Financial literacy is right up there with Mom and apple pie as an American ideal, but it's a challenge to figure out effective ways to achieve it. In the two decades I've been writing about kids and money, I've observed thousands of parents, children, teachers and students, and I've come to my own conclusions about what works best in teaching kids to be financially savvy.
I was curious, however, to see how my observations stack up against formal research in the field. To find out, I spoke with Annamaria Lusardi, head of the Global Center for Financial Literacy and professor of economics and accountancy at the George Washington School of Business. Lusardi has focused her academic career on financial literacy, and what I learned, to my relief, is that my conclusions are pretty much on target.
Take things one step at a time. Some critics say that teaching kids financial literacy won't help them read a complicated 50-page contract when they buy their first house. So why bother? "That shows a major misunderstanding," says Lusardi. "We don't teach students literature so that they can write 'War and Peace.' We teach literature so that they can appreciate a good book. Financial literacy is a basic tool that helps people cope with day-to-day financial management."
In my experience, it's best to start small. Lessons should always be age appropriate, and if you can teach kids just one thing, it can make a huge difference. For example, when teaching teenagers about credit cards, the first lesson should be that plastic is not cash; it's a loan they will have to repay, plus extra in interest. If they understand that, you'll have taken a big step toward keeping them out of debt even if they're too young to appreciate and understand a credit card agreement. That will come later.
Make lessons relevant. Studies often show that kids aren't learning money skills. But, says Lusardi, "I'd be cautious about studies that measure financial knowledge. You also need to measure other things, such as the curriculum. Do the questions have any resemblance to what is being taught?" She points out that financial literacy is often a single elective course taught at the end of high school. "Almost no one learns math or science like that."
My quibble with some financial-literacy tests is that I don't expect kids to answer questions about adult concepts such as insurance, investing or Social Security. Learning how to budget an allowance can be invaluable in teaching children how to manage money, but such lessons aren't always reflected in exam questions.
Make lessons fun and interactive. Lusardi notes that there's "a paucity of studies" on how to teach financial literacy effectively. "We need to learn more about what sticks." We know that with adults what sticks is games with a financial theme. "People learn by seeing things repeated," she says, "but we don't make multiple financial decisions about buying a house or going to college, so games help." Stock market games, for instance, seem to work with children, too.
I can attest that some of the most effective -- and fun -- lessons that I've witnessed involved games that engaged kids' attention. In fact, playing the game itself is even better than awarding prizes. I've seen teenagers clamor to shout out answers in games of financial football and soccer, and I've watched middle-school students use online tools to calculate loan rates while playing simulated-reality games in which they had to buy houses and cars.
Focus on reasonable goals. Lusardi is working with the Council for Economic Education to set uniform standards that would include a number of concepts -- "for example, gross versus net wages, compound interest, inflation, opportunity cost and risk diversification."
I have my own ideas about the money basics kids need to know before they leave home:
• How to manage a cash allowance.
• How to manage a checking account with a debit card.
• How to save for a goal.
• How to compare prices when shopping.
• How small amounts saved when you're young can grow into big piles of money (use the calculator at Moneychimp.com).
• How long it takes to pay off credit card debt (use the calculator at Moneychimp.com).
At its heart, says Lusardi, financial literacy empowers people to make choices. I say amen to that.
From taxes and credit to saving and money management, you can get lost in the complexity and abundance of financial issues. But by learning some simple fundamentals, you can take control of your finances and feel secure in your money management skills.
How well do you know the basics of personal finance?
Put your knowledge to the test with this 12-question quiz.
A. Under your mattress
D. Bank savings account
You want money you plan to use within the next three to five years to be safe and easily accessible. Lock it up in a savings or money market account. You won't earn much interest on it with rates so low, but you also won't lose any of it to the volatility of the stock market. You can find search for which accounts are offering the best rates on Bankrate.com.
