able to answer all three questions correctly (Lusardi and Mitchell 2014 ). Straightforwardly, individuals who fail to correctly answer the first two questions will likely experience difficulties when facing even basic financial decisions characterized by an investment today and returns in the future. Providing the correct answer to the third question requires some knowledge about stocks and stock mutual funds as well as about the concept of risk diversification and thus indicates if respondents are able to effectively manage their financial assets.

2.2.2 Beyond the Big Three

In subsequent analyses, surveys were extended by additional questions beyond the Big Three so as to capture other dimensions of financial literacy. Specifically, Lusardi and Mitchell added two more items measuring knowledge in asset pricing and mortgages to the 2009 National Financial Capability Study (NFCS). In a recent large scale survey of financial literacy levels in more than 140 national economies, Klapper et al. ( 2015 ) elicit four quiz questions closely related to the Big Three . Thereby, the survey addresses four fundamental concepts for financial decision-making: risk diversification Footnote 9 (related to the third question of the Big Three), inflation Footnote 10 (very similar to the second question of the Big Three ), numeracy Footnote 11 (new question, previously not included in the Big Three ) and compound interest Footnote 12 (an advancement of the first question of the Big Three as this question actually refers to the concept of interest compounding).

Recently, the OECD has adopted an even broader perspective on the measurement of financial literacy for the 2012 PISA assessment (OECD 2014 ). An expert group consisting of regulators, academics and practitioners from different countries designed questions in three dimensions: knowledge and understanding (content), approaches and mental strategies (processes) and financial situations (contexts), reflecting real-life situations of 15-year-old students. The assessment consists of 40 finance-related questions as well as questions in the areas of mathematics and reading abilities. Students were asked to analyze simple graphs, calculate interest rates or evaluate payment checks and invoices. Thus, the financial literacy measure designed for the PISA assessment differs from the Big Three along two dimensions. First, the questions asked cover a much larger array of financial issues and place emphasis on financial decisions faced by 15-year-old students. Second, due to a more extensive battery of questions, financial literacy levels elicited in the PISA assessment capture more nuances of knowledge and abilities related to personal finance matters.

2.2.3 Caveats of test-based financial literacy measures

Although test-based approaches towards measuring financial capabilities—most prominently the Big Three —have now become the international benchmark for the assessment of financial literacy, there is little evidence on whether this set of questions is indeed a superior approach to capturing financial literacy. Hastings et al. ( 2013 ) emphasize that it is generally unclear if questions are a suitable means for measuring financial capability and, if so, which questions lend themselves most effectively for identifying it. Specifically, the authors criticize that surveys eliciting financial literacy levels do not incentivize respondents to provide carefully considered answers reflecting their actual knowledge. Besides, study designs usually do not permit participants to tap into other sources of information in order to prepare their decisions. Yet, accessing the internet, talking to friends and family, or consulting with a financial advisor Footnote 13 are important channels of expertise used by many consumers to compensate for their individual lack of financial literacy when making real-life financial decisions. Ignoring them likely biases the observed impact of financial literacy on financial behavior.

Another shortcoming of test-based measures of financial literacy is their sensitivity to framing. Specifically, Lusardi and Mitchell ( 2011a , b ) and van Rooij et al. ( 2011b ) document that the answers of survey participants differ significantly based on the wording of the test questions. In fact, the percentage of correct answers doubled in the latter study when the wording for the third question of the Big Three was “ buying company stock usually provides a safer return than a stock mutual fund” as compared to phrasing the question reversely, i.e. “ buying a stock mutual fund usually provides a safer return than a company stock” . Hence, Lusardi and Mitchell ( 2014 ) conclude that some answers classified as “correct” might instead reflect simple guessing of respondents and highlight that measurement error might be an issue when eliciting financial ability based on test questions. Footnote 14

Finally, Meyer et al. ( 2015 ) document that the quality of data obtained from household surveys has declined in recent years. This development owes to increasing non-participation of households ( unit nonresponse ), a tendency of not answering certain questions ( item nonresponse ), and, finally, increased measurement error due to greater inaccuracy of the participating households when answering the survey questions. Although this trend is not limited to items related to financial literacy, it constitutes an additional issue regarding the reliability of recent surveys on financial literacy.

2.3 Self-assessed financial literacy

An alternative approach to eliciting financial literacy levels which has also become prevalent in the literature involves asking survey respondents for a self-assessment of their financial capabilities. The corresponding item is usually worded as follows (Lusardi and Mitchell 2014 , p. 11) Footnote 15 :

On a scale from 1 to 7, where 1 means very low and 7 means very high, how would you assess your overall financial knowledge?’

Comparing test-based and self-assessed financial literacy, the literature reveals that individuals tend to be overly confident about how much they really know (e.g., Agnew and Szykman 2005 ). Footnote 16 Given the far-reaching consequences of many financial decisions, this overconfidence might be a problem, especially in situations where individuals are not aware of this bias (Lusardi and Mitchell 2014 ). In particular, older people tend to have a high confidence in their financial literacy although they do rather poorly on the test questions as well as with respect to their actual financial behavior (Lusardi and Tufano 2015 ; Lusardi and Mitchell 2011a , c ; Gamble et al. 2015 ). In a cross-country study including American, Dutch, and German households, Bucher-Koenen et al. ( 2016 ) recently document gender differences not only in test-based but also in self-reported levels of financial literacy. Specifically, women are less likely to respond correctly to the Big Three and also assign themselves lower scores than men, i.e. suggesting overconfidence in financial capabilities which seems especially pronounced among males. In another recent study for Germany, Bannier and Neubert ( 2016a ) corroborate the gender gap in confidence regarding financial literacy. Analyzing data drawn from the SAVE survey Footnote 17 they show that, while men are generally overconfident with respect to their financial knowledge, women instead tend to be under confident. Finally, recent contributions on self-assessed versus test-based measures discuss whether or not high levels of confidence in one’s own financial knowledge may be beneficiary for individuals. While Lusardi and Mitchell ( 2014 ) highlight the problems associated with overconfidence, Bannier and Neubert ( 2016a ) document a positive correlation between overconfidence and investment performance for the group of highly-educated men. Footnote 18

An interesting question is how test-based and self-assessed levels of financial literacy relate to each other. Indeed, the literature finds that self-assessed financial literacy and observed financial behavior do not always correlate strongly (Collins et al. 2009 ; Hastings and Mitchell 2011 ). Agnew and Szykman ( 2005 ), for instance, document a median correlation of 0.49 between actual and self-assessed financial literacy scores, a finding which is qualitatively corroborated in Lusardi and Mitchell ( 2009 ) and Parker et al. ( 2012 ). Moreover, both types of measures have been shown to be individually associated with financial decisions (e.g., Hastings et al. 2013 ; Asaad 2015 ; Allgood and Walstad 2016 ). Specifically, Parker et al. ( 2012 ) show that both self-reported and test-based financial literacy are predictive for retirement planning and savings. Likewise, van Rooij et al. ( 2011b ) find that both self-assessed and objectively measured financial literacy predict individuals’ propensity to hold stocks. Bannier and Neubert ( 2016b ) extend this research by showing that self-assessed financial knowledge associates with riskier investments (in discount certificates, hedge funds), while objectively measured financial literacy correlates strongly with less risky standard investments (in stocks, mutual funds, or real estate trusts). Moreover, the authors observe a gender gap in that this difference in risk taking based on individuals’ own perception of their financial abilities is more pronounced for women. In a recent study, Allgood and Walstad ( 2016 ) use a combined measure of test-based and self-assessed financial literacy and find that both financial literacy measures appear to independently correlate with financial behavior, leading them to conclude that self-assessed financial literacy may be as important as test-based financial literacy in explaining financial outcomes. Finally, Kramer ( 2014 ) and von Gaudecker ( 2015 ) compare individuals’ test-based financial literacy levels with how financially literate they perceive themselves and suggest a role for overconfidence which reduces individuals’ propensity to demand professional financial advice (see Sect.  6.2 ).

2.4 Proxies for financial literacy

2.4.1 socio-demographic proxies.

Absent a survey-based measure of financial literacy, a number of studies have turned to different proxies for subjects’ financial literacy levels. Given the robust correlations between several socio-demographic characteristics and measured financial literacy (see Sect.  4.1 ), several contributions lacking an observable measure of financial capabilities exploit this evidence and use respondents’ demographics in order to capture their financial literacy. Corresponding proxies for financial sophistication used in the literature include (disposable) income and wealth (Dhar and Zhu 2006 ; Vissing-Jorgensen 2003 ; Calvet et al. 2007 , 2009 ) as well as age (Calvet et al. 2007 , 2009 ; Georgarakos and Pasini 2011 ), educational attainment (Christiansen et al. 2008 ; Calvet et al. 2007 , 2009 ), professional status (Calvet et al. 2009 ), and even IQ (Grinblatt et al. 2011 , 2012 ). Likewise, both Chalmers and Reuter ( 2012 ) and Hackethal et al. ( 2012 ) use subsets of these demographics to proxy for financial literacy in their analyses.

A methodologically advanced approach to infer a demographics-based proxy of financial literacy recently applied in Stolper ( 2016 ) combines individuals’ demographic characteristics as well as directly measured levels of financial literacy by drawing on two different datasets each of which contains an identical set of demographics for a given cohort. The difference between the two datasets, however, is that only one of them contains the explanatory variable of interest, i.e. a direct measure of financial literacy, while the other features the financial outcome of interest but lacks a financial literacy measure. To overcome this data limitation, the author resorts to the imputation method proposed by Browning and Leth-Petersen ( 2003 ) and designed to link datasets featuring the above-mentioned properties. Following Graham et al. ( 2009 ) and Korniotis and Kumar ( 2013 ), who apply this approach to infer individuals’ perceived competence and smartness, respectively, the author proceeds in two steps to obtain a demographics-based financial literacy variable. First, he estimates an empirical model of financial literacy using the first wave of the PHF survey which contains both a direct measure of financial literacy and several of the demographic characteristics that have been shown to explain a significant proportion of the cross-sectional variation in people’s financial literacy levels (see Sect.  4.1 ). In a second step, the author then employs this model to predict the financial literacy levels of the households sampled in the primary dataset which only contains the respective demographics. Specifically, he uses the coefficient estimates obtained from the PHF-based model and plugs in the relevant demographic characteristics available in the primary dataset in order to construct a variable capturing predicted financial literacy.

2.4.2 Outcomes-based proxies

Given the drawbacks of test-based measures, some have proposed alternative approaches towards capturing financial literacy. Instead of surveying households, a natural way to infer financial literacy levels from other available information is to look at individuals’ readily observable financial behavior and use the quality of their financial decisions as a proxy for their financial literacy. Such outcomes-based proxies for financial literacy comprise observed risk diversification in equity portfolios (Goetzmann and Kumar 2008 ; Grinblatt and Keloharju  2001 ), prior investment experience (Goetzmann and Kumar  2008 ; Nicolosi et al.  2009 ; Seru et al.  2010 ), and the propensity to invest in complex financial instruments (Genesove and Mayer  2001 ; Goetzmann and Kumar  2008 ). Following this idea, Calvet et al. ( 2009 ) draw on the security accounts of a large-scale panel comprising 4.8 million Swedish households and construct an index of financial sophistication based on the sampled households’ (observable) ability to avoid poor financial decisions such as holding underdiversified portfolios, displaying inertia in risk taking, and exhibiting a disposition effect. Clearly, such an outcomes-based strategy crucially hinges on increased data availability. Nevertheless, as Hastings et al. ( 2013 ) point out, using consumers’ actual financial behavior as an indicator may be a more effective approach to predict future outcomes than the existing standard which, as described above, relies on more general proxies of financial literacy such as the Big Three .

3 Financial literacy around the world

Few studies lend themselves for an inclusion to a cross-country assessment of general financial literacy levels of consumers across different countries. Straightforwardly, a major data limitation is that we have to compare identical literacy measures that have been applied in studies carried out in many countries, ultimately leaving us with only few cross-country assessments.

3.1 Financial literacy of adult consumers

To qualify for inclusion, all studies under review with respect to financial literacy levels of adults must employ the original set of the Big Three or slight variations of it; Table  2 reports the corresponding results and provides supplementary descriptives obtained from the PHF survey. In what follows, we discuss these results in light of recent contributions to the literature as well as the various studies Hastings et al. ( 2013 ) and Lusardi and Mitchell ( 2014 ) review in their survey papers. Footnote 19

Table  2 is structured as follows. Panel A reports results for our analyses on the PHF survey. Subsequent panels document previous findings documented in the literature. Panel B (Panel C) displays results for upper-income countries (middle-income countries), Panel D provides evidence for lower-income countries, while Panel E refers to transition economies.

Generally, we document large cross-country variation in proficiency levels. As can be seen in Table  2 , the share of individuals answering all Big Three questions correctly amounts to 59% (based on the PHF data) and 53% (according to the SAVE data) of respondents. This implies that financial literacy levels documented for Germany range among the highest worldwide. Among respondents in the two transition economies Russia and Romania, by contrast, the respective numbers are as low as 4%. Moreover, while proficiency levels are relatively highest in upper-income countries (Panel B), absolute levels of financial literacy are still rather low in this group. The mean fraction of survey participants answering all Big Three questions correctly is 35% for these countries as compared to only 13% for middle-income countries (Panel C) and 4% for transition economies (Panel E). Footnote 20 When disaggregating the numbers at the level of the individual question, the tests that require knowledge about interest rates and inflation seem roughly equally difficult for survey participants. Specifically, the mean fraction of correct answers amounts to 63% for the question on interest rates and 60% for the question on inflation. Corroborating the evidence documented in the original study conducted by Lusardi and Mitchell ( 2008 ), the question on risk diversification appears to be the most difficult one. Here, on average only 46% of respondents were able to provide the correct answer.

Lusardi and Mitchell ( 2014 ) document that, despite their parsimonious design, the Big Three do a good job differentiating individual levels of financial capabilities in the population. Specifically, 34.3% of respondents of the 2004 HRS pioneer survey got all, 35.8% got two, 16.3% got one, and 9.9% got none of the questions right. Based on our evidence drawn from the German PHF data, we find that, by and large, this feature still holds. When focusing on the likelihood of answering either one of the three questions correctly, we find that 59.0% of respondents answered all Big Three questions correctly, while only 26.4% (10.0, 4.7%) got two (one, zero) questions right.

Recently, Klapper et al. ( 2015 ) provide a direct cross-country comparison of financial literacy levels by analyzing data from the Standard & Poors Ratings Services Global Financial Literacy Survey (S&P Global FinLit Survey) conducted in 2014. Footnote 21 In this survey, the four test questions introduced in Sect.  2.2 were added to the Gallup World Poll survey and answered by about 150,000 randomly selected adults (aged 15 and above) in 144 national economies either face-to-face or by telephone. The authors classify an individual as being financially literate if she answers at least three of the four test questions correctly. They also document a large heterogeneity across countries. Internationally, Australia, Canada, Denmark, Finland, Germany, Israel, the Netherlands, Norway, Sweden, and the United Kingdom host the most financially knowledgeable citizens: more than 65% of adults in these countries are classified as being financially literate. With a fraction of 71% literate citizens, Scandinavian countries lead the ranking. Germany follows suit (66%). By contrast, the percentage of financially literate adults turns out remarkably low for many countries in South America, Africa, and in South Asia. Generally, roughly only one in three adults is classified as financially literate in about half of the countries included in the survey. With a proportion of only roughly 13% financially literate adults, the Republic of Yemen as well as Afghanistan and Albania score lowest in this cross-country assessment of individual financial ability.

3.2 Financial literacy of adolescents

Unlike most other datasets discussed in this review, a comprehensive cross-country survey conducted on behalf of the OECD has recently assessed the financial capabilities of adolescents. Hence, this large-scale survey among 15-year old students administered by the OECD in 2012 extends the international evidence on financial literacy levels by studying the young, whose financial decisions are arguably most likely to have long-term consequences.

Figure  2 plots mean proficiency levels of more than 29,000 students, who are representative of as much as nine million 15-year olds in the 18 participating countries, Footnote 22 and reveals considerable variation in cross-country financial literacy levels among the young, as well.

Mean financial literacy scores, by country (PISA assessment 2012). Notes : This figure plots mean financial literacy proficiency levels of more than 29,000 students representative of as much as nine million 15-year-olds in the OECD economies Australia, Belgium (Flemish Community), Czech Republic, Estonia, France, Israel, Italy, New Zealand, Poland, Slovak Republic, Slovenia, Spain and the U.S. as well as the partner countries Colombia, Croatia, Latvia, Russia and Shanghai-China. See Sect.  3.2 for further details

As plotted in Fig.  2 , 16 out of the 18 countries under review feature financial literacy levels fairly close to the OECD normalized average of 500 points. In this group, the country-specific mean scores range between 466 (Italy) and 541 (Belgium). Footnote 23 Thus, for the vast majority of countries under review, average student proficiency levels are either in Level 2 (400 to less than 475 points) or in Level 3 (475 to less than 550 points). Importantly, the OECD defines Level 2 as an international benchmark for the lower bound of financial capabilities, i.e. marking the threshold between financial literate and financially illiterate individuals. Footnote 24 There are two outliers in this rather homogeneous picture. Students from Shanghai-China perform best with a mean score of 603, Columbian students perform poorest with a mean score of 379. Consequently, the average student from Columbia features Level 1-proficiency (326 to less than 400 points) and, according to the OECD classification, fails to meet the requirements necessary for basic financially literacy. Regarding the surveyed students’ individual proficiency, Lusardi ( 2015 ) documents that about 15% of students perform at or below Level 1-proficiency. Footnote 25

3.3 Overview of international data on financial literacy

Table  3 provides the reader with an up-to-date international overview of available surveys that have elicited financial literacy levels among their respective respondents. Panel A lists the available surveys for Germany, Panel B contains European household surveys and Panel C (Panel D) refers to surveys conducted in the U.S. (in other countries).

