The Sad State of Financial Literacy Among America's Youth (and How to Fix It)

By Markets Fool.com


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America has a retirement problem, and it's very possible this problem can be traced to a lack of financial knowledge.

According to a recent GOBankingRates survey on retirement savings, 56% of Americans have $10,000 or less socked way for their golden years, including one in three with nothing at all. A similar story is seen with millennials. A five-question multiple choice quiz from the Financial Industry Regulation Authority on basic financial literacy concepts, such as interest, mortgages, inflation, and stocks, produced passing grades (four or five correct answers, out of five) for only 24% of millennial test-takers.

Our children are being set up for financial failure

But, the truly damning data comes from a survey conducted by the Programme for International Student Assessment (PISA), which is run by the Organisation for Economic Co-operation and Development (OECD). In 2012, PISA ran its Students and Money study that compared the financial literacy skills of 15-year-olds in 18 different OECD countries, including the United States. In total, about 510,000 students among these 18 countries participated in helping PISA cull its data. PISA's survey probed students' knowledge of basic financial literacy, which included money management, risk and reward identification, and application of their financial knowledge and understanding.

The results showed that despite having access to ample financial knowledge, America's youth actually performed worse than the 18-country OECD average, scoring 492 points compared to the overall average of 500 points. The top-performing OECD country was China (specifically Shanghai), with a score of 603.

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Teenagers in the United States finished below countries like Latvia, Poland, Estonia, and the Czech Republic in terms of financial literacy. The U.S. also had 17.8% of test-takers finish with the lowest level (level 1) of financial education on a scale of five, compared to just 9.4% that finished with the highest level of financial literacy possible (level 5). Comparatively, China had only 1.6% of 15-year-olds at level 1 and 42.6% at level 5. A student at level five understands the implications of income-tax brackets and can calculate the balance of a checking or savings account based on a bank statement.

To summarize: a lot needs to be done to improve the financial literacy of teens worldwide, but the answers of how to make that happen aren't exactly clear according to PISA. However, if this trend continues, we in the U.S. could be faced with a rising number of people who don't understand how to save and invest, and are thus ill-prepared come retirement.

So how do we fix this problem?

Play an active role in developing their financial literacy

The real key is that parents need to take an active role in passing along financial knowledge to their kids. While it would be great to assume that your kids are being taught basic financial skills in school, it's not a guarantee with curriculums differing on a state-by-state basis. If your child is taught the basics of balancing a checkbook, creating a budget, and investing in the stock market in middle school or high school, then great -- but don't count on it.

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One of the most important lessons you can teach your children as a parent is the value of a dollar. This starts with understanding the basics of balancing a checking account and analyzing cash flow. Although piggy banks can be great to teach very young children about saving, stuffing money under the mattress is a very impractical tool once you get older. Most adults use a checking account, and it's important that children are introduced early to the idea of balancing a checkbook to factor in money received and expenses paid. And who better to introduce them to a bank account than their parent who's likely had a checking account for years or decades.

The easiest way to do this is by opening a savings account at a local credit union for your child. Having a savings account will allow them to keep tabs on their account via a balance ledger or bank statement, and it'll also teach them about earned interest. Engraining the importance of compounding and interest at an early age can have a big impact on a persons' desire to save and invest as they age. PISA's study showed that students with a bank account scored 37 points higher than those who did not.

It's also critical that you teach your children how to live off a budget and invest. It's not enough that your children simply understand their cash flow -- they need to be able to use this cash flow data to optimize their ability to save and invest for their future. The good news is both aspects can be tackled with ease online.

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Budgeting tools can be found online that require little effort on your part, other than entering your income and expenses, which is where your and your child's understanding of cash flow will come in handy. With the software handling the adding and subtracting, you and your child can focus on how much they'd like to save, and perhaps even set up an automatic weekly or monthly transfer to an investment account to hold your child accountable to their budget. It's also just as important that you and your child set aside time each month, say 30 minutes, to review their budget and assess their progress. Remember, budgetary goals should be measurable and specific.

Teaching your child how to invest can be done online as well. Practice accounts can be found with multiple brokerage firms, allowing children to "paper trade" and get their feet wet. No one is going to become a billionaire overnight, so paper trading can allow your child the time to develop the basic analytical skills of stock research they'll need to be successful over the long-term. We at The Motley Fool also pride ourselves on the 13 Steps to Investing Foolishly, which can be a great start for someone looking to get involved in the stock market for the first time.

The key point being that children are liable to emulate their parents' financial habits. Therefore, the more responsible and knowledgeable you are with your finances, the more of an impact you can have in putting your kids on the right financial path when they become young adults.

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Sean Williamshas no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen nameTMFUltraLong, and check him out on Twitter, where he goes by the handle@TMFUltraLong.

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