One of the leading topics for discussion in the political realm is wealth inequality. Voices like Bernie Sanders argue that greed is the reason for the inequality that’s been growing in American society between the haves and the have nots. Interestingly enough, few people look at the impact that financial knowledge has on this aspect of life in the US. Three researchers from North America, Annamaria Lusardi, Pierre-Carl Michaud and Olivia S. Mitchell, recently looked into the topic of wealth inequality to see if financial knowledge had an impact. They published their findings in the Journal of Political Economy.
Those who have little knowledge of how finances and the economy work are more likely to find themselves in debt. Not only will they find themselves in debt, they are more likely to wind up with some of the worst types of debt. This bad debt can include high-interest loans like payday loans, and loans from rent-to-own establishments – which sell items at a cost equivalent to many times what the general population would pay for the same items at a department store. Additionally, these low-information borrowers will tend to get hit with high fees in addition to the high interest rates. They have no choice but to pay.
Those who are least informed in the area of finances are also more likely to borrow from their retirement accounts. When they leave their jobs, they tend to default on paying back their 401k loans. These loans will cut down on the amount of money that they have available to them during retirement.
These folks will also borrow more to buy their homes. In the years before the latest financial crisis, many Americans took out large mortgages on massive homes and paid little to no money down to take possession of them. Many of these Americans have been digging themselves deeper into debt ever since, unlike their ancestors who worked hard to pay off their mortgages as soon as possible. They are likely to report themselves drowning in debt.
On the other hand, those who invest more time in financial knowledge tend to avoid many of the more expensive mistakes that their less informed counterparts make. Those who are more informed have learned lessons from school or on the job that have allowed them to make better decisions. They tend to hold investments that are more beneficial and sophisticated and that charge lower fees. Furthermore, they are more likely to hold annuities that continue to pay out a stream of income to them until they die. This helps them maintain their standards of living in the case of longevity.
The authors of the above-referenced article found that the social safety net contributes to the financial inequality. Those who are at the lower end of the income scale might lose some of the benefits that are means tested like Social Security and welfare benefits if they make too much. Therefore, they are more likely to spend their money rather than look for ways to save for the future because they feel that they will be taken care of regardless of what they might do to prepare for their golden years.
Those who make more money are forced to look for ways to maximize their returns because they might not get as much support from social programs as those who make less income. The researchers came to the conclusion that this financial knowledge might account for somewhere between 30 and 40 percent of the wealth inequality that is evident in American society.
At BMG Money, we support well-educated financial decisions. Making financial education a greater component of education, as early as high school, can have great payoffs in the end.