Besides reporting details on initiators and respondents of the different surveys, Table  3 also provides information about the test-based measurement approach applied (e.g. financial knowledge or cognition). Moreover, the table provides information on whether the Big Three questions were implemented Footnote 26 as well as if the survey has been completed in the past or features ongoing waves. Finally, we indicate whether the data obtained in the survey is publicly available for researchers.

4 Determinants of financial literacy

After having surveyed the evidence on how financial literacy is distributed across countries, we now turn to the question if there are common determinants related to peoples’ individual financial literacy levels.

4.1 Demographic characteristics

A robust finding across countries is that financial literacy levels are lowest among the young and the old (e.g., Lusardi and Mitchell 2011a , c ). Thus, we generally observe a hump-shaped distribution of financial literacy with respect to age. Low literacy among the young might be problematic since this group faces financial decisions that influence their (financial) well-being for decades to come. This is one reason why the OECD included a battery of financial literacy questions in the 2012 PISA assessment for 15-year old students as increasing financial literacy for this group seems to be particularly promising. Footnote 27 Low levels of financial literacy among the old is also problematic as individuals aged 60 and older hold about 50% of the wealth in the U.S. (Finke et al. 2016 ). With respect to cognitive changes associated with aging, Gamble et al. ( 2015 ) show that a decrease in episodic memory is associated with decreasing abilities in numeracy. In addition, a decrease in semantic memory associated with aging comes along with a decrease in financial knowledge. In consequence, a decrease in cognitive abilities is associated with decreasing financial literacy for the elderly. With respect to the magnitude of the effect of aging, Finke et al. ( 2016 ) find that financial literacy scores decline by about 1% a year for people older than 60. As already mentioned in Sect.  2.3 , there is a wide discrepancy between test-based and self-assessed financial literacy for the elderly as this group shows high levels of overconfidence: Gamble et al. ( 2015 ) and Finke et al. ( 2016 ) show that confidence in financial abilities does not decline with age, making the elderly particularly vulnerable to financial scams and fraud (Deevy et al. 2012 ). Analyzing the SAVE survey, Bucher-Koenen and Lusardi ( 2011 ) underscore this evidence for Germans. Specifically, they also document a hump-shaped distribution of financial literacy levels with respect to respondents’ age and find that the least financially literate are individuals aged 65 and above. Admittedly, however, the negative correlation between age and financial literacy documented in the above-mentioned studies might as well be interpreted as a cohort effect: for instance, older people arguably have less investing experience in the pre-401(k) era and the proportion of individuals with higher educational attainment is lower among older cohorts.

We draw on the PHF to investigate if this widely observed age-literacy-pattern continues to hold in a recent survey among German households and find that the hump-shaped relationship between respondents’ financial capabilities and their age is indeed corroborated in the PHF data. Specifically, people older than 65 score lowest, since only about 47% of this group are able to answer all Big Three tasks correctly. The second lowest percentage is documented for the group of people that are younger than 30 years old (58%). Ultimately, the cohort of Germans in their forties are found to be most financially literate (70%).

4.1.2 Gender

Another robust finding across many countries is a gender gap with respect to financial literacy (Lusardi and Mitchell 2009 ; Lusardi and Tufano 2009 , 2015 ; Lusardi et al. 2010 ; Hung et al. 2009 ; Mottola 2013 ; Bucher-Koenen et al. 2016 ; Agnew and Harrison 2015 , Klapper et al. 2015 ): men usually score higher on measured financial literacy than women. Two channels have been found to drive this result. On the one hand, women give fewer correct answers in test questions. Lusardi and Mitchell ( 2014 ), for instance, document that in the U.S. the fraction of men having all Big Three questions right is 38.3%, while the respective number for women is 22.5%. On the other hand, women seem less confident regarding their financial capabilities as they are more likely to choose the “do not know” category. According to Lusardi and Mitchell ( 2014 ) 50.0% of women in the U.S. indicate that they do not know the answer to at least one of the Big Three questions, while the respective fraction for men is 34.3%. A number of studies try to explain this finding arguing with traditional role models (Hsu 2011 ) suggesting that women only have an incentive to invest in financial literacy late in their lives (Fonseca et al. 2012 ), differing levels of confidence (Bucher-Koenen et al. 2016 ), and diverging interests in financial matters (Brown and Graf  2013 ). However, none of the approaches can entirely explain the gender gap, thus making the issue a promising avenue for further research.

Again, we use the PHF survey to investigate if the gender gap can be observed for recently collected German data, too. As can been seen in Fig.  3 b, we indeed observe a moderate, yet statistically significant gender gap in the PHF survey for Germany. The fraction of participants answering all Big Three questions correctly is 64% for male and 57% for female respondents, respectively. Note that previous evidence obtained from the 2009 wave of the SAVE survey (Bucher-Koenen and Lusardi 2011 ) documented a larger gender gap among German consumers. Specifically, the authors find that almost 60% of male respondents give correct answers to all Big Three questions as opposed to only roughly 48% of surveyed females.

Percentage providing correct answers to all Big Three questions, by demographic groups. a Financial literacy levels by age. b Financial literacy levels by gender. c Financial literacy levels by educational attainment. d Financial literacy levels by employment status. e Financial literacy levels by income. f Financial literacy levels by wealth. Notes : This figure plots the percentage of individuals surveyed in the first wave of the Panel on Household Finances (PHF) who have answered all Big Three questions correctly, sorted on respondents’ demographic characteristics (age, gender, educational attainment, employment status, income, wealth). See Sect.  4.1 for further details

4.1.3 Education

Furthermore, the majority of contributions to the literature document a positive correlation between formal education and financial literacy (Lusardi and Mitchell 2011c ; Christelis et al. 2010 ; Lusardi 2012 ). For example, Lusardi and Mitchell ( 2014 ) report that in the Netherlands 69.8% of individuals with a university degree answer all Big Three questions correctly, whereas among the least educated, the respective percentage amounts to only 28.0%. Of course, it is important to analyze whether the positive correlation might be driven by cognitive abilities of respondents rather than by formal education. However, few studies try to separate cognition from the effect of formal education. Lusardi et al. ( 2010 ), e.g., find that formal education is a relevant factor even after controlling for cognitive abilities.

Figure  3 c reports the evidence we draw from the PHF data and turns out consistent with the general finding that formal education correlates positively with financial literacy. Among those respondents featuring the highest educational attainment, an overwhelming majority of almost 90% manage to answer all Big Three questions correctly, whereas for the group of least educated individuals, the respective fraction comes to only 53%. Footnote 28 At this, the novel data we analyze broadly confirm earlier evidence for Germany provided by Bucher-Koenen and Lusardi ( 2011 ) who also document a positive relationship between education and financial literacy based on the SAVE survey.

4.1.4 Professional status, income, and wealth

Furthermore, the PHF survey collects information about participants’ professional status. Figure  3 d shows that the self-employed are significantly more likely to answer the Big Three questions correctly, a finding which has also been documented in Bucher-Koenen and Lusardi ( 2011 ). Finally, a number of contributions have found a positive association between individuals’ income and wealth levels and their levels of financial literacy (e.g., Hung et al. 2009 ; Lusardi and Tufano 2015 ; Lusardi and Mitchell 2011c ; Klapper et al. 2015 ). As can be seen in Fig.  3 e, f, we again confirm this finding for the PHF survey. With respect to income, 76% of the individuals in the highest income quintile managed to answer all Big Three questions correctly. The respective fraction for the lowest income quintile turns out significantly lower (50%). We find a similar result with respect to wealth; 73% of the individuals in the highest wealth quintile answer all Big Three questions correctly, whereas the respective fraction for the lowest wealth quintile is 51%. Footnote 29

4.2 Additional patterns

Recently, some contributions have examined the impact of peoples’ financial socialization on their financial literacy levels. For example, Grohmann et al. ( 2015 ) identify three potential channels of financial socialization: family, school and work and find that two of the three channels, i.e. family and school, indeed have a positive impact on the financial literacy of the adult subjects in their study. Regarding peoples’ family background, Lusardi et al. ( 2010 ) analyze financial literacy levels of young adults and relate them to the financial literacy levels observed for other members of the households in which they were raised. The authors document a positive correlation between financial literacy levels documented for the young adults and both financial literacy scores and educational attainment of their parents. Footnote 30 Moreover, financial behaviors of the respondents’ parents and their educational background are shown to independently influence financial literacy levels measured for their children. Finally, in a related study on the role of financial socialization, Lachance ( 2014 ) finds that even the educational attainment of respondents’ neighbors on average impacts their financial literacy levels.

5 The role of financial literacy for financial behavior

5.1 endogeneity concerns, 5.1.1 sources of endogeneity.

As mentioned above, the relevance of financial literacy crucially depends on its impact with regard to sound financial behavior. Consequently, a voluminous literature analyzes the question whether high levels of financial literacy trigger superior financial decision making. As we will review shortly, the majority of papers document a positive correlation between measures of financial literacy and sound financial behavior in various domains. Footnote 31 However, absent true randomized control experiments allowing for direct causal inference, the effect of financial literacy on the quality of individual financial decisions is difficult to pin down. Since most evidence on the impact of financial literacy stems from non-experimental research, endogeneity presents a pervasive issue which should be considered carefully when examining the role of financial literacy for financial outcomes. While endogeneity does not rule out the possibility that financial literacy improves individuals’ financial decision making per se , it complicates interpreting the magnitudes of the estimated effects as they are almost surely upwardly biased in magnitude (Hastings et al.  2013 ).

What causes endogeneity and how does it impact inference? Omitted variables are one of the three sources of endogeneity and refer to those explanatory variables that should be included in the model but in fact are not. If the positive correlation between financial literacy and good financial decisions observed in a given setting likely owes to some underlying third factor which contributes to both higher levels of financial literacy and better financial outcomes, endogeneity enters the model by way of one or more omitted variables. In statistical terms, the inability to explicitly include these determinants in the regression equation means that instead of appearing among the explanatory variables, the impact of these omitted variables appears in the error term, thus distorting estimators and making reliable inference virtually impossible.

Indeed, financial literacy might not be distributed randomly and those individuals exhibiting high levels of financial literacy might share certain characteristics like superior numerical abilities, intelligence, motivation to deal with personal finances, or patience. The literature documents several instances of such hard-to-capture factors likely to influence both financial literacy and financial behavior. Meier and Sprenger ( 2010 ) show that those who voluntarily participate in financial education programs are more future-oriented. Hastings and Mitchell ( 2011 ) find that those who show patience in an experiment also have a higher propensity to save additional amounts for retirement in their pension accounts. In the same vein, Bucher-Koenen and Lusardi ( 2011 ) hypothesize that there might exist an omitted variable bias stemming from missing information on individuals’ ability or motivation to deal with financial matters.

Additionally, a positive correlation between financial literacy and sound financial decision making could stem from reverse causality. Specifically, does financial literacy improve financial behavior or does being involved in certain financial activities instead lead to greater financial literacy? Again, the literature provides a number of examples of potential endogeneity due to a reverse causation channel. Disney et al. ( 2015 ) investigate the effect of financial literacy on the decision to seek credit counseling and argue that financial literacy may develop endogenously with the receipt of credit counseling. Bucher-Koenen and Lusardi ( 2011 ) hypothesize that individuals with higher levels of financial literacy might better recognize the need and the financial benefits of saving for retirement and thus be more inclined to enroll in a savings plan. They acknowledge, however, that it may as well be retirement planning which affects financial literacy rather than the other way around: Those who have planned for retirement have acquired some level of financial literacy simply by virtue of their savings plan participation. Likewise, the finding of Hilgert et al. ( 2003 ) that most individuals cite personal experience as the most important source of their financial learning suggests that some element of reverse causality is likely.

Finally, endogeneity may also arise from measurement error when it comes to the financial literacy variables, e.g. the possibility that answers to test-based financial literacy measures might not measure “true” financial knowledge. As mentioned above, Lusardi and Mitchell ( 2009 ), for instance, show that the Big Three are sensitive to framing, i.e. implying that some answers judged to be “correct” are likely attributable to guessing rather than skill.

5.1.2 Towards a causal interpretation of the effect of financial literacy on financial behavior

The standard approach to address endogeneity is finding an instrumental variable (IV) for the endogenous regressor and use this IV in a two-stage least squares (2SLS) regression in order to produce consistent parameter estimates. Generally, a clear understanding of the economics governing the question of interest is key to identifying a valid instrument. A good example of instrument choice is given in van Rooij et al. ( 2011b ) who document a positive relationship between stock market participation and financial literacy which is not only consistent with financially savvy investors having knowledge about expected excess returns of stocks, but also with shareholders learning from their investment experience. Footnote 32 To establish causality, the authors resort to IV estimation and instrument financial literacy with information regarding the personal finances of their siblings and parents, respectively. Specifically, they asked respondents whether the financial situation of their oldest sibling is either worse or the same or better than their own financial situation and also collected information on how they assess the level of financial knowledge of their parents. Why do these items make particularly good IVs? For one, these instruments for financial literacy are exogenous with respect to respondents’ stock market participation since, arguably, the financial experience of others is beyond their control. At the same time, however, respondents likely learn from their families, thereby increasing their own literacy. Footnote 33 Hence, the instruments affect the outcome (the respondent’s propensity to participate in the stock market) only via their effect on the endogenous variable (the respondent’s financial literacy level), i.e. satisfy both the relevance and the exclusion condition required to hold for a valid IV.

Observational studies using carefully chosen IVs are sometimes regarded as being equivalent to quasi experiments regarding their power to support causal claims (Angrist and Krueger 2001 ). However, a few general comments are in order when discussing the IV regression approach. First, since the error term is unobservable, one cannot empirically test the exclusion condition, i.e. whether or not an instrument is correlated with the regression error term. Consequently, there is no way to statistically ensure that an endogeneity problem has been solved. Moreover, Roberts and Whited ( 2013 ) stress that truly exogenous instruments are difficult to find and, in particular, that it should be rigorous economic arguments rather than formal falsification tests that eventually decide over the instrument’s validity.

5.1.3 Is there an endogeneity bias in the effect of financial literacy on financial behavior?

Evidence on the question of whether or not there is an endogeneity bias caused by omitted variables, reverse causality, or measurement error in studies examining links between measured financial literacy and financial behavior is rather inconsistent. In their review of 11 studies estimating both OLS and IV specifications from their data, Lusardi and Mitchell ( 2014 ) find that the IV financial literacy estimates always prove to be larger than the ordinary least squares estimates and conclude that, if anything, non-instrumented estimates of financial literacy underestimate the true effect. This evidence is a strong case for substantial measurement error biasing the OLS estimates, since the magnitude of the coefficients should be upwardly biased if omitted variables and reverse causality were the only sources of endogeneity. By contrast, Fernandes et al. ( 2014 ), who conduct a meta-analysis of the relationship between financial literacy and financial outcomes and—unlike Lusardi and Mitchell ( 2014 )—consider standardized coefficients, find significantly smaller effects for 24 studies using both instrumental variables and OLS estimation lacking those controls. They conjecture that non-instrumented regression models in fact overestimate the effect of financial literacy, which reflects endogeneity bias predominantly owing to omitted variables and reverse causality in the OLS designs. Additionally, they test the proposition that designs using instruments for financial literacy and 2SLS are similar to quasi experiments with regards to their ability to support causal inferences—in which case effect sizes should be comparable to what one finds in intervention studies that manipulate financial literacy by means of providing financial education to the treatment group. However, rejecting this claim, they find that intervention studies on average show much smaller effects than econometric studies with instrumental variables and question the validity of instruments used for financial literacy in the studies they review in their meta-analysis. Based on these findings, the authors conclude that past work supporting a causal role for financial literacy might need revisiting on methodological grounds.

Taken together, both the relevance of endogeneity concerns and the tools to remedy potential endogeneity bias are discussed rather controversially in the literature. Outside of controlled experiments, there is no way to ensure that endogeneity problems are eliminated or sufficiently mitigated to allow for reliable causal inferences. Thus, addressing endogeneity concerns by way of IVs should always rest on the strength of the researcher’s arguments supporting the identification strategy.

In what follows, we survey the literature on the impact of financial literacy on financial decision making in various different domains. While we will not explicitly discuss potential endogeneity concerns in the contributions under review, the reader should keep in mind that these issues might still apply.

5.2 Savings and investment decisions

5.2.1 retirement planning.

With respect to investment and savings decisions, arguably most research has been conducted on whether financial sophistication has a positive impact on retirement planning (e.g., Lusardi and Mitchell 2007 , 2008 ; van Rooij et al. 2011a ). Analyzing German survey data, Bucher-Koenen and Lusardi ( 2011 ) provide evidence for a strong correlation between financial literacy and retirement planning. Regarding the Big Three , the authors show that about 70% of the households who have planned for retirement give correct answers to all Big Three questions, whereas the respective fraction is only 54% for non-planners. Studies analyzing financial behavior in the U.S. also find that individuals with low levels of financial literacy are less likely to plan for their retirement (e.g., Lusardi and Mitchell 2007 , 2011b ). In a recent study, Clark et al. ( 2015 ), using a dataset that links administrative data on investment success with financial literacy, document a positive relationship between individuals’ financial literacy and their propensity to participate in a 401(k) plan as well as the profitability of the respective investments. A related strand of literature has also documented a positive relation between financial literacy and savings behavior (e.g., Lusardi and Mitchell 2011c ; Chan and Stevens 2008 ; Behrman et al. 2012 ), i.e. providing additional evidence that financially literate individuals exhibit a greater tendency to plan ahead.

