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Financial Knowledge and Financial Literacy at the Household Level

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  • Alan L. Gustman

    (Dartmouth College and NBER)

  • Thomas L. Steinmeier

    (Texas Tech University)

  • Nahid Tabatabai

    (Dartmouth College)

Abstract

This paper uses data from the Health and Retirement Study to explore the mechanism that underlies the robust relation found in the literature between cognitive ability, and in particular numeracy, and wealth, income constant. We have a number of findings. First, the more valuable the pension, the more knowledgeable are covered workers about their pensions. We suggest that causality is more likely to run from pension wealth to pension knowledge, rather than the other way around. Second, most measures of cognitive ability, including numeracy, are not significant determinants of pension and Social Security knowledge. Third, standardizing for incomes and other factors, a pension of higher value does not substitute for other forms of wealth. Rather, counting pensions in total wealth, those with more valuable pensions save more for retirement, other things the same. Fourth, there is no evidence that wealth held outside of pensions is influenced by knowledge of pensions. In sum, numeracy does not influence wealth in whole or in part by affecting financial knowledge of one's pension plan, where financial knowledge of the pension then influences other decisions about retirement saving. These findings raise questions about the mechanism that underlies the relation between cognition, especially numeracy, and wealth. From a policy perspective, they suggest that the numeracy-wealth relation should not be taken as evidence that increasing financial literacy will increase the wealth of households as they enter into retirement.

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Bibliographic Info

Paper provided by University of Michigan, Michigan Retirement Research Center in its series Working Papers with number wp223.

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Length: 52 pages
Date of creation: Sep 2010
Date of revision:
Handle: RePEc:mrr:papers:wp223

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References

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  1. Victor Stango & Jonathan Zinman, 2009. "Exponential Growth Bias and Household Finance," Journal of Finance, American Finance Association, vol. 64(6), pages 2807-2849, December.
  2. McArdle, John J. & Smith, James P. & Willis, Robert, 2009. "Cognition and Economic Outcomes in the Health and Retirement Survey," IZA Discussion Papers 4269, Institute for the Study of Labor (IZA).
  3. Annamaria Lusardi & Olivia S. Mitchell, 2006. "Baby Boomer Retirement Security: The Roles of Planning, Financial Literacy, and Housing Wealth," Working Papers wp114, University of Michigan, Michigan Retirement Research Center.
  4. Kristopher Gerardi & Lorenz Goette & Stephan Meier, 2010. "Financial literacy and subprime mortgage delinquency: evidence from a survey matched to administrative data," Working Paper 2010-10, Federal Reserve Bank of Atlanta.
  5. James Banks & Zoƫ Oldfield, 2006. "Understanding pensions: cognitive function, numerical ability and retirement saving," IFS Working Papers W06/05, Institute for Fiscal Studies.
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Cited by:
  1. Annamaria Lusardi & Olivia S. Mitchell, 2013. "The Economic Importance of Financial Literacy: Theory and Evidence," CeRP Working Papers 134, Center for Research on Pensions and Welfare Policies, Turin (Italy).
  2. Jappelli, Tullio & Padula, Mario, 2011. "Investment in financial literacy and saving decisions," CFS Working Paper Series 2011/07, Center for Financial Studies (CFS).
  3. Maarten C.J. van Rooij & Annamaria Lusardi & Rob J.M. Alessie, 2012. "Financial Literacy, Retirement Planning and Household Wealth," Economic Journal, Royal Economic Society, vol. 122(560), pages 449-478, 05.
  4. James P. Smith & John J. McArdle & Robert Willis, 2010. "Financial Decision Making and Cognition in a Family Context," Economic Journal, Royal Economic Society, vol. 120(548), pages F363-F380, November.
  5. John V. Duca & Anil Kumar, 2011. "Financial literacy and mortgage equity withdrawals," Working Papers 1110, Federal Reserve Bank of Dallas.

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