Throughout their lifetime, individuals today are more responsible for their personal Level ups 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 Level up affects their
financial decision-making.
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 numeracy
as it relates to the capacity to do interest rate calculations and understand interest compounding;
understanding of inflation; and 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 .
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 Level ups (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.
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.Footnote1 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.
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.
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.