5.2.2 Stock market participation

Another robust finding in the literature is a positive correlation between stock market participation and financial literacy (e.g., Kimball and Shumway 2006 ; Christelis et al. 2010 ; van Rooij et al. 2011b ; Balloch et al. 2015 ; Clark et al. 2015 ). Specifically, van Rooij et al. ( 2011b ) document that financial sophistication is positively related to stock market participation of retail investors in the Netherlands. Analyzing U.S. survey data, Yoong ( 2011 ) confirms that financially sophisticated individuals are more likely to hold stocks and mutual funds. In a related study among retail investors in the U.S., Balloch et al. ( 2015 ) find that, besides trust, stock market literacy positively correlates with their likelihood of stock market participation. In addition, they show a positive association between financial sophistication and the conditional magnitude of investing in stocks for those households who do hold stocks in their portfolios. Finally, Jappelli and Padula ( 2015 ) present an intertemporal choice model in which individuals can invest in financial literacy. Drawing on cross-country data, the authors find empirical support for the model’s main prediction, i.e. that stock market participation and financial literacy are positively correlated.

5.2.3 Investment choices

A related strand of literature analyzes the association between financial literacy and trading behavior (e.g., Feng and Seasholes 2005 ; Bilias et al. 2010 ; Hoffmann et al. 2013 ; Bucher-Koenen and Ziegelmeyer 2014 ; Guiso and Viviano 2015 ) and the corresponding studies generally document a positive impact of financial literacy as financially sophisticated investors tend to commit less investment mistakes. Footnote 34 In a recent contribution, Bucher-Koenen and Ziegelmeyer ( 2014 ) use the financial crisis as a natural experiment to examine individual investors’ ability to cope with sudden economic shocks and document that low literate households are significantly more likely to sell off assets that have lost in value, thereby making paper losses permanent. Shunning stock markets altogether is also associated with a decrease in expected returns on investments (Bucher-Koenen and Ziegelmeyer 2014 ). Other research in the field has documented that financial literacy is associated with smart choices when it comes to the selection of financial products. Müller and Weber ( 2010 ), for instance, investigate the role of financial literacy for mutual fund selection and show that financially sophisticated German retail investors pay lower front-end loads, are less biased in their past return estimates, and are more likely to correctly assess the risk profile of their fund investments. In a related laboratory study, Choi et al. ( 2009 ) show that many U.S. investors—even those with high self-assessed financial literacy levels—fail to choose a fee minimizing portfolio even in a setting where fees are the only relevant distinguishing characteristic of the investments and differences in fees are considerable. Moreover, a number of studies has documented a positive link between financial literacy and portfolio diversification: highly literate investors tend to manage their risks significantly better than the group of low literate individuals (e.g., Calvet et al. 2007 ; Goetzmann and Kumar 2008 ; Guiso and Jappelli 2008 ; von Gaudecker 2015 ; Clark et al. 2015 ).

5.2.4 Investment performance

The literature also documents a positive link between financial literacy and sound investment decisions. Calvet et al. ( 2007 , 2009 ) show for investors in Sweden a positive correlation between financial sophistication and account performance and conclude that richer and financially more sophisticated individuals invest more efficiently. Likewise, Clark et al. ( 2015 ) document a positive correlation between financial sophistication and excess stock returns among U.S. individuals, while von Gaudecker ( 2015 ) finds that this group of retail investors is more likely to hold well-diversified portfolios. Deuflhard et al. ( 2014 ) analyze interest rate levels for savings accounts of Dutch consumers. They find that financial literacy is positively associated with higher returns on these accounts. By contrast, Bodnaruk and Simonov ( 2015 ) provide evidence against the common finding of a positive relation between financial sophistication and investment performance. In particular, the authors have access to the private portfolios of Swedish mutual fund managers—arguably highly sophisticated market participants—and show that this unique group of individual investors neither outperform, nor diversify their risks more effectively as compared to similar investors in terms of age, gender, education, income, and wealth.

5.2.5 Additional evidence

Finally, the literature documents a positive role of financial capabilities in a variety of other domains. For example, Shen et al. ( 2016 ) document for Taiwan that individuals with higher levels of financial literacy are less likely to engage in financial disputes. Banks et al. ( 2015 ) find for the U.K. that financial literacy and numeracy are significantly positively related to individuals’ propensity to shop around for an annuity when receiving funds from their defined contribution pensions. In an early contribution to the literature, Hilgert et al. ( 2003 ) find a strong correlation between financial sophistication and day-to-day financial management skills such as cash-flow and credit management. Finally, de Bassa Scheresberg ( 2013 ) documents a positive relation between consumers’ financial literacy and their individual likelihood to hold precautionary savings.

5.3 Financing decisions

5.3.1 high-cost borrowing.

Compared to the large body of literature linking financial literacy to saving and investment decisions, evidence on the role of consumers’ financial capabilities for their financing behavior is scarce. Not surprisingly, the literature typically documents a negative correlation between financial literacy and mistakes in financing decisions: the less financially literate individuals are, the more likely they are to make poor financing decisions. Most prominently, there is solid evidence that low levels of financial literacy are associated with high-cost borrowing and suboptimal mortgage choices (e.g., Moore 2003 ; Lusardi and Tufano 2015 ; Lusardi and de Bassa Scheresberg 2013 ; Disney and Gathergood 2013 ). Lusardi and Tufano ( 2015 ) show for the U.S. that individuals exhibiting low levels of financial literacy use high-cost borrowing and pay higher transaction costs and fees. Lusardi and de Bassa Scheresberg ( 2013 ) also examine high-cost borrowing in the U.S., including payday loans, pawn shops and auto title insurance. They also confirm that low literate individuals are substantially exposed to high-cost methods of borrowing. Disney and Gathergood ( 2013 ) confirm this finding for the U.K. by showing that low levels of financial literacy are associated with an excessive use of high-cost credit like payday loans or mail order catalogue debt.

5.3.2 Costly credit card practices and excessive debt accumulation

Other recent studies document that individuals with low levels of financial literacy are significantly less likely to use their credit cards efficiently (e.g., Lusardi and Tufano 2015 ; Mottola 2013 ; Allgood and Walstad 2013 ). Analyzing U.S. adults, Allgood and Walstad ( 2013 ) find a robust negative relation between financial literacy and costly credit card practices. The authors also show that the influence of self-assessed financial literacy on costly credit card practices is greater than that of test-based financial literacy, providing evidence that the two concepts are distinct from each other. Footnote 35 Analyzing the same dataset, Mottola ( 2013 ) also confirms that the financially literate respondents are less often found to exhibit costly credit card behaviors such as being charged a late fee for late payment or not paying down credit card debt in full. In addition, some studies show that a lack of financial literacy is associated with excessive debt accumulation (e.g., Stango and Zinman 2009 ; Lusardi and Tufano 2015 ). Analyzing U.S. consumers, Lusardi and Tufano ( 2015 ) show that the least sophisticated with respect to debt literacy are exposed to excessive debt loads and the authors also find that this group is not able to judge their debt positions. Finally, Gerardi et al. ( 2013 ) find that numerical abilities—a skill set which is positively associated with financial sophistication—are strongly negatively correlated with mortgage defaults.

6 Towards improved financial decision making

6.1 financial education, 6.1.1 the case for financial education.

The arguments in favor of financial education are straightforward. Common sense suggests that introducing financial education initiatives will increase financial literacy, and improved financial literacy, in turn, relates to better financial decision making (Alsemgeest 2015 ). Accordingly, governments around the world have identified financial education as an intuitive remedy in order to help individuals mastering their personal financial affairs (Fernandes et al. 2014 ; Willis 2011 ). For example, policy makers in the U.S. have embraced financial literacy as a means to avoid poor financial decision making and launched a number of financial education initiatives in the wake of the financial crisis. Most prominently, the Office for Financial Education, a subdivision of the Consumer Financial Protection Bureau (CFPB) which was established in the wake of the financial crisis, has an explicit mandate to develop a strategy to increase the financial literacy of U.S. consumers as well as to make recommendations for the launch of programs to improve financial education outcomes.

Although great effort is put in financial education, the question whether educating individuals in the financial domain is beneficial remains controversial both from a theoretical and an empirical perspective. Accordingly, Willis ( 2008 , 2011 ) provides a number of arguments against financial education. First, she questions whether financial literacy programs can improve consumers’ financial knowledge to an extent that truly qualifies them for the complexity of novel financial products. In particular, she suggests that “the predicate belief in the effectiveness of financial literacy education lacks empirical support. Moreover, the belief is implausible, given the velocity of change in the financial marketplace, the gulf between current consumer skills and those needed to understand today’s complex nonstandardized financial products, the persistence of biases in financial decision making, and the disparity between educators and financial - services firms in resources with which to reach consumers.” (p. 197). Second, she is concerned that individuals’ perceived confidence might increase due to financial education while their actual abilities have not significantly improved which might lead to even poorer financial decision making. Third, she suspects financial education to weaken the position of consumers as related initiatives might come along with a “regulation-through-education model” which blames individuals for bad financial outcomes and thus prevents effective market regulation (Willis 2008 ). Finally, she pledges for a division of labor as consumers usually do not serve as their own doctors and lawyers and, following this notion, should not serve as their own financial experts, either.

6.1.2 Selected financial education initiatives and the costs of financial education

Although the systematic conceptualization of financial literacy is a rather recent development, financial education programs have a long tradition, at least in the U.S. These programs have been initiated by either policymakers, the financial services industry, employees, or nonprofit organizations. Footnote 36 Hastings et al. ( 2013 ) report that financial education interventions in the U.S. date back as long as to the 1950s. Tang and Peter ( 2015 ) document that the number of U.S. states in which a personal finance course is required for high school graduation has risen from 13 in 2009 to 17 in 2013, thus highlighting the increased relevance of the topic. The authors also report that the financial services industry is very active in encouraging financial education as, e.g., 98% of U.S. community banks sponsor financial literacy programs and 72% provide an individual program for customers.

Table  4 provides a list of selected financial education programs and we include this list for scholars interested in researching specific programs with respect to their effectiveness. We compiled the list of initiatives by searching the literature on financial education programs and by searching the web for respective keywords. Since we cannot do justice to the large number of financial education programs initiated around the world, we focus on initiatives carried out in German-speaking countries (Panel A) and extend this sample by selected programs in other countries arguably most relevant for previous research on financial literacy (Panel B).

As can be inferred from the table, the initiatives differ in terms of the initiator (e.g. banks, endowments, supranational organizations), the target group (e.g. adults, teenagers, low-income individuals), the educational approach (e.g. in-class teaching or online courses), the intensity of the intervention, and, finally, whether the effectiveness of the respective program has received an academic evaluation.

In what follows, we will review the literature assessing the effectiveness of the different financial education programs. Clearly, the implementation of such programs comes at a cost and, furthermore, their specific content might be biased by initiators’ incentives as well as political agendas. With regard to costs, Fernandes et al. ( 2014 ) highlight that educational interventions are not only associated with real costs but might create much larger opportunity costs. Taking high school education as an example, introducing personal finance courses is most likely associated with replacing other important elective courses. With respect to politically differing views of the world, left-wing governments might want to implement other curricula as opposed to right-wing or market-liberal governments. As far as the financial education initiatives of the financial services industry are concerned, these programs will most likely omit important topics like, e.g., fees. So, these programs would hardly teach participants to buy index funds instead of actively managed funds although refraining from actively managed funds is generally regarded as good financial behavior.

6.1.3 The effectiveness of financial education programs

A voluminous literature evaluates the association of financial education and test-based financial literacy (e.g., Mandell 2008 ; Walstad et al. 2010 ; Heinberg et al. 2010 ; Lührmann et al. 2015 ) as well as financial behavior (e.g., Bernheim et al. 2001 ; Servon and Kaestner  2008 ; Clark et al. 2015 ; Lührmann et al. 2015 ). The literature usually approaches the topic as follows: A particular financial education intervention is analyzed with respect to its impact on measured financial literacy and—in most assessments—on financial behavior. One way to elicit potential changes in financial literacy levels involves measuring test-based literacy scores prior to educating subjects about the financial matters of interest and at some point in time after they have received the respective manipulation (e.g., Walstad et al. 2010 ). Alternatively, the financial literacy scores of a treatment and a control group are contrasted after a given educational intervention (e.g., Lührmann et al. 2015 ). The effectiveness of the programs is usually measured by tracking self-reported financial behavior of the participants which is elicited by means of a questionnaire (e.g., Lusardi and Mitchell 2007 ; Bell et al. 2009 ; Lührmann et al. 2015 ).

Fernandes et al. ( 2014 ) have recently conducted a meta-analysis in which they include the entire universe of published and unpublished studies on financial education interventions and standardize effect sizes reported in the original studies when aggregating the respective findings. Thus, the conclusions derived from this meta-analysis are arguably less prone to criticism on methodological grounds. The authors evaluate as much as 90 studies in which a financial education intervention has been examined and conclude that, on aggregate, financial education interventions explain no more than 0.1% of the variance in financial behavior. Moreover, they confirm prior findings showing that the already small effects of financial education initiatives tend to decline over time. Specifically, they show that even large interventions have only little impact when financial decisions are made 20 months or later after the subject has received a financial education unit. Taken together, Fernandes et al. ( 2014 ) confirm—on more solid empirical grounds—the conclusions drawn in earlier studies which survey the literature on financial education (Hastings et al.  2013 ; Hung et al.  2009 ), i.e. a lack of conclusive evidence as to whether a positive impact of financial education can be observed for consumers’ financial behavior. Recently, Lührmann et al. ( 2015 ) extend the literature by an assessment of the effectiveness of a financial education program carried out among German high school students ( My Finance Coach ) and generally find a positive impact of that intervention on students’ financial knowledge. With respect to financial behavior, the evidence depends on the different financial domains examined. While students participating in the program on average exhibit a higher propensity to suppress impulsive purchases, the authors do not find evidence of a significant increase with regard to savings.

6.1.4 Reasons for ineffectiveness and potential remedies

Fernandes et al. ( 2014 ) highlight that their findings should not be interpreted as evidence against the usefulness of financial education since a large number of financial education programs has never been evaluated and non-assessed initiatives obviously did not enter the sample. A number of reasons for the rather surprising finding of little effectiveness of educational interventions have been discussed in the literature. First, Fernandes et al. ( 2014 ) as well as Lusardi and Mitchell ( 2014 ), question the quality and motivation of teachers with respect to personal finance issues. As such, Way and Holden ( 2009 ), for example, find that less than 20% of high school teachers felt well prepared to teach personal finance topics. Moreover, individuals are heterogeneous in various dimensions. Lusardi and Mitchell ( 2013 ) show in a theoretical model that due to this heterogeneity, not everyone should change its behavior after receiving standardized financial training.

Moreover, while the average impact of financial education may be low, the literature has identified several circumstances in which an intervention might be promising. Lusardi and Mitchell ( 2014 ), in their review of related research, claim that financial education programs have to be targeted to specific groups in order to incorporate the heterogeneity of individuals. For example, the authors argue that females are ideal targets for specific financial literacy programs, since—other than the average male subject—they are aware of their low financial literacy levels. In their meta-analysis, Fernandes et al. ( 2014 ) have identified future directions for designing more successful programs. Specifically, they suggest that improving individuals’ soft skills—e.g. their confidence to be proactive and their willingness to take investment risks—is likely more promising than teaching financial knowledge about, e.g., compound interest. In addition, since the authors find that the effect of financial education declines over time, promising programs should be designed as just - in - time interventions tied to a particular decision. In a recent study, Goedde-Menke et al. ( 2017 ) even suggest that one potential explanation for why financial literacy programs are mostly ineffective is the very fact that being financially literate is typically equated with having specific financial knowledge rather than having a basic understanding of fundamental economic concepts. In their study among German adolescents, the authors document that basic economic skills beneficially relate to both individual debt attitudes and behaviors while financial literacy levels turn out to be insignificant. Accordingly, they conclude that a stronger consideration of fundamental economic concepts in financial literacy programs might be a fruitful way to increase their effectiveness.

6.2 Financial advice as a substitute for financial literacy?

6.2.1 financial advice versus financial education.

While financial education programs have enjoyed strong political support as a means to address poor financial decision-making, Willis ( 2011 ) stresses that, besides the fact that they are unable to turn everyone into a financial expert, this should not be the path to take for reasons of efficient division of labor alone (see Sect.  6.1 ). Thus, instead of trying to educate inexperienced individuals, an alternative way to enhance the quality of their decisions on a market for financial services and products characterized by a growing complexity might be to delegate the job by relying on the services offered by professional financial advisors. Footnote 37 Indeed, a large proportion of households seek expert advice when making financial decisions. Bluethgen et al. ( 2008 ) indicate that roughly 80% of individual investors in Germany turn to financial advisors for their investment decisions. In the U.S., 81% of the households investing in mutual funds, outside a retirement plan, rely on financial advice (ICI 2007 ), and 75% of them seek advice before conducting stock market or mutual fund transactions (Hung and Yoong  2010 ).

