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Financial Knowledge and Financial Literacy at the Household Level

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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.

Key Findings

  • The more valuable the pension, the more knowledgeable are covered workers about their pensions. We argue that causality is more likely to run from pension wealth to pension knowledge than the other way around.
  • Most measures of cognitive ability, including numeracy, are not significant determinants of pension and Social Security knowledge.
  • Standardizing for incomes and other factors, a pension of higher value does not substitute for other forms of wealth. Counting pensions in total wealth, those with more valuable pensions save more for retirement, ceteris paribus.
  • There is no evidence that wealth held outside of pensions is related to knowledge of pensions.
  • Our findings raise questions about the avenues through which cognition and numeracy increase retirement wealth. 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.
  • Accordingly, our analysis raises questions about whether the apparently robust numeracy-wealth relation provides a justification for designing policies that are aimed at increasing retirement saving by increasing numeracy or financial literacy.

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Project

Paper ID

WP 2010-223

Publication Type

Working Paper

Publication Year

2010