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Celebrating Financial Literacy Month

Happy Financial Literacy Month! Ever since Congress passed Resolution 316 into law back in 2003 (with some lobbying help from the FPA, among others) we've seen hundreds of poster contests, surveys, promotional events, workshops, contests, calls for volunteers and stentorian messages declaring the importance of promoting financial literacy in America and around the world.

Raising the level of financial literacy in our population is clearly a noble and important goal. But… What's missing in the great majority of these messages is a clear definition of what this goal would look like if it were achieved.

What do we actually mean when we talk about financial literacy? What, exactly, do we want to happen?

I think we start to gain some measure of clarity if we divide financial literacy into layers, sort of like the way colleges break out the levels of mastery in their coursework. If you arrive on campus without having mastered certain remedial skills, then the college will help you catch up in basic math or reading. From there, it offers 100-level courses that are part of the core curriculum for all majors–which, in other words, everybody has to take, so that graduates have master the basics of a variety of subjects. The 200-level coursework, meanwhile, is for students majoring in the subject, and you move up the ladder into 300, 400 and 500-level courses through graduate studies.

If we apply this structure to financial literacy, then the remedial subjects are the things that everybody needs to master before they can function as normal members of our society. Everybody should be able to balance a checkbook. Everybody should understand how credit cards work, what a home or auto loan is and what it means to pay interest rates on various kinds of debt. I would argue that people need to understand at least the difference between a stock and a bond, between debt and equity, and the basics of homeowners, auto and health insurance.

Are people financially literate if they pass this remedial level? I would say no. They need to also master the 100-level material.

The 100-level courses would teach people how to compare their expenses and income. It would include the basics of creating a budget. People would learn the importance of setting aside, systematically and regularly, a percentage of their total income for savings and investing.  Morningstar's Don Phillips has said that saving and investing is "an adult responsibility," and I think that's a great way of framing the importance of mastering 100-level financial literacy.  People who are able to set aside at least 15% of their income, regularly over their working lives, become wealthy simply as a matter of systematic routine.

Before they pass the 100-level coursework, consumers would have to understand that the investment markets have, over time, given people more than their initial investment back, despite all the short-term volatility that makes them look risky. This is a casino where the odds are in your favor, if you're willing to be patient. Ideally, upon completion of the full coursework, people know enough to turn off the cable financial channels and cancel their subscription to Money magazine.

I would say that people are "financially literate" once they complete this 100-level coursework.

If they decide to advance to the 200 level, then we can start to think of people as "financial majors"–or, in our normal parlance, as astute do-it-yourself investors.

At the 200 level, they start to master the more intricate nuances of investing: the importance of a balanced portfolio holding noncorrelated asset classes and the risks associated with concentrated holdings, the (often hidden) costs associated with investing, the dangers of chasing investment fads or trends or the next hot stock or mutual fund, the gravitational impact of constant reversions to the mean, the fact that certain investments can become expensive or cheap, and you're better off thinking like a shopper (buy at a discount) than like most investors (The market is up! Buy!).

At the 300 level, people understand how to use debt to their advantage and can talk about the correlation coefficients of different investments. They are capable of investing knowledgeably in things like private real estate and private equity. They can model their own financial future using spreadsheets or more sophisticated software tools, and they actually understand the output of a Monte Carlo engine.

We might loosely describe the CFA, CFP and CPA designations as graduate degrees in financial literacy.

This spectrum of knowledge helps us better define what we're trying to accomplish when we promote financial literacy. The important social goal we're trying to highlight with these silly "financial literacy month" promotions is getting people functionally literate in their personal finances, the way we want them to be literate in their ability to comprehend the written word.  The higher percentage of our population masters the basics of personal finance, the healthier our society will be.

I would argue that if we can get people to the 100 level, they will be functionally literate in the most important financial matters. They will be able to sustain themselves as economic units throughout their lifetime, and they have the awareness and understanding to create wealth.  

Meanwhile, I would argue that our goal should NOT be to move people to the 200 level and above. This would be the equivalent of remedial reading and writing programs trying to get their students to appreciate the works of Shakespeare.  You could argue that this would be a wonderful thing, but I'm not sure it makes our society any healthier.

Like most of you who hold a graduate degree in financial literacy, I wholeheartedly support the idea of Financial Literacy month, and of promoting greater financial fluency in general. In fact, I think this effort should not be confined to a single month. And I would dearly like to see exactly this educational outline made a part of the normal college course experience.

But I also think we have an obligation to be clear about what, exactly, we're promoting. If, this month, we did nothing more than help the general public understand what, exactly, we professionals believe they should know in order to be effective in our complex economic system, that alone would be a significant achievement.