However, the potential benefits of financial advice hinge on two important conditions. First, the advice itself must be accurate, suitable, and consistent with the client’s goals. Whether financial expert intervention indeed benefits consumers remains controversial, though. While some studies concerned with household finance suggest that financial counseling can help individuals develop better financial practices and reduce their debt levels and delinquency rates (Collins and O’Rouke  2010 ; Agarwal et al.  2011 ), the evidence as to whether individuals’ investment decisions benefit from expert financial advice is rather mixed. It could be shown that professionally-managed portfolios are better diversified (Bluethgen et al.  2008 ; Gerhardt and Hackethal  2009 ) and exhibit weaker disposition effects (Shapira and Venezia  2001 ) than portfolios of self-directed retail investors. Yet, a number of contributions in the field find that advised accounts are on average associated with higher costs, lower returns and inferior risk-return tradeoffs (Bergstresser et al. 2009 ; Hackethal et al. 2012 ; Kramer 2012 ) and conclude that advisors do not add value through their investment recommendations when judged relative to passive investment benchmarks (Foerster et al.  2014 ). Also, while there is some consensus that advice can improve retail investor portfolio decisions if conflicts of interest are mitigated (Bhattacharya et al. 2012 ; Hung and Yoong 2010 ), a typical advisor’s incentive structure does in fact create a conflict of interest, leading advisors to reinforce biases of their clients instead of correcting them (Mullainathan et al. 2012 ) and tilt their recommendations towards costly transactions (Hoechle et al.  2015 ).

Notably, however, while the German government has done little to improve consumers’ financial literacy by means of financial education initiatives, addressing the supply-side issues of retail financial markets has been the top priority of German regulatory authorities in recent years. With respect to financial advice, for instance, regulators now require banks to ask their clients for their prior investment experience before advising them on risky financial products. Moreover, financial advisors are required to assess the risk propensity of their clients before they are allowed to provide them with recommendations. Additionally, banks are obliged to provide advisees with product information sheets disclosing arguably decision-relevant characteristics of financial products. Finally, regulators require advisors to prepare a detailed transcript of each client meeting which has to be authorized by the advisee. The rationale behind these regulations is that the reasons which prevent people from benefiting from financial advice are essentially rooted in the supply side and increasing access to neutral advice should solve the problem of poor financial decision-making. Similarly, regulatory authorities in the Netherlands and in the U.K. have recently enforced a new legislation prohibiting commissions for brokers and advisors altogether. Taken together, we state that regulators in Germany and elsewhere in the world have implemented a number of different measures banning incentives for biased financial advice. In what follows, we thus do not focus on potential conflicts of interest with respect to financial advice.

6.2.2 Financial literacy and the demand for financial advice

A second condition which must hold for professional financial advice to be able to substitute for financial literacy, is that low literate individuals must of course seek the support of professional advisors in the first place. Otherwise, measures imposed by regulators to protect consumers arguably will not benefit those who need them most. Thus, knowledge about how financial literacy relates to the demand for financial advice has recently received increasing attention among academics and policymakers.

The notion that financial advice can substitute for low levels of financial literacy rests on the assumption that less knowledgeable individuals face higher hurdles with regards to the collection and processing of information and thus save more on information and search costs when turning to an advisor. Moreover, low literate households may be less aware of potential conflicts of interest arising from advisors’ typical incentive structures and hence more willing to assign an advisor with planning their personal finances (Inderst and Ottaviani  2009 ). Georgarakos and Inderst ( 2011 ) sketch an analytical framework of individual behavior in the context of financial advice using a “cheap-talk”-game in which uninformed investors must decide whether or not to trust the advice they receive whereas informed advisors can opt to ignore the advice. Thus, in their model, consumer information and financial advice are substitutes. Using a large-scale survey among households in 15 EU countries, the authors empirically confirm that trust only matters for the less literate consumers. Similarly, Disney et al. ( 2015 ) recently analyze the decision of indebted consumers in the U.K. to ask for financial advice in the form of credit counseling and conclude that professional counseling substitutes for financial literacy: answering an additional financial literacy question correctly reduces the likelihood of an individual seeking assistance by roughly 60%. As can be seen from Table  5 , which provides a summary of the empirical evidence regarding the link between financial literacy and advice-seeking, other studies also provide evidence pointing to a negative relationship between financial literacy and the demand for expert financial advice. In the U.S., Hung and Yoong ( 2010 ) conduct an experiment among defined-contribution plan holders in the RAND American Life Panel and show that the least sophisticated were most likely to take advice, and Chalmers and Reuter ( 2012 ), applying a demographics-based financial literacy proxy, find that younger, less highly educated, and less well-paid (i.e. on average less financially sophisticated) university employees are more likely to demand financial advice on defined-contribution retirement planning.

However, a growing number of studies in the field challenge the negative relationship between peoples’ knowledge in financial matters and their propensity to seek expert assistance and instead point to a complementarity between financial literacy and financial advice. Bucher-Koenen and Koenen ( 2015 ) present a model in which advisors have an incentive to provide better advice to consumers who they perceive to be better informed, thus pointing to the fact that financial literacy and the quality of financial advice are complements rather than substitutes. In their analytical framework, it is assumed that advisees with better financial knowledge more likely understand the advice they obtain. This in turn provides the advisor with more incentives to develop sound recommendations for the financially sophisticated investors. Drawing on the 2008 and 2009 waves of the German SAVE household survey, the authors find that smarter investors indeed receive better advice, thus confirming their model predictions. In a related study, Bhattacharya et al. ( 2012 ) find that those customers of a German online broker who opted to obtain financial advice in a field study were among the most financially literate clients, and Hackethal et al. ( 2012 ) show that advisors of a large German retail bank are matched with wealthier and older investors (proxied to be more financially sophisticated), which also points to a complementarity of financial literacy and financial advice. The authors interpret their findings with respect to both the demand-side and the supply-side of advice. On the one hand, higher opportunity costs of time may induce wealthier clients to make use of financial advice, although they are relatively better prepared to perform the task themselves. On the other hand, financial advisors with commission-based compensation systems should have an incentive to prefer clients with substantial amounts of assets who are more likely to generate significant trading fees.

Empirical evidence indicating that professional financial advice serves as a complement rather than a substitute for financial literacy is not limited to the German market, though. In the US, Collins ( 2012 ) uses data from the 2009 FINRA Financial Capability Survey and finds that individuals with higher incomes, higher educational attainment, and higher levels of financial literacy are most likely to receive financial advice. Similarly, Finke ( 2013 ) draws on the 2008 wave of the National Longitudinal Survey and documents that financial sophistication increases the demand for financial advice: those individuals most likely to seek advice are not those who are most prone to make financial mistakes. Corroborating this empirical evidence, van Rooij et al. ( 2011b ) exploit the Dutch Household Survey (DHS) and show that people who are less financially literate rely more on informal sources of financial advice, such as friends and family.

Finally, the finding that low literate individuals rely less on expert advice also ties in with psychological evidence, which challenges the notion that people are sophisticated enough to turn to advice in order to overcome their own lack of financial capability. By contrast, this literature suggests that individuals who do not know much about a subject tend not to recognize their ignorance and therefore typically fail to seek better information (Kruger and Dunning  1999 ).

6.2.3 Test-based versus self-assessed financial literacy and the role of overconfidence in seeking financial advice

In a recent contribution, Kramer ( 2014 ) suggests that the ambiguous results as to the role of financial knowledge for advice-seeking may at least partly be explained by the different approaches that have been employed to elicit financial literacy. He concludes that studies using self-assessed financial literacy typically find a negative relationship with demanding advice, while those that rely on test-based financial literacy report a positive or insignificant relationship. This discrepancy between the role of self-assessed versus test-based financial literacy implies a role for overconfidence as proposed in the model of Guiso and Jappelli ( 2006 ) in which overconfident investors are less willing to rely on information provided by financial advisors, banks or brokers and more likely to collect information directly because they perceive their self-collected information to be of better quality than it actually is. Using the DHS survey data, Kramer ( 2014 ) explicitly differentiates between self-reported and objectively elicited financial literacy and shows that confidence in one’s own knowledge is negatively related to asking for help, while actual expertise is not significantly associated with seeking professional financial advice. This finding is confirmed in another recent study based on the DHS data, which analyzes the role of financial literacy and financial advice for households’ portfolio diversification and does not find a significant association between financial literacy and the likelihood of turning to financial advice (von Gaudecker  2015 ). However, most losses from insufficient diversification are spotted among overconfident investors, which neither are financially literate nor consult with financial advisors.

6.2.4 How does financial literacy relate to the propensity to follow advice?

While seeking financial advice is an important step for the low literate in order to arrive at more informed decisions, one would also like to know if they choose to follow the advice they receive in order to properly assess the potential of professional advice as a substitute for financial literacy. Clearly, financial advice does not translate into sound financial decisions if individuals do not act on the recommendations of their advisors. Surprisingly, however, the question of whether advisees in fact implement the advice they receive is still largely unanswered and very few contributions have considered the role of financial literacy when it comes to following expert advice. The rightmost column of Table  5 summarizes the empirical evidence pertaining to this link.

Calcagno and Monticone ( 2015 ) present a stylized model of strategic interaction between advisees and better informed advisors with conflicts of interest. Unlike previous research, however, the authors allow for different degrees of interaction intensity ranging from consulting the advisor in order to enhance one’s information set to completely delegating all decisions to her. Consistent with the framework of Bucher-Koenen and Koenen ( 2015 ), the model predicts that the more financially sophisticated are more likely to consult with financial advisors because they anticipate that they will receive valuable information from their advisors. However, once low literate individuals decide to seek the help of financial experts, they are more likely to delegate the decision-making entirely to the advisor. Using data from a survey among the retail customers of Italy’s largest bank, the authors empirically confirm the model predictions showing that financial literacy indeed appears to play a role when it comes to how people implement the advice which they receive from their advisors.

Several studies drawing on German data corroborate the negative relationship between financial literacy and the propensity to follow financial advice. Hackethal et al. ( 2011 ), who study the trading behavior of advised retail clients using data from German brokerage accounts, find that they are less likely to implement the advice given to them when their financial sophistication is higher. Bucher-Koenen and Koenen ( 2015 ) also document a negative relationship between financial knowledge and advisees’ self-reported propensity to follow advisors’ recommendations. Finally, Stolper ( 2016 ) directly matches the recommendations of financial advisors at a German advisory firm with their clients’ post-advice account activity and find that the degree of following the advice is highest for those exhibiting the lowest levels of financial literacy.

6.2.5 Discussion

To rationalize the ambiguous impact of financial literacy on the use of financial advice, it is argued in the literature that financial sophistication carries two dimensions, i.e. the ability to understand advice on the one hand, and the literacy to question it as well as to process information privately (a possibility which Bucher-Koenen and Koenen  2015 , refer to as outside option ), on the other hand. While the skills to understand the advice increase the propensity of demanding it, the competence to challenge the advice, along with the ability to collect and handle private information, reduces the likelihood of following it. This is because the financially sophisticated advisee understands the advice and only opts to follow it if she prefers the recommendations to searching on her own, while she ignores it otherwise.

To conclude, the evidence on whether financial advice can be considered a substitute for financial literacy is inconsistent. While some studies document the required negative relationship between the two potential channels to improve financial decision-making, several studies challenge this view by showing that those who would benefit the most from advice are least likely to seek it. Once the advice has been obtained, however, recent contributions to the literature suggest that it is indeed the low literate who are most likely to follow it.

7 Conclusion

7.1 summary.

We review the literature on the rapidly evolving field of financial literacy. Interestingly, although the topic has become an important field in academia and also attracts the attention of policymakers around the globe, a universally accepted definition of the term has not yet been offered. Consequently, it comes to no surprise that there is no common operationalization, either. Instead, various measures for financial literacy have been developed, mostly based on a set of questions included in household surveys. Initially proposed as a starting point to measure financial literacy, Lusardi and Mitchell ( 2008 ) have developed a parsimonious set of three questions related to financial literacy which have now become known as the Big Three . By now, these questions have become the gold standard in measuring individuals’ financial knowledge and abilities and have been incorporated in many household surveys around the world, including the novel PHF survey for Germany.

Focusing on the empirical evidence regarding the Big Three questions, we document that the level of financial literacy is generally rather low and we also find substantial differences between national economies and demographic cohorts. In particular, financial literacy turns out to be considerably lower in transition economies and lower-income economies as compared to industrial economies, a finding which is also corroborated in the recently conducted Standard and Poors FinLit Survey (Klapper et al. 2015 ). According to Klapper et al. ( 2015 ) as well as our analyses of the data provided by the PHF survey, financial literacy levels of German citizens are among the highest in the world. However, even in Germany almost half of the survey participants are not able to answer all Big Three questions correctly, leaving room for substantial improvements of financial literacy. In addition, in Germany and elsewhere, the elderly and the young as well as the least educated and lowest-income individuals possess particularly low literacy levels. These groups have the highest propensity to commit financial mistakes. Thus, policy makers and interest groups around the world have put considerable effort in increasing peoples’ financial literacy. As becomes obvious from our review of the literature, however, the educational initiatives yielded rather disappointing results and apparently, their capability to improve the quality of financial behavior is limited. Thus, improving the effectiveness of the programs seems key in order to literate individuals to sufficient levels. We also review the current literature on financial advice, since financial advice might act as a substitute for financial literacy, thereby improving individuals’ financial decision making without treating them to extensive financial education programs. By and large, the corresponding evidence is inconclusive but promising if moral hazard issues leading to conflicts of interests in the advisor-advisee relationship can be effectively mitigated or even eliminated.

7.2 Directions for future research

In what follows, we would like to highlight a number of topics which—from our perspective—represent fruitful avenues for future research. First, the majority of research on financial literacy has been conducted with a geographic focus on the U.S. and there is far less evidence available for Europe, e.g. for Germany. Does this focus on the U.S. pose an issue to our knowledge about individuals’ financial literacy? We believe the answer is yes: financial decisions faced by U.S. citizens and German citizens, for instance, differ a great deal.

Specifically, one of the major financial issues pertaining to the asset side of a U.S. household’s balance sheet is the investment decision concerning 401(k) plans as part of a company pension scheme. How much should one contribute to the plan in order to maximize matching of the employer and how should the contributions be invested wisely across asset classes and financial products? In Germany, unlike in the U.S., decisions regarding defined contribution plans are much less relevant. On the one hand, the public pension system is still comparably generous and payments from corporate pension plans for retirees are of subordinate importance. On the other hand, plan participants in Germany usually do not have the discretion to determine the asset allocation of contributions. Thus, financial literacy is not as relevant when it comes to this decision. Although the designs of company pension schemes differ substantially between the two countries, a German household’s choice whether or not to participate in state-subsidized private pensions schemes (most prominently Riester plans) is comparable to decisions faced when dealing with 401(k) plans along several dimensions. Consequently, we encourage more research in the vein of Coppola and Gasche ( 2011 ) in the future.

From a German perspective, we currently see one additional major issue with respect to financial literacy and financial decision making that is rarely addressed in the literature, most probably because it is rather specific to Germans savers: due to a lack of knowledge and experience regarding stockholdings and equity mutual fund investments, an overwhelming majority of German households is still exclusively invested in savings products. Clearly, this investment strategy is quasi deterministically associated with a loss in household purchasing power in times of interest levels persistently close to zero. We believe that extending the conceptualization and measurement of financial literacy including knowledge about the long-run distributional characteristics of stock investment returns can be a promising avenue to increase the below-average willingness to participate in the stock market observed among Germans.

Turning the attention to the liability side of the household’s balance sheet, U.S. Americans and Germans also face very different challenges. While households in the U.S. were exposed to highly complex mortgage arrangements prior to the subprime crisis, plain vanilla debt contracts have been dominant in Germany ever since. In addition, issues like illiterate credit card use have typically been much less of an issue in Germany since credit card balances are charged against the cardholder’s bank account on a monthly basis. Thus, financial debt literacy appears less of an issue in Germany than in the U.S.

Recently, there has been notable progress in fostering research outside the U.S. The PHF survey, for instance, gives researchers the opportunity to relate financial literacy to various demographics as well as to a number of financial decisions of households. With the second wave of the PHF survey available for scientific use since April 2016, scholars are now able to conduct detailed analyses of households’ financial situation across subjects and over time. We are looking forward to interesting and novel insights concerning the relationship between financial literacy and financial behavior in the German context based on this rich dataset. For future cross-country analyses, it is crucial that survey data is elicited using a consistent methodological approach (e.g. identical selection and training criteria for interviewers) in all participating countries to ensure comparability of outcomes. The launch of the Eurosystem Household Finance and Consumption Survey (HFCS)—the German part of it covered via the PHF—marks a first step in this direction. Similarly, we embrace other cross-country initiatives such as the above-mentioned OECD initiative and S&P’s Finlit Survey both of which elicit consistent and readily comparable data across a number of different countries.

Although we observe a positive development with regard to cross-country household surveys, we have to acknowledge that research based on household surveys is anything but unproblematic. As Meyer et al. ( 2015 ) have shown, household surveys are subject to issues regarding the quality of data elicited. Related challenges affect both the measurement of financial literacy itself and the financial behavior captured in surveys on households’ financial situation. We believe that linking individuals’ financial literacy directly with their real-world financial decisions, as is done in Choi et al. ( 2011 ), Clark et al. ( 2015 ) and Stolper ( 2016 ), for instance, is a promising approach in order to enhance the quality of empirical results obtained in financial literacy research.

Finally, the research we review in this paper relates to the relevance of financial literacy in the context of household finance. Although financial mistakes associated with low financial literacy correlate with high costs for households, low levels of financial literacy might also be important in a business context. Footnote 38 Decision makers in blue-collar business, for instance, often are not especially knowledgeable in financial matters. Yet, they frequently make a range of finance-related decisions such as paying invoices in due time and aggregating costs for estimates they give. Of course, one could argue that individuals are less prone to financial mistakes if they act as professionals. However, the literature on behavioral biases has documented less severe but still significant investment mistakes conducted by, for instance, money managers (e.g., Kaustia et al. 2008 ). In this spirit, the research of Bodnaruk and Simonov ( 2015 ) is an interesting example for simultaneously analyzing individuals’ financial behavior in the private and in the professional domain. To us, it appears that financial literacy in the business context is an interesting and still largely under-researched subject: as can be inferred from Table  1 , 19 out of the 20 most cited papers focus on financial decisions of households, the only exception being McDaniel et al. ( 2002 ), who discuss financial literacy in the context of audit committees.

