Compound Interest: Knowledge Builds Wealth, Which Fuels More Learning

A string of new research builds the case that financial literacy at an early age is at the heart of wealth creation. Financial understanding leads to asset building, which leads to a more vigorous quest to understand personal finance. It's a virtuous circle that can give an edge to anyone who latches on.

  • Share
  • Read Later

Evidence keeps piling up showing that people 1.) generally lack the minimum financial awareness they need, and 2.) through excess fees and missed saving and earning opportunities pay a stiff price for this knowledge gap over their lives.

Money troubles often develop in college, as students and parents load up on education debt they don’t understand. A recent study out of the U.K. found that nearly two-thirds of college-bound teens don’t understand the most basic elements of paying back student debt. Rather than dig into the terms, families seem to figure the simple solution is making sure that their expensive education leads to a great career. In a recent Discover survey of parents with college-bound teens, 70% said that earning potential was more important than choosing a major.

(MORE: The Big Business of Bandwagon Baseball)

Actually, the two often go hand in hand. What the survey really reveals, Discover says, is that parents finally have begun to weigh what college majors are worth in the workforce. Says P.K. Parekh, vice president of student loans for Discover Financial Services:

“Our surveys, focus groups and marketing research with parents, graduate students and undergrads continue to bring out the importance of families and students understanding the college funding process—before, during and after graduation. We strongly encourage families to research all options to learn which ones make the most sense when investing in a university degree.”

Student loans, of course, are just a small part of the financial landscape and according to a new analysis of World Bank data people who do not understand financial concepts are less likely to trust financial institutions and use banking products that could boost their savings and earnings potential. These people are at a disadvantage for their entire lives.

Meanwhile, in a paper unveiled a few months ago, researchers led by Annamaria Lusardi, professor of economics at George Washington University, found that an early understanding of financial concepts accounts for as much as half of the wealth gap between the affluent and those with low incomes. Lusardi also found an exponential effect: Those who acquire financial understanding early tend to accumulate assets faster and those with more assets tend to keep learning about personal finance because they have more at stake.

(MORE: The Kickstarter Economy)

Lusardi is part of a team now writing national standards for financial education in our school system. It’s not enough to teach rules of thumb, Lusardi asserts. Preaching that you should save 10% of everything you make is far less beneficial in the long run than teaching an understanding of what underlies that rule: the miracle of compound growth. In her blog, Lusardi writes:

“Financial literacy is no different in Vermont than it is in California, and it is not clear why we have so many different curricula in different states.”

National standards would be a welcome step towards getting everyone on the same page—and reaching young people before they take out the wrong student loan or choose to borrow heavily for a field of study that will never pay enough to justify their debt. Let’s set them on the right course early, so that they understand bank products and begin building wealth right away, and become life-long learners in this critical area.