On Wednesday I participated in Minnesota Jump$tart’s annual event at the Federal Reserve Bank of Minneapolis. Minnesota Jump$tart is part of a national coalition focusing on boosting financial literacy among young folks. They asked good questions. The title of my talk captures my perspective: “Where there is financial literacy, there’s optimism.’’
Financial literacy matters more than ever. Although there are many factors at play, a major reason is two fundamental shifts over the past three decades in how we manage money. The first involves retirement savings. Companies moved away from traditional pensions where the company takes all the financial risk. Instead, management embraced 401(k) savings plans. Employees decide how much money to invest and where to invest it, depending on the limits established by law and the choices offered by the employer’s plan. Employees bear all the investment risk.
The 401(k) mind-set has spread. Colleges now count on parents and their children to come up with more tuition dollars on their own. Hard to believe, but as recently as the early 1990s the student loan market wasn’t very big. Student loan debt burdens have since exploded and graduates need to be schooled in the various repayment options.
Employers increasingly rely on the same 401(k)-type approach with their employees’ health care benefits. Financial literacy means understanding the risks and returns of the money decisions we face.
The second shift involves the “democratization of credit.” Credit choices once limited to the well-off have gradually been offered throughout society. Personally, I don’t share nostalgia for past restrictions. As recently as the early 1970s many women could only get a credit card through their husband. Low-income minority neighborhoods were redlined — denied credit. Still, the modern credit economy comes with a steep price tag. Lenders are adept at promoting the convenience of credit and hiding the true cost of debt. Worse, low-income households are flooded with high-cost loans that condemn some to an endless cycle of debt repayments. Financial literacy means steering clear of predators.
The bedrock idea behind personal finance is a financial margin of safety. It’s important to save for emergencies. Savings also let you pursue opportunities when they come along, to take risks and embrace changes that could lead to greater engagement. Safety and opportunity, like risk and return, are two sides of the margin-of-safety coin.
Financial literacy boils down to a few good habits. Here’s my list:
• Create a margin of financial safety.
• Save 20 percent of your money.
• Max out your retirement savings plan.
• Pay your credit card balance in full every month.
• Buy inexpensive, well-diversified index funds.
• Generosity or giving is the key to managing money well over a lifetime.
• Pay attention to fees.
• Stick with high-quality investments.
• Invest in your education over a lifetime.
• Borrow only to fund investments, like a home and education.
• Diversify. Diversify. Diversify.