7.3 Policy recommendations

As far as policy recommendations are concerned, we propose a holistic approach. Based on the empirical evidence on individuals’ financial literacy level that we review in this paper, it seems important to pursue a policy mix that does not treat financial literacy and financial education separately but instead incorporates their interdependence with potential substitutes like financial advice, the implementation of an intelligent choice architecture and a thoughtful regulation concerning financial products offered to households. Indeed, this multi-dimensional approach is currently the way of choice in many countries. Moreover, even though evidence regarding the effectiveness of financial education programs with respect to financial decision making is at best mixed, we want to highlight the relevance of enabling citizens when it comes to financial matters. Prior to the financial crisis, many private (and professional) market participants bought products whose underlying mechanisms they did not understand, e.g. overly complex certificates or mortgage backed securities (MBS). Collectively, these financial products were dismissed as toxic or—quoting investment legend Warren Buffet—as “ weapons of mass destruction ”. However, financial innovations have served their goal to improve and facilitate financial products and services for the most part. In fact, functioning financial markets require peoples’ acceptance of financial innovations and sufficient knowledge and ability regarding financial matters is an indispensable foundation for this acceptance.

Section  2.1 of this paper provides details on the conceptualization of financial literacy.

The Web of Science (formerly known as Web of Knowledge ) is a scientific citation index maintained by Thomson Reuters which provides access to multiple databases that reference cross-disciplinary research and allows for in-depth exploration of specialized areas within an academic or scientific discipline.

See the Appendix to this paper for a detailed description of the PHF data.

For an excellent review of the theory of financial literacy, the reader is referred to Lusardi and Mitchell ( 2014 ).

For a comprehensive evaluation of initiatives to improve consumers’ financial literacy, see Sect.  6.1 .

The Health and Retirement Study (HRS) is a survey among U.S. households aged 50 and older. See Table  3 for details on the different surveys employed in the studies we review in this paper.

See Table  2 for a survey.

Correct answers are displayed in bold.

The first question reads: “Suppose you have some money. Is it safer to put your money into one business or investment, or to put your money into multiple businesses or investments?".

The wording of the second question is: “Suppose over the next 10   years the prices of the things you buy double. If your income also doubles, will you be able to buy less than you can buy today, the same as you can buy today, or more than you can buy today?”.

The third question reads: “Suppose you need to borrow 100 US dollars. Which is the lower amount to pay back: 105 US dollars or 100 US dollars plus three percent?”.

The wording of the fourth question is: “Suppose you put money in the bank for two years and the bank agrees to add 15% per year to your account. Will the bank add more money to your account the second year than it did the first year, or will it add the same amount of money both years?”.

For details regarding the impact of individuals’ financial literacy on their use of financial advice, see Sect.  6.2 .

See Sect.  5.1 for a detailed discussion of how measurement error affects inference.

Note that some studies use alternative concepts of self-assessed financial literacy, which, however, yield broadly comparable results. Specifically, Hastings et al. ( 2013 ) use the 2009 NFCS to compare three different measures of self-reported financial capability (self-assessed overall financial knowledge, self-assessed mathematical knowledge, and self-assessed capability at dealing with financial matters) for various demographic subgroups and find that the different constructs are all highly correlated with each other.

Exceptions to this behavioral trait are Japanese individuals (Sekita 2011 ).

Unlike in the DHS and SHARE surveys, replies in the PHF and SAVE datasets stem from one individual per household. As described in Bucher-Koenen and Lusardi ( 2011 ), SAVE draws on a randomly chosen household member who has information on the household’s finances . Thus, the individual completing the questionnaire is not necessarily the household head. Consistent with this approach, interviews in the PHF were conducted with financially knowledgeable persons familiar with the household’s financial situation (one per household), who again need not necessarily be the head of the surveyed household. Hence, owing to their largely similar elicitation modes, the PHF and SAVE data are to a great extent comparable regarding respondents’ answers.

At the same time, however, Bannier and Neubert ( 2016a ) find a negative association between female under confidence and financial planning outcomes, which turns out statistically significant for the subgroup of highly-educated women.

Note, however, that findings across the different studies are not always readily comparable, since the individual surveys naturally differ in terms of year of data, survey mode, and size of sampled cohort.

Note that mean values reported in this section are equally-weighted across the sampled studies.

In a related study, Japelli ( 2010 ) conducts a cross-country assessment of economic literacy in 55 countries based on the IMD World Competitive Yearbook (WCY). Note, however, that Japelli ( 2010 ) differs from the studies surveyed above in two respects. First, economic literacy is distinct from financial literacy. Second, he provides insights on literacy levels of senior business leaders, while our focus is on private households.

The analysis comprises the OECD economies Australia, Belgium (Flemish Community), Czech Republic, Estonia, France, Israel, Italy, New Zealand, Poland, Slovak Republic, Slovenia, Spain and the U.S. as well as the partner countries Colombia, Croatia, Latvia, Russia and Shanghai-China. Please note that Germany did not participate in this OECD study.

Note that in statistical terms, the differences between the country scores reported in Fig.  2 and the OECD average—with the exception of the U.S.—all turn out significant at all conventional levels.

For a detailed description of the different proficiency levels see Lusardi ( 2015 ).

Within the countries under review, the percentage of financially illiterate students range from 2% (Shanghai-China) to 56% (Columbia).

A complete list of questions raised in each household survey is available upon request.

See Sect.  6.1 for a detailed discussion of the costs and benefits of financial education initiatives.

Bannier and Neubert ( 2016a ), drawing on the SAVE data, show that the effect of formal education is strongest for women.

Note, however, that the literature has produced mixed results as to whether causality runs from wealth to financial literacy or rather the other way round. While Monticone ( 2010 ) documents that wealth has a positive (albeit small) effect on the degree of financial knowledge, wealth has been shown to be endogenous in other contributions. Van Rooij et al. ( 2012 ), e.g., provide evidence of a strong positive association between financial literacy and financial wealth and argue that it is financial literacy, which facilitates wealth accumulation. In a related study, Lusardi et al. ( 2013 ) develop a life-cycle model with endogenous financial knowledge accumulation and conclude that it explains a large proportion of wealth inequality.

The effect of childhood experience on financial behavior is also analyzed in Bucciol and Veronesi ( 2014 ) and Webley and Nyhus ( 2006 , 2013 ).

Intuitively, we have to agree on a definition of sound financial behavior in order to be able to interpret this relationship. Depending on the context, this proves a nontrivial task. While investing in the stock market, for instance, is generally considered smart, individuals with extreme levels of risk aversion or short-term liquidity needs might not be well-advised to do so. In what follows, however, we adopt the literature consensus and thus, e.g., classify index fund investments (as opposed to investments in actively managed mutual funds) as sound financial decisions.

For further examples of particularly strong instruments for financial literacy, see Lusardi and Mitchell ( 2014 ).

van Rooij et al. ( 2011b ) argue that the negative correlation between respondents’ financial literacy levels and the financial condition of their siblings and the financial knowledge of their parents, respectively, support the notion of a learning channel rather than the existence of family fixed effects. Note that the underlying assumption is that respondents learn from the negative experience of their family members.

In a related study, Koestner et al. ( 2017 ) identify investment experience as another potential channel to mitigate investment mistakes.

See Sect.  2.3 for a detailed discussion of this issue.

Collins ( 2012 ) surveys the role of nonprofit providers in financial education.

Yet another approach to support peoples’ financial decision making process exploits a robust finding in behavioral economics, i.e. that different formulations of otherwise identical choice options (so-called frames ) affect individuals’ behavior. Accordingly, a mindful framing of peoples’ decision environment (referred to as choice architecture ) may be an additional avenue towards improved financial behavior. Indeed, this approach is promoted by, e.g., Choi et al. ( 2004 ) and Thaler and Benartzi ( 2004 ) who find that opt-out regimes in 401(k) pension plans result in a large and persistent increase in pension participation rates relative to conventional opt-in arrangements.

Please note that the Kreditanstalt für Wiederaufbau (KfW) as of the 2014 wave inserted financial literacy questions into the Gründungsmonitor survey of entrepreneurs in Germany. In particular, the respondents have to self-assess their financial literacy as well as to answer the Big Three and three other questions on financial literacy.

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We gratefully acknowledge the comments of Christina Bannier and Wolfgang Breuer, the editors, as well as two anonymous referees. Moreover, we would like to thank Dennis Bär, Daniel Czaja, Lea Meyer and Tobias Meyll for excellent research assistance.

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Appendix: Panel on Household Finances (PHF): data description

We draw on novel survey data on household finance and wealth provided by the Deutsche Bundesbank in the Panel on Household Finances  (PHF) which is representative of the German population. In the first wave of the PHF, face-to-face computer aided interviews were conducted between September 2010 and July 2011 with the financially knowledgeable persons (one per household) in a sample of 3565 households in total. Questions cover a wide range of items related to the household balance sheet including financial and non-financial assets as well as household debt. This information is then supplemented with demographic and psychological characteristics of the household members as well as a household-specific financial literacy score. The PHF features (a) survey weights to adjust for the oversampling of wealthy households during the data collection and (b) multiple imputations in order to mitigate the issue of missing data due to item non-response. We make use of the survey weights and the corresponding replicate weights to adjust point estimates as well as variance and standard error estimates in all our baseline analyses. Note that this correction of the sampling design does not materially affect our results (corresponding tables available upon request). Similarly, for the independent variables, we use the average of the five imputed values provided in the data. For robustness, we re-estimate our main model using multiple imputations via Rubin’s rule (Rubin 1996 ). Results remain virtually unchanged and are also available upon request.

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Stolper, O.A., Walter, A. Financial literacy, financial advice, and financial behavior. J Bus Econ 87 , 581–643 (2017). https://doi.org/10.1007/s11573-017-0853-9

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FINANCIAL LITERACY, FINANCIAL EDUCATION AND ECONOMIC OUTCOMES

In this article we review the literature on financial literacy, financial education, and consumer financial outcomes. We consider how financial literacy is measured in the current literature, and examine how well the existing literature addresses whether financial education improves financial literacy or personal financial outcomes. We discuss the extent to which a competitive market provides incentives for firms to educate consumers or offer products that facilitate informed choice. We review the literature on alternative policies to improve financial outcomes, and compare the evidence to evidence on the efficacy and cost of financial education. Finally, we discuss directions for future research.

“The future of our country depends upon making every individual, young and old, fully realize the obligations and responsibilities belonging to citizenship...The future of each individual rests in the individual, providing each is given a fair and proper education and training in the useful things of life...Habits of life are formed in youth...What we need in this country now...is to teach the growing generations to realize that thrift and economy, coupled with industry, are necessary now as they were in past generations.”

--Theodore Vail, President of AT&T and first chairman of the Junior Achievement Bureau (1919, as quoted in Francomano, Lavitt and Lavitt, 1988 )

“Just as it was not possible to live in an industrialized society without print literacy—the ability to read and write, so it is not possible to live in today's world without being financially literate... Financial literacy is an essential tool for anyone who wants to be able to succeed in today's society, make sound financial decisions, and—ultimately—be a good citizen.”

-- Annamaria Lusardi (2011)

1. INTRODUCTION

Can individuals effectively manage their personal financial affairs? Is there a role for public policy in helping consumers achieve better financial outcomes? And if so, what form should government intervention take? These questions are central to many current policy debates and reforms in the U.S. and around the world in the wake of the recent global financial crises.

In the U.S., concerns about poor financial decision making and weak consumer protections in consumer financial markets provided the impetus for the creation of the Consumer Financial Protection Bureau (CFPB) as part of the Dodd-Frank Wall Street Reform and Consumer Project Act which was signed into law by President Obama on July 21, 2010. This law gives the CFPB oversight of consumer financial products in a variety of markets, including checking and savings accounts, payday loans, credit cards, and mortgages (CFPB authority does not extend to investments such as stocks and mutual funds which are regulated by the SEC, or personal insurance products that are largely regulated at the state level). In addition to establishing its regulatory authority, the Dodd-Frank Act mandates that the CFPB establish “the Office of Financial Education, which shall develop a strategy to improve the financial literacy of consumers.” It goes on to state that the Comptroller must study “effective methods, tools, and strategies intended to educate and empower consumers about personal financial management” and make recommendations for the “development of programs that effectively improve financial education outcomes.” 1

In line with this second mandate for the CFPB, there has been much recent public discussion on financial literacy and the role of financial education as an antidote to limited individual financial capabilities. As the title suggests, this is a main focus of the current paper; however, it is important not to lose the forest for the trees in the debate on policy prescriptions. The market failure that calls for a policy response is not limited to financial literacy per se, but the full complement of conditions that lead to suboptimal consumer financial outcomes of which limited financial literacy is one contributing factor. Similarly, the policy tools for improving consumer financial outcomes include financial education but also encompass a wide variety of regulatory approaches. One of our aims in this paper is to place financial literacy and financial education in this broader context of both problems and solutions.

The sense of public urgency over the level of financial literacy in the population is, we believe, a reaction to a changing economic climate in which individuals now shoulder greater personal financial responsibility in the face of increasingly complicated financial products. For example, in the U.S. and elsewhere across the globe, individuals have been given greater control and responsibility over the investments funding their retirement (in both private retirement savings plan such as 401(k)s and in social security schemes with private accounts). Consumers confront ever more diverse options to obtain credit (credit cards, mortgages, home equity loans, payday loans, etc.) and a veritable alphabet soup of savings alternatives (CDs, HSAs, 401(k)s, IRAs, 529s, KEOUGHs, etc.). Can individuals successfully navigate this increasingly complicated financial terrain?

We begin by framing financial literacy within the context of standard models of consumer financial decision making. We then consider how to define and measure financial literacy, with an emphasis on the growing literature documenting the financial capabilities of individuals in the U.S. and other countries. We then survey the literature on the relationship between financial literacy and economic outcomes, including wealth accumulation, savings decisions, investment choices, and credit outcomes. We then assess the evidence on the impact of financial education on financial literacy and on economic outcomes. Next we evaluate the role of government in consumer financial markets: what problems do limited financial capabilities pose, and are market mechanisms likely to correct these problems? Finally, we suggest directions for future research on financial literacy, financial education, and other mechanisms for improving consumer financial outcomes.

2. WHAT IS FINANICAL LITERACY AND WHY IS IT IMPORTANT?

“Financial literacy” as a construct was first championed by the Jump$tart Coalition for Personal Financial Literacy in its inaugural 1997 study Jump$tart Survey of Financial Literacy Among High School Students. In this study, Jump$tart defined “financial literacy” as “the ability to use knowledge and skills to manage one's financial resources effectively for lifetime financial security.” As operationalized in the academic literature, financial literacy has taken on a variety of meanings; it has been used to refer to knowledge of financial products (e.g., what is a stock vs. a bond; the difference between a fixed vs. an adjustable rate mortgage), knowledge of financial concepts (inflation, compounding, diversification, credit scores), having the mathematical skills or numeracy necessary for effective financial decision making, and being engaged in certain activities such as financial planning.

Although financial literacy as a construct is a fairly recent development, financial education as an antidote to poor financial decision making is not. In the U.S., policy initiatives to improve the quality of personal financial decision making through financial education extend back at least to the 1950s and 1960s when states began mandating inclusion of personal finance, economics, and other consumer education topics in the K-12 educational curriculum ( Bernheim et al. 2001 ; citing Alexander 1979, Joint Council on Economic Education 1989, and National Coalition for Consumer Education 1990). 2 Private financial and economic education initiatives have an even longer history; the Junior Achievement organization had its genesis during World War I, and the Council for Economic Education goes back at least sixty years. 3

Why are financial literacy and financial education as a tool to increase financial literacy potentially important? In answering these questions, it is useful to place financial literacy within the context of standard models of consumer financial decision making and market competition. We start with a simple two-period model of intertemporal choice in the face of uncertainty. A household decides between consumption and savings at time 0, given an initial time 0 budget, y , an expected real interest rate, r , and current and future expected prices, p , for goods consumed, x .

Solving this simple model requires both numeracy (the ability to add, subtract, and multiply), and some degree of financial literacy (an understanding of interest rates, market risks, real versus nominal returns, prices and inflation).

Alternatively, consider a simple model of single-period profit maximization for a single-product firm competing on price in a differentiated products market:

The firm chooses price, p , to maximize profits given marginal costs, mc , its product characteristics, x , its competitors’ prices and product characteristics, p -j and x -j , respectively, and the distribution of consumer preferences over price and product characteristics, θ . Doing so results in the familiar formula relating price mark-up over costs to the price elasticity of demand: prices are higher relative to costs in product markets in which demand is less sensitive to price.

Competitive outcomes in this model rest on the assumption that individuals can and do make comparisons across products in terms of both product attributes and the prices paid for those attributes. This may be a relatively straightforward task for some products (e.g., breakfast cereal), but is a potentially tall order for products with multidimensional attributes and complicated and uncertain pricing (e.g., health care plans, cell phone plans, credit cards, or adjustable rate mortgages).

