Articlediamond2013

The Geography of Financial Literacy

Christopher Bumcrot · Judy Lin · Annamaria Lusardi

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Financial Literacy, Pension, Retirement Analysis Decision-Making and Behavioral Economics Financial Literacy and Behavior

Abstract

This paper explores how well equipped today’s households are to make complex financial decisions in the face of often high-cost and high-risk financial instruments. Specifically we focus on financial literacy. Most importantly, we describe the geography of financial literacy, i.e., how financial literacy is distributed across the fifty US states. We describe the correlation of financial literacy and some important aggregate variables, such as state-level poverty rates. Finally, we examine the extent to which differences in financial literacy can be explained by states’ demographic and economic characteristics. To assess financial literacy, five questions were added to the 2009 National Financial Capability Study, covering fundamental concepts of economics and finance encountered in everyday life: simple calculations about interest rates and inflation, the workings of risk diversification, the relationship between bond prices and interest rates, and the relationship between interest payments and maturity in mortgages. We constructed an index of financial literacy based on the number of correct answers provided by each respondent to the five financial literacy questions. The financial literacy index reveals wide variation in financial literacy across states. Much of the variation is attributable to differences in the demographic makeup of the states; however, a handful of states have either higher or lower levels of financial literacy than is explained by demographics alone. Also, there is a significant correlation between the financial literacy of a state and that state’s poverty level. The findings indicate directions for policy makers and practitioners interested in targeting areas where financial literacy is low.

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References

2007Financial Literacy and Stock Market Participation 2007Baby Boomer retirement security: The roles of planning, financial literacy, and housing wealth 2011Financial literacy around the world: an overview 2010Financial Literacy among the Young 2003Household Financial Management: The Connection between Knowledge and Behavior 2008Planning and Financial Literacy: How Do Women Fare?2003The Role of Information and Social Interactions in Retirement Plan Decisions: Evidence from a Randomized Experiment 2010Cognitive Ability and Portfolio Choice

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