Financial literacy among Americans is more important now than it ever has been because retirement savings has moved away from defined benefit plans, where people expected to get a set amount when they retired, to defined-contribution plans, where they are asked to make decisions about how they want to invest their money.
"To navigate the path toward a comfortable retirement requires sound knowledge of financial basics and the existing investment choices, as well as the ability to understand and cope with the ever-changing set of financial instruments," according to a new report by the Employee Benefit Research Institute that looks at the difference between financial behavior and financial literacy.
People with higher levels of financial literacy tend to approach retirement with much higher levels of wealth, according to the report. It also found that the majority of Americans have limited financial knowledge about basic concepts like inflation, compound interest, risk diversification and numeracy skills.
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The EBRI study investigates the role of the states in explaining financial literacy and behavior. This analysis addresses the question of whether there is any structural difference in financial literacy and financial behavior among states that cannot be attributed to individual characteristics such as income, education, gender or race.
The objective of the surveys used to devise this report was to construct measures of financial literacy and behavior and study how they vary across states. The research found that 15 states appeared in the top 15 of both rankings, financial literacy and financial behavior: New Hampshire, Minnesota, Idaho, Washington, Colorado, Wisconsin, Utah, Alaska, and Maryland. Louisiana was at the bottom of the rankings for financial literacy, while West Virginia was at the bottom of the rankings for financial behavior.
"But based on these rankings alone, it cannot necessarily be concluded that there is something structurally lacking in these states. It could be the case that these states have a large concentration of low education/low-income households that are unable to attain adequate financial literacy. But if the analysis can control for the individual demographic characteristics and still show that some states are more likely to perform worse than others in terms of financial literacy and financial behavior indicators, then policymakers in those states would have something to think about," the report found.
The data show that mostly the same states tend to appear at the top and bottom of financial literacy and financial behavior rankings. This suggests that there might be something going on at the state level whereby individual financial literacy and financial behavior are being shaped not only by individual demographic characteristics but also by the state in which people live, the report concluded.
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