A lack of financial literacy is problematic if it renders individuals unable to optimize their own welfare, especially when the stakes are high, or to exert the type of competitive pressure necessary for market efficiency. This has obvious consequences for individual and social welfare. It also makes the standard models used to capture consumer behavior and shape economic policy less useful for these particular tasks.

Research has documented widespread and avoidable financial mistakes by consumers, some with non-trivial financial consequences. For example, in the U.S., Choi et al. (2011) examine contributions to 401(k) plans by employees over age 59 ½ who are eligible for an employer match, vested in their plan, and able to make immediate penalty-free withdrawals due to their age. They find that 36% of these employees either don't participate or contribute less than the amount that would garner the full employer match, essentially foregoing 1.6% of their annual pay in matching contributions; the cumulative losses over time for these individuals are likely to be much larger.

Duarte & Hastings (2011) and Hastings et al. (2012) show that many participants in the private account Social Security system in Mexico invest their account balances with dominated financial providers who charge high fees that are not offset by higher returns, contributing to high management fees in the system overall. Similarly, Choi et al. (2009) use a laboratory experiment that show that many investors, even those who are well educated, fail to choose a fee minimizing portfolio even in a context (the choice between four different S&P 500 Index Funds) in which fees are the only significant distinguishing characteristic of the investments and the dispersion in fees is large.

Campbell (2006) highlights several other of financial mistakes: low levels of stock market participation, inadequate diversification due to households’ apparent preferences to invest in local firms and employer stock, individuals’ tendencies to sell assets that have appreciated while holding on to assets whose value has declined even if future return prospects are the same (the disposition effect first documented in Odean 1998 ), and failing to refinance fixed rate mortgages in a period of declining interest rates.

Other financial mistakes discussed in the literature include purchasing whole life insurance rather than a cheaper combination of term life insurance in conjunction with a savings account ( Anagol et al. 2012 ); simultaneously holding high-interest credit card debt and low-interest checking account balances ( Gross & Souleles 2002 ); holding taxable assets in taxable accounts and non-taxable or tax-preferred assets in tax-deferred accounts ( Bergstresser & Poterba 2004 , Barber & Odean 2003 ); paying down a mortgage faster than the amortization schedule requires while failing to contribute to a matched tax-deferred savings account (Amromin et al. 2007); and borrowing from a payday lender when cheaper sources of credit are available ( Agarwal et al. 2009b ).

Agarwal et al. (2009a) document the prevalence of several different financial mistakes ranging from suboptimal credit card use after making a balance transfer to an account with a low teaser rate, to paying unnecessarily high interest rates on a home equity loan or line of credit. They find that across many domains, sizeable fractions of consumers make avoidable financial mistakes. They also find that the frequency of financial mistakes varies with age, following a U-shaped pattern: financial mistakes decline with age until individuals reach their early 50s, then begin to increase. The declining pattern up to the early 50s is consistent with the acquisition of increased financial decision-making capital over time, either formally or through learning from experience ( Agarwal et al. 2011 ); but the reversal at older ages highlights the natural limits that the aging process places on individuals’ financial decision-making capabilities, however those capabilities are acquired.

The constellation of findings described above has been cited by some as prima facie evidence that individuals lack the requisite levels of financial literacy for effective financial decision making. On the other hand, Milton Friedman (1953) famously suggested that just as pool players need not be experts in physics to play pool well, individuals need not be financial experts if they can learn to behave optimally through trial and error. There is some evidence that such personal financial learning does occur. Agarwal et al. (2011) find that in credit card markets during the first three years after an account is opened, the fees paid by new card holders fall by 75% due to negative feedback: by paying a fee, consumers learn how to avoid triggering future fees. The role of experience is also evident in the answers to a University of Michigan Surveys of Consumers question that asked about the most important way respondents’ learned about personal finance. Half cited personal financial experience, more than twice the fraction who cited friends and family, and four to five times the fraction who credit formal financial education as their most important source of learning (Hilgert & Hogarth 2003).

Although experiential learning may be an important self-correcting mechanism in financial markets, many important financial decisions like saving and investing for retirement, choosing a mortgage, or investing in an education, are undertaken only infrequently and have delayed outcomes that are subject to large random shocks. Learning by doing may not be an effective substitute for limited financial knowledge in these circumstances ( Campbell et al. 2010 ), and consumers may instead rely on whatever limited institutional knowledge and numeracy skills they have.

3. MEASURING FINANCIAL LITERACY

If financial literacy is an important ingredient in effective financial decision making, a natural question to ask is how financially literate are consumers? Are they well equipped to make consequential financial decisions? Or do they fall short? Efforts to measure financial literacy date back to at least the early 1990s when the Consumer Federation of America (1990; 1991; 1993; 1998) began conducting a series of “Consumer Knowledge” surveys among different populations which included questions on several personal finance topics: consumer credit, bank accounts, insurance, and major consumer expenditures areas such as housing, food and automobiles. The 1997 Jump$tart survey of high school students referenced above has been repeated biennially since 2000 and was expanded to include college students in 2008 (see Mandell 2009 , for an analysis these surveys). Hilgert et al. (2003) analyze a set of “Financial IQ” questions included in the University of Michigan's monthly Surveys of Consumers in November and December 2001.

More recently, Lusardi & Mitchell (2006) added a set of financial literacy questions to the 2004 Health and Retirement Study (HRS, a survey of U.S. households aged 50 and older) that have, in the past decade, served as the foundational questions in several surveys designed to measure financial literacy in the U.S. and other countries. The three core questions in the original 2004 HRS financial literacy module were designed to assess understanding of three core financial concepts: compound interest, real rates of return, and risk diversification (see Table 1 ). Because these questions are parsimonious and have been widely replicated and adapted, they have come to be known as the “Big Three.”

Financial Literacy Questions in the 2004 Health and Retirement Study (HRS) and the 2009 National Financial Capability Study (NFCS)

Note: The answer categorized as correct is italicized in the last column.

These questions were incorporated into the 2009 National Financial Capability Study (NFCS) in the U.S., a large national survey of the financial capabilities of the adult population. 4 The NFCS asked two additional financial literacy questions which, together with the “Big Three,” have collectively come to be known as the “Big Five.” These two additional questions test knowledge about mortgage interest and bond prices. Table 1 lists the “Big Five” questions as asked with their potential answers (the correct answers are italicized).

Because the “Big Three” questions have been more widely adopted in other surveys, we focus here on the answers to these three questions, although we return to the “Big Five” later. The second and fourth columns of Table 2 report the percent of correct and “Don't know” responses to each of the “Big Three” questions for the 2004 HRS respondents and the 2009 NFCS respondents. Because the NFCS represents the entire adult population, we focus on those results here. Among respondents to the 2009 NFCS, 78% correctly answered the first question on interest rates and compounding, 65% correctly answered the second question on inflation and purchasing power, and 53% correctly answered the third question on risk diversification. Note that all three questions were multiple choice (rather than open-ended), so that guessing would yield a correct answer to the first two questions 33% of the time and to the last question 50% of the time. Only 39% of respondents correctly answered all three questions.

Financial Literacy Around the World

Notes: Countries ranked by 2010-2011 International Monetary Fund GDP per capita. + denotes statistics directly drawn from publications: Netherlands: van Rooij et al. 2011 . Financial literacy and retirement preparation in the Netherlands. J. Pension. Econ. 10(4): 527-545; Japan: Sekita. 2011. Financial literacy and retirement planning in Japan. J. Pension. Econ. 10(4): 637-656. Germany: Lusardi & Bucher-Koenen. 2011. Financial literacy and retirement planning in Germany. J. Pension. Econ. 10(4): 565-584. Cole et al. 2011. Prices or knowledge? What drives demand for financial services in emerging markets. J. Financ. 66(6): 1933-1967.

X denotes missing information.

Clearly individuals who cannot answer the first or second questions will have a difficult time navigating financial decisions that involve an investment today and real rates of return over time; they are likely to have trouble making even the basic calculations assumed in a rational intertemporal decision-making framework. The inability to correctly answer the third question demonstrates ignorance about the benefits of diversification (reduced risk) and casts doubt on whether individuals can effectively manage their financial assets. With only 39% of the population able to answer these three fairly basic financial literacy questions correctly, we might be justifiably concerned about how many individuals make suboptimal financial decisions in everyday life and the types of marketplace distortions that could follow.

As noted earlier, dozens of surveys in addition to the NFCS have included the trio of questions discussed above from the 2004 HRS. In addition to the results for the 2004 HRS and the 2009 NFCS, Table 2 shows how respondents in several countries answered these same questions. The first six columns list comparative statistics for six developed economy surveys from the U.S., The Netherlands, Japan and Germany. The next three columns take data from the upper-middle income countries of Chile and Mexico. The last two columns report responses from the lower-income countries of India and Indonesia. Proficiency rates vary widely; in Germany, 53% of respondents correctly answer the three HRS financial literacy questions, whereas only 8% of respondents in Chile do so. In general, the level of financial literacy is highest in the developed countries and lowest in the lower-income countries. The responses to these questions in the 2004 and 2010 HRS suggest that financial literacy for HRS respondents has increased somewhat over time, perhaps from participating in the panel, or perhaps as a result of increased financial discussion surrounding the 2008 financial crisis. In Chile and Mexico, respondents have particularly low levels of financial literacy despite being responsible for managing the investment decisions for the balances accumulated in their privatized social security accounts. Chile also witnessed massive student protests over college loan debt in 2011, and yet only 16% of college entrants can correctly answer these three questions despite the fact that 22% of them are taking out student loans. 5

Although the Lusardi and Mitchell “Big Three” questions from the 2004 HRS have quickly become an international standard in assessing financial literacy, there is remarkably little evidence on whether this set of survey questions is the best approach, or even a superior approach, to measuring financial literacy. The question of how best to assess the desired behavioral capabilities remains open, both in terms of establishing whether survey questions are best-suited for the task or which questions are most effective. Longer financial literacy survey batteries do exist, including the National Financial Capability Study (NFCS) which asks the “Big Five” financial literacy questions described above along with an extensive set of questions on individual financial behaviors. The biennial Jump$tart Coalition financial literacy surveys used to assess the financial literacy of high school and college students in the U.S. include more than fifty questions. Whether using additional survey questions (and how many more) better explains individual behavior is unclear as little research has evaluated the relative efficacy of different measurements.

Table 3 lists the fraction of respondents correctly answering the “Big Three” and “Big Five” financial literacy questions in the 2009 NFCS for various demographic subgroups. There is a strong positive correlation between the performance on the “Big Three” and the “Big Five” questions (although part of this correlation is mechanical as the “Big Three” are a subset of the “Big Five”). Table 3 also lists three other self-assessed measures of financial capability (self-assessed overall financial knowledge, self-assessed mathematical knowledge and self-assessed capability at dealing with financial matters). These self-assessed measures are all highly correlated with each other, and fairly highly correlated with the performance-based measures of financial literacy in the first two columns. All of the measures of financial capability are also highly correlated with educational attainment, suggesting that traditional measures of education could also serve as proxies for financial literacy (we will discuss causality in Section 4).

Measures of Financial Literacy

Note: Authors’ calculations from the 2009 NFCS State-by-State Survey (n=28,146). The top panel of Table 1 lists the “Big 3” questions in Column (1); the “Big 5” questions in Column (2) include the “Big 3” and the additional two questions from the bottom panel of Table 1 . Columns (3) through (5) report the mean of the participants’ self-assessments based on the following scale: 1=Strongly Disagree to 7= Strongly Agree.

In a survey of 18 different financial literacy studies, Hung et al. (2009) report that the predominant approach used to operationalize the concept of financial literacy is either the number, or the fraction, of correct answers on some sort of performance test (measures akin to those in columns 1 and 2 of Table 3 ). This approach was used in all of the studies they evaluated, although two adopted a more sophisticated methodology, using factor analysis to construct an index that assigned different weights to each question ( Lusardi & Mitchell 2009 , van Rooij et al. 2011 ).

In addition to evaluating how previous studies have operationalized the concept of financial literacy, Hung et al. (2009) also perform a construct validation of seven different financial literacy measures calculated from various question batteries administered to the same set of respondents in four different waves of the RAND American Life Panel. Their measures include three performance tests (one of which has three subtests) based on either 13, 23, or 70 questions, and one behavioral outcome (performance in a hypothetical financial decision-making task). They find that the measures based on the different performance tests are highly correlated with each other, and when the same questions are asked in multiple waves, the answers have high test-retest reliability. The outcomes of the performance tests are less highly correlated with outcomes in the decision-making task. They also find that the relationship between demographics and the different performance test based measures of financial literacy is similar, but that the relationship between demographics and the outcomes in the decision-making task is much weaker. The different financial literacy measures are more variable in their predictive relationships for actual financial behaviors such as planning for retirement, saving, and wealth accumulation.

One unanswered question in this literature is whether test-based measures provide an accurate measure of actual financial capability. To our knowledge, no study has provided incentives for giving correct answers as a mechanism to encourage thoughtful answers that reflect actual knowledge; neither has any study allowed individuals to access other sources of information (e.g., the internet, or friends and family) in completing a performance test to assess whether individuals understand their limitations and can compensate for them by engaging other sources of expertise. If individuals have effective compensatory mechanisms, we may see discrepancies between performance test results and actual outcomes and behaviors in the field.

A second measure of financial literacy that has been operationalized in the literature is individuals’ self-assessments of their financial knowledge or, alternatively, the level of confidence in their financial abilities. In the 18 studies evaluated by Hung et al. (2009) discussed above, one-third analyzed self-reported financial literacy in addition to a performance test-based measure. Two issues with such self-reporting warrant mention. First, individual self-reports and actual financial decisions do not always correlate strongly ( Hastings & Mitchell 2011 , Collins et. al. 2009 ). Second, consumers are often overly optimistic about how much they actually know ( Agnew & Szykman 2005 , OECD 2005 ). Even so, in general the literature finds that self-assessed financial capabilities and more objective measures of financial literacy are positively correlated (e.g., Lusardi & Mitchell 2009 , Parker et al. 2012 ), and self-reported financial literacy or confidence often have independent predictive power for financial outcomes relative to more objective test-based measures of financial literacy. For example, Allgood & Walstad (2012) find that in the 2009 NFCS State-by-State survey, both self-assessed financial literacy and the fraction of correct answers on the “Big Five” financial literacy questions are predictive of financial behaviors in a variety of domains: credit cards (e.g., incurring interest charges or making only minimum payments), investments (e.g., holding stocks, bonds, mutual funds or other securities), loans (e.g., making late payments on a mortgage, comparison shopping for a mortgage or auto loan), insurance coverage, and financial counseling (e.g., seeking professional advice for a mortgage, loan, insurance, tax planning or debt counseling). Similarly, Parker et al. (2012) find that both self-reported financial confidence and a test-based measure of financial literacy predict self-reported retirement planning and saving, and van Rooij et al. (2011) find that both self-perceived financial knowledge and a test-based measure of financial literacy predict stock market participation.

Although test-based and self-assessed measures of financial literacy are the norm in the literature, other approaches to measuring financial literacy may be worth considering. One alternative measurement strategy, limited by the requirement for robust administrative data, is to identify individuals exhibiting financially sophisticated behavior (e.g., capitalizing on matching contributions in an employer's savings plan, or consistently refinancing a mortgage when interest rates fall) and use these indicators to predict other outcomes. For example, Calvet et al. (2009) use administrative data from Sweden to construct an index of financial sophistication based on whether individuals succumb to three different types of financial “mistakes”: under-diversification, inertia in risk taking, and the disposition effect in stock holding.

An outcomes-based approach like this may be fruitful for predicting future behavior, more so than the traditionally used measures of financial literacy (although Calvet et al. 2009 do not perform such an exercise in their analysis). If we are interested in understanding the abilities that improve financial outcomes, we should define successful measures as those that, when changed, produce improved financial behavior. Such a strategy will likely generate greater internal validity for predicting consumer decisions in specific areas (e.g., portfolio choice or retirement savings), although it will significantly increase the requirements for research relative to strategies that rely on more general indicators of financial literacy (e.g., the “Big Three”).

4. WHAT IS THE RELATIONSHIP BETWEEN FINANCIAL EDUCATION, FINANCIAL LITERACY AND FINANCIAL OUTCOMES?

Consistent with the notion that financial literacy matters for financial optimization, a sizeable and growing literature has established a correlation between financial literacy and several different financial behaviors and outcomes. In one of the first studies in this vein, Hilgert et al. (2003) document a strong relationship between financial knowledge and the likelihood of engaging in a number of financial practices: paying bills on time, tracking expenses, budgeting, paying credit card bills in full each month, saving out of each paycheck, maintaining an emergency fund, diversifying investments, and setting financial goals. Subsequent research has found that financial literacy is positively correlated with planning for retirement, savings and wealth accumulation ( Ameriks et al. 2003 , Lusardi 2004 , Lusardi & Mitchell 2006 ; 2007 , Stango & Zinman 2008, Hung et al. 2009 , van Rooij et al. 2012 ). Financial literacy is predictive of investment behaviors including stock market participation ( van Rooij, et al. 2011 , Kimball & Shumway 2006 , Christelis et al. 2006), choosing a low fee investment portfolio ( Choi et al. 2011 , Hastings 2012), and better diversification and more frequent stock trading ( Graham et al. 2009 ). Finally, low financial literacy is associated with negative credit behaviors such as debt accumulation (Stango & Zinman 2008, Lusardi & Tufano 2009 ), high-cost borrowing ( Lusardi & Tufano 2009 ), poor mortgage choice ( Moore 2003 ), and mortgage delinquency and home foreclosure ( Gerardi et al. 2010 ).

