Should Schools Teach Financial Literacy?

And if they do, how?

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When I was in middle school, I wondered whether I'd ever care about the definition of "mitochondria," but it actually turned out to be useful information: now I can more easily understand jokes about how school teaches us lots of things that won't have direct practical applications to our lives, and doesn't tell us much about how to do taxes, whether or not to consider an adjustable-rate mortgage, and the advantages and disadvantages of a Roth IRA.

But if you try to turn that impulse into a curriculum, it quickly gets tricky. For example: a common reason people say "They didn't tell us about this in school" is that they did, and the person complaining about it hadn’t paid attention. Believe it or not, compound interest is a grade school topic, and that’s true for a few reasons: 

  1. It's an illustration that "understanding math" can have a direct causal connection to "having a million dollars," which often makes a big impression.

  2. It's not intuitive, especially at the extremes (there's the grain of rice, doubled every day story, for example—which also doubles as a harmless example of someone using cleverness to stump an authority figure, which is always a big hit with some students).

  3. And, of course, it's fun to keep mashing the "=" sign on a calculator and watch the number march upward.

It's a little less fun when the person mashing that equals sign is preparing the statement for your deferred student loan payment—there's a cottage industry of college-educated adults forgetting elementary school math examples right before they ask why they've paid so much in interest on their student loans and still have an outstanding balance.1

But this is really a common complaint with schools, both from teachers and students: learning concepts is one thing, but it's another to actually realize that you're looking at a suspiciously bimodal distribution, or that hitting your nutritional macros while staying in a certain calorie range is just linear algebra, or that those infection reports you keep hearing about follow a suspiciously exponential curve. Months learning about compound interest go out the window when you hear about N easy monthly payments of just $X and slot that into a budget instead of calculating an APR.

Schools could walk through the mechanics of some of this, and could certainly explain what a mutual fund is or how to file your taxes, but a lot of that information falls into the category of “things that are easily accessible to any reasonably curious person with an Internet connection”. Yes, taxes get complicated when you're realizing capital gains in multiple currencies, some of which have names like "dogwifhat," or you're trying to figure out what exact part of your house counts as a home office. But this is just something that people pick up through the process of downloading a Form 1040, filling it out, and Googling anything confusing. Plus, the tax code changes all the time, so the information you transmit to a fourteen-year-old about how to file taxes will decay even faster than all of the other things we teach people at that age.

But perhaps we could tell them about investing: companies raise money, they use this money to build a business, the business produces returns in the form of dividends and capital appreciation. This is a very useful model to have in one's head, but applying it runs into another problem. Schools are well-equipped to teach people about generally-applicable absolutes, like arithmetic or grammar. They can, if they choose, expose their students to the canonical works of their civilization. What they're bad at is teaching people to win in adversarial environments. And they're also bad at the meta-game of reminding someone that knowing the basic mechanics of some process does not make them an expert, but does make them a mark. Said differently: if you know which hands win in poker, thinking that this means you know how to play the game makes you a mark, not an expert.

Finance is an adversarial game at all levels: traders seek uninformed counterparties, asset managers want people who will pay high fees for mediocre products, and the ones who have good products want to eventually capture 100% of the alpha. And it's hard for a teacher to end a class by telling students that they got an A+ in financial literacy and are now equipped to get ripped off in entirely new ways by an entirely different set of adversaries. But it's also impossible to create a repeatable standardized test that accurately simulates such an adversarial environment, because any time everyone gets the same correct answer, that answer would need to become wrong.

That being said, finance is still worth studying as a liberal art. In the abstract, it's close to history, where part of the discipline is to recognize patterns, and part of it is to recognize when those patterns no longer apply. It's also like history in that it's highly contextual and path-dependent. My elementary school experience was that recent history was never on the test (I finished high school in 2005 and my most up-to-date textbooks typically ran through the end of the Cold War with a tiny bit of more recent material). Fresh history is news, but it's also politics, and it requires an enormous amount of effort to write a history of, say, the Covid pandemic or the Trump administration without irritating the majority of adult readers. So it is with finance: a personal finance class in the 1990s would probably have absorbed the popular narrative that stocks earn 11% annually and that you can never go wrong if you just keep buying, while a personal finance class in the 1970s would have spent most of its time talking about how to deal with inflation. These cycles are visible in retrospect, but they can't happen without being at least partly invisible at the time.

So: arithmetic and reading comprehension will get people to the point that they can handle the basics, some financial concepts are very useful, but the more applied a school-level finance class gets, the more likely it is to teach accidental overconfidence that more than offsets the benefits of the underlying course material. A financial history elective, perhaps combining contemporary fictional treatments with the story of what actually happened—reading about the collapse of the Bank of United States one week and discussing The Grapes of Wrath the next—would be a very good thing. But when it comes to paying taxes and saving for retirement, it's best for schools to leave you on your own.

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Education is explicitly an occasional topic in The Diff and implicitly what the whole newsletter is about—it’s a collaborative attempt to figure out an important, high-leverage part of the world. Some examples:

1. The answer, of course, is that in no other context could someone who doesn't understand compound interest borrow five figures at a low rate backed by no collateral whatsoever; a lender completely focused on the economics of the loan, and targeting such an audience, is going to be following a very different model with higher rates and shorter-duration loans.

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