A. Suck up to the boss
B. Get a second job
C. Adjust your tax withholding
If you typically get a tax refund each spring (and most of you do), file a new Form W-4 with your employer to increase the number of exemptions you claim - and lower the amount Uncle Sam takes from your paycheck. Try our easy-to-use tax withholding calculator to help you figure the right number for your situation.
A. Pay bills on time and keep credit-card balances low
B. Limit applications for new credit and keep old accounts open
C. Sweet-talk the credit-card company phone rep
The simple act of paying bills on time and keeping your balances low accounts for 65% of your credit score. New credit and the length of your credit history make up 25% of your score. The remaining 10% factors in the types of credit you use. Sorry, sweet-talking will get you nowhere.
A. Treasury bonds
B. Money market account
D. Residential real estate
Stocks fare best over long stretches of time. Take the 20-year period through 2012, for example. The average taxable U.S. money-market fund returned 2.8% annualized. Residential real estate, as measured by Standard & Poor's Case-Shiller index, did just slightly better with 3.0% annualized. Barclay's U.S. Treasury index earned 6.3% a year, on average. And the S&P 500 trumped them all, delivering 8.2% annualized.
A. Life insurance
B. Health insurance
C. Auto insurance
You only need life insurance if you have someone depending on you financially. Bob is unwed and childless, so he doesn't need it. However, he will need health insurance and auto insurance to protect himself against disaster.
B. 529 plan
C. Municipal bonds
D. Certificate of deposit
E. None of the above
A bank CD falls under federal protection if it's FDIC insured. That means up to $250,000 is protected in case a bank goes under, and you get up to $250,000 of insurance at each bank where you buy CDs. Municipal bonds, 529 plans, 401(k)s and other investments are not covered. You invest at your own risk.
Ashley, age 20, contributes $3,000 per year to an individual retirement account for ten years, then stops, letting her money sit in the account. Adam, age 30, contributes $3,000 each year to an IRA for 35 years. Who will have more money at age 65, assuming they get identical investment returns?
Ashley comes out ahead, thanks to the magic of compounding. Even though she stopped contributing after only ten years, her money will grow to about $694,000 by the time she retires, assuming an 8% annual return. Adam, who got a late start, but pitched in more money out of pocket, will amass about $558,000.
A. Your credit score
B. Your car make and model
C. Your car color
D. Your address
Insurers look at a variety of factors to calculate your risk, but the color of your car isn't one of them. Your financial habits, the type of car you drive and where you drive do matter.
A. At age 16
B. At age 18
C. When they get their first job
D. When their income reaches certain levels
A child's age or job has nothing to do with it. Rather, the IRS cares about how much the child made and the source of the income. For example, children who have investment income of more than $950 or have wage income of more than $5,950 in 2012 need to file a return. Children who receive a paycheck and have taxes withheld may want to file even if they don't have to - they could reclaim most or all of their income taxes.
You can withdraw contributions you made to a Roth IRA at any time, for any purpose without paying any taxes or penalties, and without having to pay it back - ever.
Any money you put into your Roth IRA is yours for the taking - even if you aren't retired. The money your account earns, however, cannot be touched until you're 59½ and have had a Roth for at least five years. Otherwise, you'll owe taxes and a 10% early withdrawal penalty on earnings. An exception: Once the money's been in your account for five years, you can tap your earnings to buy your first home.
B. Notify your bank and credit-card companies
C. Contact the credit bureaus
D. Call the Social Security office
Put your tears of frustration on hold. First, notify your credit-card companies and bank to monitor your accounts for fraudulent charges, just in case your wallet falls into the wrong hands. Second, contact the credit bureaus and put a fraud alert on your report. This will require lenders to make an effort to verify your identity before issuing new credit in your name. It also gives you a free copy of your credit report so you can review it for suspicious activity.
A. Upgrade your lifestyle: You've been pinching pennies for too long. It's time to reward yourself and live it up.
B. Maintain your lifestyle: Take this opportunity to pay off your high-interest debts and boost your savings. It's time to get ahead.
Sure, it's tempting to spend the money, but using it to strengthen your financial footing is the smarter choice that'll pay off exponentially in the long run.