Other related research documents a relationship between either numeracy or more general cognitive abilities and financial outcomes. Although these concepts are distinct from financial literacy, they tend to be positively correlated: individuals with higher general cognitive abilities or greater facility with numbers and numerical calculations tend to have higher levels of financial literacy ( Banks & Oldfield 2007 , Gerardi et al. 2010 ). Numeracy and more general cognitive ability predict stockholding ( Banks & Oldfield 2007 , Christelis et al. 2010 ), wealth accumulation ( Banks & Oldfield 2007 ), and portfolio allocation ( Grinblatt et al. 2009 ).

Although this evidence might lead one to conclude that financial education should be an effective mechanism to improve financial outcomes, the causality in these relationships is inherently difficult to pin down. Does financial literacy lead to better economic outcomes? Or does being engaged in certain types of economic behaviors lead to greater financial literacy? Or does some underlying third factor (e.g., numerical ability, general intelligence, interest in financial matters, patience) contribute to both higher levels of financial literacy and better financial outcomes? To give a more concrete example, individuals with higher levels of financial literacy might better recognize the financial benefits and be more inclined to enroll in a savings plan offered by their employer. On the other hand, if an employer automatically enrolls employees in the firm's saving plan, the employees may acquire some level of financial literacy simply by virtue of their savings plan participation. The finding noted earlier that most individuals cite personal experience as the most important source of their financial learning ( Hilgert et al. 2003 ) suggests that some element of reverse causality is likely. While this endogeneity does not rule out the possibility that financial literacy improves financial outcomes, it does make interpreting the magnitudes of the effects estimated in the literature difficult to interpret as they are almost surely upwardly biased in magnitude.

In addition, unobserved factors such as predisposition for patience or forward-looking behavior could contribute to both increased financial literacy and better financial outcomes. Meier & Sprenger (2010) find that those who voluntarily participate in financial education opportunities are more future-oriented. Hastings & Mitchell (2011) find that those who display patience in a field-experiment task are also more likely to invest in health and opt to save additional amounts for retirement in their mandatory pension accounts. Other unobserved factors like personality ( Borgans et al. 2008 ) or family background ( Cunha & Heckman 2007 , Cunha et al. 2010 ) could upwardly bias the observed relationship between financial education and financial behavior in non-experimental research.

Despite the challenges in pinning down causality, understanding causal mechanisms is necessary to make effective policy prescriptions. If the policy goal is increased financial literacy, then we need to know how individuals acquire financial literacy. How important is financial education? And how important is personal experience? And how do they interact? If, on the other hand, the goal is to improve financial outcomes for consumers, then we need to know if financial education improves financial outcomes (assuming it increases literacy) and we need to be able to weigh the cost effectiveness of financial education against other policy options that also impact financial outcomes.

What evidence is there that financial education actually increases financial literacy? The evidence is more limited and not as encouraging as one might expect. One empirical strategy has been to exploit cross sectional variation in the receipt of financial education. Studies using this approach have often found almost no relationship between financial education and individual performance on financial literacy tests. For example, Jumps$tart (2006) and Mandell (2008) document surprisingly little correlation between high school students’ financial knowledge levels and whether or not they have completed a financial education class. This empirical approach has obvious problems for making causal inferences: the students who take financial education courses in districts where such courses are voluntary are likely to be different from the students who choose not to take such courses, and the districts who make such courses mandatory for all students are likely to be different from the districts that have no such mandate. Nonetheless, the lack of any compelling evidence of a positive impact is surprising. Carpena et al. (2011) use a more convincing empirical methodology to get at the impact of financial education on financial literacy and financial outcomes. They evaluate a relatively large randomized financial education intervention in India and find that while financial education does not improve financial decisions that require numeracy, it does improve financial product awareness and individuals’ attitudes towards making financial decisions. There is definitely room in the literature for more research using credible empirical methodologies that examine whether, or in what contexts, financial education actually impacts financial literacy.

In the end, we are more interested in financial outcomes than financial knowledge per se. The literature on financial education and financial outcomes includes several studies with plausibly exogenous sources of variation in the receipt of financial education, ranging from small-scale field experiments to large-scale natural experiments. The evidence in these papers on whether financial education actually improves financial outcomes is best described as contradictory.

Several studies have looked toward natural experiments as a source of exogenous variation in who receives financial education. Skimmyhorn (2012) uses administrative data to evaluate the effects of a mandatory eight-hour financial literacy course rolled out by the U.S. military during 2007 and 2008 for all new Army enlisted personnel. Because the roll-out of the financial education program was staggered across different military bases, we can rule out time effects as a confounding factor in the results. He finds that soldiers who joined the Army just after the financial education course was implemented have participation rates in and average monthly contributions to the Federal Thrift Savings Plan (a 401(k)-like savings account) that are roughly double those of personnel who joined the Army just prior to the introduction of the financial education course. The effects are present throughout the savings distribution and persist for at least 2 years (the duration of the data). Using individually-matched credit data for a random subsample, he finds limited evidence of more widespread improved financial outcomes as measured by credit card balances, auto loan balances, unpaid debts, and adverse legal actions (foreclosures, liens, judgments and repossessions).

Bernheim et al. (2001) and Cole & Shastry (2012) examine another natural experiment which created variation in financial education exposure: the expansion over time and across states in high school financial education mandates. The first of these studies concludes that financial education mandates do have an impact on at least one measure of financial behavior: wealth accumulation. But Cole & Shastry (2012) , using a different data source and a more flexible empirical specification, 6 examine the same natural experiment and conclude that there is no effect of the state high school financial education mandates on wealth accumulation, but rather, that the state adoption of these mandates was correlated with economic growth which could have had an independent effect on savings and wealth accumulation.

In addition to examining natural experiments, researchers have also randomly assigned financial aid provision to evaluate the impact of financial education on financial outcomes. For example, Drexler et al. (2012) examine the impact of two different financial education programs targeted at micro-entrepreneurs in the Dominican Republic as part of a randomized controlled trial on the effects of financial education. Their sample of micro-entrepreneurs was randomized to be in either a control group or one of two treatment groups. Members of one treatment group participated in several sessions of more traditional, principles-based financial education; members of the other treatment group participated in several sessions of financial education oriented around simple financial management rules of thumb. The authors examine participants’ use of several different financial management practices approximately one year after the financial education courses were completed. Relative to the control group, the authors find no difference in the financial behaviors of the treatment group who received the principles-based financial education; they do find statistically significant and economically meaningful improvements in the financial behavior of the treatment group who participated in the rule-of-thumb oriented financial education course. The results of this study suggest that how financial education is structured could matter in whether it has meaningful effects at the end of the day, and might help explain why many other studies have found much weaker links between financial education and economic outcomes.

Gartner & Todd (2005) evaluate a randomized credit education plan for first-year college students but find no statistically significant differences between the control and treatment groups in their credit balances or timeliness of payments. Servon & Kaestner (2008) used random variation in a financial literacy training and technology assistance program find virtually no differences between the control and treatment groups in a variety of financial behaviors (having investments, having a credit card, banking online, saving money, financial planning, timely bill payment and others), though they suspect that the program was implemented imperfectly. In a small randomized field experiment, Collins (2010) evaluates a financial education program for low and moderate income families and finds improvements in self-reported knowledge and behaviors (increased savings and small improvements in credit scores twelve months later), but the sample studied suffers from non-random attrition. Finally, Choi et al. (2011) randomly assign some participants in a survey to an educational intervention designed to teach them about the value of the employer match in an employer sponsored savings plan. Using administrative data, they find statistically insignificant differences in future savings plan contributions between the treatment and the control group, even in the face of significant financial incentives for savings plan participation.

Additional non-experimental research using self-reported outcomes and potentially endogenous selection into financial education suggests a positive relationship between financial education and financial behavior. This positive relationship has been documented for credit counseling ( Staten 2006 ), retirement seminars ( Lusardi 2004 , Bernheim & Garrett 2003 ), optional high school programs ( Boyce & Danes 2004 ), more general financial literacy education ( Lusardi & Mitchell 2007 ), and in the military ( Bell et al. 2008 ; 2009 ).

Altogether, there remains substantial disagreement over the efficacy of financial education. While the most recent reviews and meta-analyses of the non-experimental evidence ( Collins et al. 2009 , Gale & Levine 2011 ) suggest that financial literacy can improve financial behavior, these reviews do not appear to fully discount non-experimental research and its limitations for causal inference. Of the few studies that exploit randomization or natural experiments, there is at best mixed evidence that financial education improves financial outcomes. The current literature is inadequate to draw conclusions about if and under what conditions financial education works. While there do not appear to be any negative effects of financial education other than increased expenditures, there are also almost no studies detailing the costs of financial education programs on small or large scales ( Coussens 2006 ), and few that causally identify their benefits towards improved financial outcomes.

To inform policy discussion, this literature needs additional large-scale randomized interventions designed to effectively identify causal effects. Randomized interventions coupled with measures of financial literacy could address the question of how best to measure financial literacy while also providing credible assessments of the effect of financial education on financial literacy and economic outcomes. A starting point could be incorporating experimental components into existing large scale surveys like the NFCS; for example, a subset of respondents could be randomized to participate in an on-line financial education course or to receive a take-home reference guide to making better financial decisions. Measuring financial literacy before and immediately after the short course would test if financial education improves various measures of financial literacy in the short-run. A subsequent follow-up survey linked to administrative data on financial outcomes (e.g., credit scores) would measure if short-run improvements in financial literacy last, and which measures of financial literacy, if any, are correlated with improved financial outcomes. Studies along these lines are needed to identify the causal effects of financial education on financial literacy and financial outcomes, identify the best measures of financial literacy, and inform policy makers about the costs and benefits of financial education as a means to improve financial outcomes.

5. WHAT IS THE ROLE OF PUBLIC POLICY IN IMPROVING INDIVIDUAL FINANCIAL OUTCOMES?

Given the current inconclusive evidence on the causal effects of financial education on either financial literacy or financial outcomes, there remains disagreement over whether financial education is the most appropriate policy tool for improving consumer financial outcomes. As expected, those who believe that financial education works favor more financial education ( Lusardi & Mitchell 2007 , Hogarth 2006 , Martin 2007 ). Others, optimistic about the promise of financial education despite what they view as weak empirical evidence of positive effects, support more targeted and timely education with greater emphasis on experimental design and evaluation ( Hathaway & Khatiwada 2008 , Collins & O'Rourke 2010 ). Finally, some who do not believe the research demonstrates positive effects support other policy options ( Willis 2008 ; 2009 ; 2011 ). In this section, we place financial education in the context of the broader research on alternative ways to improve financial outcomes.

5.1 Is There a Market Failure?

As economists, we start this section with the question of market failure: Is there a need for public policy in improving financial knowledge and financial outcomes, or can the market work efficiently without government intervention? If, like other forms of human capital, financial knowledge is costly to accumulate, there may be an optimal level of financial literacy acquisition that varies across individuals based on the expected need for financial expertise and individual preference parameters (e.g., discount rates). Jappelli & Padula (2011) and Lusardi et al. (2012) both use the relationship between financial literacy and wealth as their point of departure in modeling the endogenous accumulation of financial literacy. In both papers, investments in financial literacy have both costs (time and monetary resources) and benefits (access to better investment opportunities) which may be correlated with household education or initial endowments. In the model of Jappelli & Padula (2011) , the optimal stock of financial literacy increases with income, the discount factor (patience), the return to financial literacy, and the initial stock of financial literacy. 7 In the model of Lusardi et al. (2012) , more educated households have higher earnings trajectories than those with less education and also have stronger savings motives due to the progressivity built into the social safety net. Because they save more, they value better financial management technologies more than those with lower incomes, and they rationally acquire a higher level of financial literacy.

These models suggest that differences in financial literacy acquisition may be individually rational. Consistent with this supposition, Hsu (2011) uses data from the Cognitive Economics Survey which includes measures of financial literacy for a set of husbands and their wives to examine the determination of financial literacy in married couples. She finds that wives have a lower average level of financial literacy than their husbands (cf. the gender differences in Table 3 ), which she posits arise from a rational division of household labor with men being more likely to manage household finances. Women, however, have longer life expectancies than their husbands and many will eventually need to assume financial management responsibilities. She finds that women actually acquire increased financial literacy as they approach widowhood, with the majority catching up to their husbands prior to being widowed.

More generally, limited financial knowledge may be a rational outcome if other entities—a spouse, an employer, a financial advisor—can help individuals compensate for their deficiencies by providing information, advice, or financial management. We don't expect individuals to be experts in all other domains of life—that is the essence of comparative advantage. Specialization in financial expertise may be efficient if it allows computational and educational investment to be concentrated or aggregated in specialized individuals or entities that develop algorithms and methods to guide consumers through financial waters.

Although low levels of financial literacy acquisition may be individually rational in some models, limited financial knowledge may create externalities such as reduced competitive pressure in markets which leads to higher equilibrium prices ( Hastings et al. 2012 ), higher social safety net usage, lower quality of civic participation, and negative impacts on neighborhoods ( Campbell et al. 2011 ), children ( Figlio et al. 2011 ) and families. Such externalities may imply a role for government in facilitating improved financial decision making through financial education or other mechanisms.

Individuals may also be subject to biases such as present-bias that lead to lower investments in financial knowledge today but which imply ex post regret in the future (sometimes referred to as an “internality”). Barr et al. (2009) note that in some contexts, firms have incentives to help consumers overcome their fallibilities. For example, if present bias leads consumers to save too little, financial institutions whose profits are tied to assets under management have incentives reduce consumer bias and encourage individuals to save more. In other contexts, however, firms may have incentives to exploit cognitive biases and limited financial literacy. For example, if consumers misunderstand how interest compounds and as a consequence borrow too much ( Stango & Zinman 2009 ), financial institutions whose profits are tied to borrowing have little incentive to educate consumers in a way that would correct their misperceptions.

What evidence is there on whether markets help individuals compensate for their limited financial capabilities? Unfortunately, many firms exploit rather than offset consumer shortcomings. Ellison (2005) and Gabaix & Laibson (2006) develop models of add-on and hidden pricing to explain the ubiquitous pricing contracts observed in the banking, hotel, and retail internet sales industries. Both models have naïve and informed customers and show that for reasonable parameter values, firms do not have an incentive to debias naïve consumers even in a competitive market. This leads to equilibrium contracts with low advertised prices on a “salient” price and high hidden fees and add-ons which naïve customers pay and sophisticated customers take action to avoid.

Opaque and complicated fees are widespread, and several empirical papers link these fee structures to shortcomings in consumer optimization. Ausubel (1999) analyzes a large field experiment in which a credit card company randomized mail solicitations varying the interest rate and duration of the credit card's introductory offer. He finds that individuals are overly responsive to the terms of the introductory offer and appear to underestimate their likelihood of holding balances past the introductory offer period with a low interest rate. 8 In a similar vein, Ponce (2008) evaluates a field experiment in Mexico in which a bank randomized the introductory teaser rate offered to prospective customers. He finds that a lower teaser rates leads to substantially higher levels of debt, even several months after the teaser rate expires, and that the higher debt results from lower payments rather than higher purchases or cash advances. Evaluating non-randomized offers to potential customers, he shows that banks do not randomly assign teaser rates but dynamically price discriminate by targeting offers to consumers who are more likely to permanently increase their balances.

Given that many firms are trying to actively obfuscate prices, it should not be surprising that there is little evidence that firms act to debias consumers through informative advertising or investments in financial education. In models of add-on prices, firms can hide prices or make them salient. Similarly, firms can invest in advertising that lowers price sensitivity, focusing consumer choice on non-price attributes, or in advertising that increases price competition by alerting customers to lower prices. In models of informative advertising, firms reduce information costs and expand the market by informing consumers of their price and location in product space. In contrast, in models of persuasive advertising, firms emphasize certain product characteristics and deemphasize others to change consumer's expressed preferences. For example a financial firm could advertise returns for the last year rather than management fees to convince investors that they should primarily evaluate past returns when choosing a fund manager. A financially literate consumer may be unmoved by this advertising strategy, but those who are less literate might be persuaded and end up paying higher management fees.

Hastings et al. (2012) use administrative data on advertising and fund manager choices for account holders in Mexico's privatized pension system. When the privatized system started, the government presumed that firms would compete on price (management fees) and engage in informative advertising to explain fees to consumers and win their accounts. Instead, firms invested heavily in sales force and marketing, and the authors find that heavier exposure to sales force (appropriately instrumented) resulted in lower price sensitivity and higher brand loyalty. This in turn lowered demand elasticity (recall equation 2) and increased management fees in equilibrium.

Importantly, informative advertising itself may be a public good. For example, advertising that explains the value of savings to individuals can benefit both the firm that makes the investment and its competitors if it increases demand for savings products in general. On the other hand, persuasive advertising attempts to convince customers that one product is better than another so that the benefits accrue to the firm that is advertising. The market may underprovide informative advertising in equilibrium because of the inherent free rider problem. Hastings et al. (in progress) test this theory using a marketing field experiment with two large banks in the Philippines. They find evidence that if firms face advertising constraints, persuasive rather than informative advertising maximizes profits. This suggests a role for government to remedy underprovision of public goods. In particular, these results suggest that financial products firms would welcome a tax that would fund public financial education as it would expand the market (e.g., increase total savings) and commit each institution to contribute to the public good. Note in equilibrium this could change firms’ incentives for add-on pricing as well by lowering the fraction of naïve customers in financial products markets ( Gabaix & Laibson 2006 ).

Even if firms do not have incentives to facilitate efficient consumer outcomes, a competitive market may generate an intermediate sector providing advice and guidance. This sector could provide unbiased decision-making-assistance that would lower decision making costs and efficiently expand the market. However, classic principal-agent problems may make such an efficient intermediate market difficult to attain.

