Financial literacy is a growing concern in the US, with many lacking essential knowledge for informed financial decisions. A study by Goalsetter assessed the financial literacy of 1065 undergraduates from Harvard, Stanford, and the University of Pennsylvania. Using an online quiz aligned with JumpStart.org and Council for Economic Education (CEE) standards, the results revealed unexpected gaps in knowledge among these top students. Let’s explore these findings.
Majority Scoring Failing Grades On The Quiz
51% of the participating students failed this personal finance quiz, and only 13% scored enough to get a grade of C-. It is concerning since 93% of the students owned a debit card, which shows their familiarity with spending. However, only 48% knew what compound interest is. Without understanding the time value of money (which compound interest represents), students might make hasty spending decisions. Plus, not knowing how compound interest can grow savings over time can hinder long-term financial planning.
Don’t Know The Difference Of Various Savings Accounts
54% of the respondents did not know the difference between a high-yield savings account (HYSA) and a regular savings account. High-yield savings accounts offer a better return on your savings compared to traditional savings accounts. This means your money grows faster. This is all while your money is FDIC-insured, just like regular savings. 30% thought HYSA requires a long-term commitment, which is why it is perfect for building an emergency fund or saving for a big purchase.
More Than Half Didn’t Know The 50/30/20 Rule
Emergency saving funds are a big part of personal finance, and 50/30/20 is one of the most used rules for efficiently managing personal finance. Two-thirds of the participants knew that they should have their three to six months of expenses in emergency savings funds; only 47% knew how to do that using this rule. According to this rule, 50% of your income goes towards essential needs (rent, groceries, bills), 30% goes towards wants (dining out, entertainment, hobbies), and 20% goes towards savings and debt repayment (emergency fund, retirement, loans.
Doubtful Future Homeowners
While 87% of the participating students want to own a home someday, only 48% know the basics of private mortgages. Private mortgage insurance needs to be paid on top of traditional home insurance when a borrower takes out a conventional mortgage loan with a downpayment of less than 20%.
Don’t Know How Stocks & Bonds Differ
Among all the students who wish to retire early, 26% didn’t know the difference between stocks and bonds. Stocks and bonds are two fundamental investment types. Knowing the difference between the two can help one manage risks better. For example, stocks can provide growth potential, while bonds offer stability and income.
No Idea Of IRA
Only 48% of the participating students knew the definition of an IRA. At the same time, 17% believed that an IRA is something that the Social Security Administration provides. Another 15% believed that employers provide IRAs. Both groups that believe IRAs are provided by the Social Security Administration or employers are incorrect. An IRA (Individual Retirement Account) is a retirement savings account that an individual sets up. It’s a personal investment vehicle, not a government program or an employer benefit. While some employers offer matching contributions to employee-sponsored retirement plans like 401(k)s, these are separate from IRAs.
Poor Early Retirement Plans
While almost all of the students agree on planning an early retirement, their calculations don’t seem to align. Only 10% of the respondents knew the recommended amount of money they needed to save towards retirement by the time they hit 30, which is 1X of their salary. The majority of the students (90%) thought they needed to save 200% of their annual salaries by the age of 30 to retire early. While this seems harmless, and some might support this by saying they are aiming for the high, it has some downsides, too. Setting these extremely hard-to-achieve goals might force them to quit early retirement plans, even without executing them. Having a rational number in mind will help them plan better.
Not Knowing Credit Card Fundamentals
While 77% of the participating students knew that payment history is a big contributor to building a good credit score, only 49% knew that keeping the credit card spending under 30% of the total card limit boosts credit score.
Unrealistic Plans for Credit Card Repayments
82% of the students in the survey agreed that it is a sound idea to invest their money and use the interest generated from it to repay their credit card debt. They think picking an investment scheme that offers higher interest rates than their credit card’s interest is the solution. This shows that their knowledge of practical investment plans is very limited. This is because there are very few low-risk investment schemes where the investment returns would be higher than the credit card’s interest.
Taking a Loan Is No No For Credit Card Repayment
55% of the students participating in the survey said that they would never take a loan to pay their credit card bills. This shows that they are unaware of the concept of debt consolidation. It is the process of combining multiple debts into a single loan and paying only one monthly payment. It is a viable option if the loan comes with a lower interest rate than the credit card’s. Plus, the improved credit score over time becomes an added bonus.
Parent’s Education Influences Financial Literacy
The survey found that students with parents who had higher education (more than a diploma) were more aware of financial concepts.
55 % of students whose parents studied up to a Diploma didn’t know about the guidelines for emergency funds. On the other hand, 73% of students from a higher-educated family knew about the same.
58% of the students from advanced degree households knew the rule of 72, whereas the number for the other group was only 44%. Similar results were found when it came to concepts of tax liability and knowing the difference between stocks and bonds.
Parent’s Wealth Also Influences Financial Literacy
The survey showed that students who belonged to a household where the income was less than $250K were less aware of the basics of finance.
64% of the students from the wealthiest families understood the rules of 72, while only 47% of students belonged to an under 250K household.
Similarly, 61% of wealthy students knew about the power of compound interest compared to 46% of families earning under $250K. The same situation is also noticed when it comes to having knowledge of stocks and bonds. 82% of wealthy kids knew the difference between stocks and bonds, while it is only 67% of the other group.
At Least Self-aware Of Their Knowledge Gap
The before and after statistics of the quiz indicated that the students were quite self-aware. Prior to the quiz, 44% of the participating students thought that they had a solid understanding of core personal finance concepts. However, after the quiz, the number suddenly dropped to 27%. It is a positive sign. It shows that the students are self-aware of their shortcomings and willing to learn in the future.