Two recent studies highlight the limits of the financial advice industry as incentive-compatible providers of guidance and counsel on financial products and financial decision making. Mullainathan et al. (2012) conduct an audit study of financial advisors in Boston, sending to them scripted investors who present needs that are either in line with or at odds with the financial advisor's personal interests (e.g., passively managed vs. actively managed funds). They find that many advisors act in their personal interests regardless of the client's actual needs and that they reinforce client biases (e.g., about the merits of employer stock) when it benefits them to do so. Similarly, Anagol et al. (2012) conduct an audit study of life insurance agents in India who are largely commission motivated. As in the previous study, scripted customers present themselves to the agents with differing amounts of financial and product knowledge. They find that life insurance agents recommend products with higher commissions even if the product is suboptimal for the customer. They also find that agents are likely to cater to customer's beliefs, even if those beliefs are incorrect. Finally, instead of debiasing less literate consumers, agents are less likely to give correct advice if the customer presents with a low degree of financial sophistication. Together these studies suggest that with asymmetric information, there is both a principal agent problem and an incentive for advisors to compete by reinforcing biases rather than providing truthful recommendations ( Gentzkow & Shapiro 2006 ; 2010 , Che et al. 2011 ).

Overall, this section suggests that are several potential roles for government in improving financial outcomes for consumers. First, government can help solve the public goods problems which result in underinvestment in financial education. Second, government can regulate the disclosure of fees and pricing. And third, government can provide unbiased information and advice.

5.2 The Scope for Government Intervention

If there is a role for government intervention, what form should it take? We have already summarized the literature on financial education. Briefly, there is at best conflicting evidence that financial education leads to improved economic outcomes either through increasing financial literacy directly or otherwise. So while the logical public policy response to many observers is to increase public support for financial education, this option may not be an efficient use of public resources even if it will likely do no harm. 9 In some contexts, other policy responses such as regulation may be more cost effective.

One regulatory alternative is to design policies that address biases and reduce the decision making costs that consumers face in financial product markets ( Thaler & Sunstein 2008 ). Because the financial literacy literature currently offers only limited models of behavior that give rise to the observed differences in financial literacy and economic outcomes, it is difficult to turn to this literature to design policies that address the underlying behaviors that lead to low levels of financial literacy and poor financial decision making. However, the literatures in behavioral economics and decision theory have developed several models that are relevant, and policies from this literature that address behavioral biases like present bias and choice overload may provide templates for effective and efficient remedies.

Several papers in this vein have already had substantial policy influence. For example, Madrian & Shea (2001) and Beshears et al. (2008) examine the impact of default rules on retirement savings outcomes. They find that participation in employer-sponsored savings plans is substantially higher when the default outcome is savings plan participation (automatic enrollment) relative to when the default is non-participation. Beshears et al. ascribe this finding to three factors. First, automatic enrollment simplifies the decision about whether or not to participate in the savings plan by divorcing the participation decision from related choices about contribution rates and asset allocation. Second, automatic enrollment directly addresses problems of present bias which may result in well-intentioned savers procrastinating their savings plan enrollment indefinitely. Finally, the automatic enrollment default may service as an endorsement (implicit advice) that individuals should be saving. In related research, Thaler & Benartzi (2004) find that automatic contribution escalation leads to substantially higher savings plan contribution rates over a period of four years. These results collectively motivated the adoption of provisions in the Pension Protection Act of 2006 that encourage U.S. employers to adopt automatic enrollment and automatic contribution escalation in their savings plan.

Hastings and co-authors ( Duarte & Hastings 2011 , Hastings et al. 2012 , Hastings, in progress) examine Mexico's experience in privatizing their social security system and draw lessons for policy design. Hastings et al. (2012) find that without regulation, advertising reduces investor sensitivity to financial management fees and increases investor focus on non-price attributes such as brand name and past returns. In simulations, they find that neutralizing the impact of advertising on preferences results in price-elastic demand. These results suggest that centralized information provision and regulation of both disclosure and advertising are important to ensure that individuals with limited financial capabilities have access to the information necessary for effective decision making and to minimize their confusion or persuasion by questionable advertising tactics.

In a related paper, Duarte & Hastings (2011) examine the impact of an information disclosure policy mandated in Mexico. In 2005 the government attempted to increase fee transparency in the privatized social security system by introducing a single fee index which collapsed multiple fees (loads and fees on assets under management) into one measure. Prior to the policy, investor behavior was inelastic to either type of fee or, indeed, any measure of management costs. In contrast, after the policy, demand was very responsive to the fee index. Once investors had a simple way to assess ‘price’, they shifted their investments to the funds with a low index value. This example suggests that investors can be greatly helped by policies that simplify fee structures and either advertise fees or require that they are disclosed in an easy-to-understand way. This example also highlights the potential pitfalls of ill-conceived regulations. Although the policy shifted demand, it had little impact on overall management costs. This is because the index combined fees according to a formula and firms could game the index by lowering one fee while raising another. Not surprisingly, firms optimized accordingly (another example of obfuscated pricing as discussed earlier). The government eventually responded by restricting asset managers to charging only one kind of fee, obviating the need for a fee index.

Hastings (in progress) evaluates two field experiments as part of a household survey (the 2010 EERA referenced in Table 2 ) to further understand the impact of information and incentives on management fund choice by affiliates of Mexico's privatized social security system. Households in the survey were randomly assigned to receive simplified information on fund manager net returns (the official information required by the social security system at the time) presented as either a personalized projected account balance or as an annual percentage rate. In addition to that treatment, households were randomly assigned to receive a small immediate cash incentive for transferring assets to any fund manager that had a better net return (or a higher projected personal balance). While those with lower financial literacy scores are better able to rank the fund managers correctly when presented with information on balance projections instead of APRs (replicating prior results in Hastings & Tejeda-Ashton 2008 , Hastings & Mitchell 2011 ), she finds no impact of this information on subsequent decisions to change fund managers. Rather, individuals who receive the small cash incentive are more likely to change fund managers (for the better) regardless of the type of information received. These preliminary results suggest that incentives that both address procrastination and that are tied to better behavior may be more effective than financial education as financial education does not carry with it any incentive to act. We note that these results are still short-run and preliminary as they are based on a follow-up survey. Final results will depend on administrative records for switching which are not subject to problems inherent in self-reports. 10

Campbell et al. (2011) lay out a useful framework for thinking about potential policy options to improve financial outcomes for consumers. They suggest that evaluating consumers along two dimensions, their preference heterogeneity and their level of financial sophistication (or, in the parlance of this paper, their financial literacy), may help narrow the set of appropriate policy levers for improving consumer financial outcomes. At one extreme, take the case of stored value cards, a product used by a large number of unsophisticated consumers and for which consumer preferences are relatively homogeneous. Campbell et al. propose that in this case, since everyone largely wants the same thing, consumers are probably best served through the application of strict rules. This is likely to be more efficient and cost effective than attempting to educate consumers in an environment in which firms are less stringently regulated. In contrast, if consumers are financially knowledgeable and have heterogeneous preferences other approaches may make more sense. Although Campbell et al. do not discuss financial education in this context, it would seem that financial education, to the extent that it impacts financial literacy and economic outcomes, is a tool that holds most promise in markets for products with some degree of preference heterogeneity and that require some degree of financial knowledge. At the other extreme, there are products like hedge funds that cater to individuals with tremendous preference heterogeneity and that require a sizeable amount of financial knowledge for effective use. The latter condition may seem like a perfect reason to justify financial education. We would counter, however, that in such a context it may be difficult for public policy to effectively intervene in providing the level of financial education that would be required. For products for which extensive expertise is required, it may be more efficient to restrict markets to those who can demonstrate the skills requisite for appropriate and effective use.

Overall, the literature suggests that there are many alternatives to financial education that can be used to improve financial outcomes for consumers: strict regulation, providing incentives for improved choice architecture, simplifying disclosure about product fees, terms, or characteristics, and providing incentives to take action. Although none of the studies that we reviewed here ran a horse race between these other approaches and financial education, many of them show larger effects than can be ascribed to financial education in the existing literature. Expanding these studies to other relevant markets such as credit card regulation, payday loan regulation, mortgages, and car or appliance loans present important next steps in understanding how best to improve consumer financial outcomes.

6. DIRECTIONS FOR FUTURE RESEARCH

In this paper, we have evaluated the literature on financial literacy, financial education, and consumer financial outcomes. This literature consistently finds that many individuals perform poorly on test-based measures of financial literacy. These findings, coupled with a growing literature on consumers’ financial mistakes and documenting a positive correlation between financial literacy and suboptimal financial outcomes, have driven policy interest in efforts to increase financial literacy through financial education. However, there is little consensus in the literature on the efficacy of financial education. The existing research is inadequate for drawing conclusions about if and under what conditions financial education works.

The directions for future research depend in part on the goal at hand. If the goal is to improve financial literacy, the directions for future research that follow hinge on financial literacy and the role of financial education in enhancing financial literacy.

One set of fundamental issues relate to capabilities. What are the basic financial competencies that individuals need? What financial decisions should we expect individuals to successfully make independently, and what decisions are best relegated to an expert? To draw an analogy, we don't expect individuals to be experts in all domains of life—that is the essence of comparative advantage. Most of us consult doctors when we are ill and mechanics when our cars are broken, but we are mostly able to care for a common cold and fill the car with gas and check our tire pressure independently. What level of financial literacy is necessary or desirable? And should certain financial transactions be predicated on demonstrating an adequate level of financial literacy, much like taking a driver's education course or passing a driver's education test is a prerequisite for getting a driver's license. If so, for what types of financial decisions would such a licensing approach make most sense?

Another set of open questions relate to measurement. How do we best measure financial literacy? Which measurement approaches work best at predicting financial outcomes? And what are the tradeoffs implicit in using different measures of financial literacy (e.g., how does the marginal cost compare to the marginal benefit of having a more effective measure?).

A third set of issues surrounds how individuals acquire financial literacy and the mechanisms that link financial literacy to financial outcomes. How important are skills like numeracy or general cognitive ability in determining financial literacy, and can those skills be taught? To the extent that financial literacy is acquired through experience, how do we limit the potential harm that consumers suffer in the process of learning by doing? Is financial education a substitute or a complement for personal experience?

We need much more causal research on financial education, particularly randomized controlled trials. Does financial education work, and if so, what types of financial education are most cost effective? Much of the literature on financial education focuses on traditional, classroom based courses. Is this the best way to deliver financial education? More generally, how does this approach compare with other alternatives? Is a course of a few hours length enough, or should we think more expansively about integrated approaches to financial education over the lifecycle? Or, on the other extreme, should financial education be episodic and narrowly focused to coincide with specific financial tasks? There are many other ways to deliver educational content that could improve financial decision making: internet-based instruction, podcasts, web sites, games, apps, printed material. How effective (and how cost effective) are these different delivery mechanisms, and are some better-suited to some groups of individuals or types of problems than others? Should the content of financial education initiatives be focused on teaching financial principles, or rules of thumb? In the randomized controlled trial of two different approaches to financial education for microenterprise owners in the Dominican Republic discussed earlier, Drexler et al. (2011) find that rule-of-thumb based financial education is more effective at improving financial practices than principles-based education. How robust is this finding? And to what extent can firms nullify rules-of-thumb through endogenous responses to consumer behavior (see Duarte & Hastings 2011 )?

Even if we can develop effective mechanisms to deliver financial education, how do we induce the people who most need financial education to get it? School-based financial education programs have the advantage that, while in school, students are a captive audience. But schools can only teach so much. Many of the financial decisions that individuals will face in their adult lives have little relevance to a 17-year-old high school student: purchasing life insurance, picking a fixed vs. an adjustable rate mortgage, choosing an asset allocation in a retirement savings account, whether to file for bankruptcy. How do we deliver financial education to adults before they make financial mistakes, or in ways that limit their financial mistakes, when we don't have a captive audience and financial education is only one of many things competing for time and attention?

Finally, what is the appropriate role of government in either directly providing or funding the private provision of financial education? If financial education is a public good (Hastings et al., in progress), would industry support a tax to finance publically-provided financial education? If so, what form would that take?

If instead of improving financial literacy our goal is to improve financial outcomes, then the directions for future research are slightly different. The overarching questions in this case center around the tools that are available to improve financial outcomes. This might include financial education, but it might also include better financial market regulation, different approaches to changing the institutional framework for individual and household financial decision making, or incentives for innovation to create products that improve financial outcomes.

With this broader frame, one important question on which we have little evidence is which tools are most cost effective at improving financial outcomes? For some outcomes, the most cost effective tool might be financial education, but for other outcomes, different approaches might work better. For example, financial education programs have had only modest success at increasing participation in and contributions to employer-sponsored savings plans; in contrast, automatic enrollment and automatic contribution escalation lead to dramatic increases in savings plan participation and contributions ( Madrian & Shea 2001 , Beshears et al. 2008 , Thaler & Benartzi 2004 ). Moreover, automatic enrollment and contribution escalation are less expensive to implement than financial education programs. What approaches to changing financial behavior generate the biggest bang for the buck, and how does financial education compare to other levers that can be used to change outcomes?

Despite the contradictory evidence on the effectiveness of financial education, financial literacy is in short supply and increasing the financial capabilities of the population is a desirable and socially beneficial goal. We believe that well designed and well executed financial education initiatives can have an effect. But to design cost effective financial education programs, we need better research on what does and does not work. We also should not lose sight of the larger goal—financial education is a tool, one of many, for improving financial outcomes. Financial education programs that don't improve financial outcomes can hardly be considered a success.

Unfortunately, we have little concrete evidence to provide answers. We have a pressing need for more and better research to inform the design of financial education interventions and to prioritize where financial education resources can be best spent. To achieve this, funding for financial education needs to be coupled with funding for evaluation, and the design and implementation of financial education interventions needs to be done in a way that facilitates rigorous evaluation.

Acknowledgments

We acknowledge financial support from the National Institute on Aging (grants R01-AG-032411-01, A2R01-AG-021650 and P01-AG-005842). We thank Daisy Sun for outstanding research assistance. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Institute on Aging, the National Bureau of Economic Research, or the authors’ home universities. For William Skimmyhorn, the views expressed herein are those of the author and do not reflect the position of the United States Military Academy, the Department of the Army, the Department of Defense, or the National Bureau of Economic Research. See the authors’ websites for lists of their outside activities. When citing this paper, please use the following: Hastings JS, Madrian BC, SkimmyhornWL. 2012. Financial Literacy, Financial Education and Economic Outcomes. Annual Review of Economics 5: Submitted. Doi: 10.1146/annurev-economics-082312-125807.

NBER working papers are circulated for discussion and comment purposes. They have not been peer-reviewed or been subject to the review by the NBER Board of Directors that accompanies official NBER publications.

Financial Literacy, Financial Education and Economic Outcomes Justine S. Hastings, Brigitte C. Madrian, and William L. Skimmyhorn NBER Working Paper No. 18412 September 2012 JEL No. C93,D14,D18,D91,G11,G28

1 See Dodd-Frank Wall Street Reform and Consumer Protection Act. H.R. 4173. Title X - Bureau of Consumer Financial Protection 2010, Section 1013. < http://www.gpo.gov/fdsys/pkg/BILLS-111hr4173enr/pdf/BILLS-111hr4173enr.pdf , accessed September 13, 2012>

2 By 2011, economic education had been incorporated into the K-12 educational standards of every state except Rhode Island, and personal finance was a component of the K-12 educational standards in all states except Alaska, California, New Mexico, Rhode Island, and the District of Columbia (Council for Economic Education, 2011).

3 See http://www.ja.org/about/about_history.shtml and http://www.councilforeconed.org/about/ .

4 The NFCS has three components, a national random-digit-dialed telephone survey, a state-by-state on-line survey, and a survey of U.S. military personnel and their spouses.

5 Based on author's calculations using TNE survey responses from 2012 linked to college loan taking data in Chile. See Hastings, Neilson and Zimmerman (in progress) for details on the survey and data.

6 Cole and Shastry (2010) are able to replicate the qualitative results of Bernheim, Garrett and Maki (2001) when using the same empirical specification even though they use a different source of data.

7 Financial literacy and savings are positively correlated in this model, although the relationship is not causal as both are endogenously determined.

8 See the Frontline documentary ”The Card Game” about how teaser rate policies were developed in response to customer service calls in which consumers were persistently overconfident in their ability to repay their debt.

9 See the discussion in Section 4. There is also a large literature in the economics of education documenting the fact that large increases in real spending per pupil in the United States has led to no measurable increase in knowledge as measured by ability to answer questions on standardized tests.

10 If the preliminary results hold, this policy is a very inexpensive alternative to financial education. Hastings notes that the immediate return (net of the incentive) on each incentivized offer from resorting of individuals across fund managers, before allowing firms to drop prices in response, results in $30 USD in expectation. Aggregated over 30 million account holders, this is a large savings even before allowing for secondary competitive effects, and in equilibrium it is virtually costless to implement.

RELATED RESOURCES

The following datasets with financial literacy questions that are referenced in this article are currently publically available.

2004 U.S. Health and Retirement Survey: http://hrsonline.isr.umich.edu/index.php?p=data

2010 U.S. Health and Retirement Survey: http://hrsonline.isr.umich.edu/index.php?p=data

2009 Rand American Life Panel Wellbeing 64: https://mmicdata.rand.org/alp/index.php?page=data&p=showsurvey&syid=64

2009 U.S. National Financial Capability Study: http://www.finrafoundation.org/programs/p123306

2009 Chilean Social Protection Survey (EPS): http://www.proteccionsocial.cl/index.asp

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