1 Cost of Economic Ignorance

The economic landscape has changed profoundly over the past fifty years. A few examples prove the point:

Retirement security has shifted from employer-provided defined-benefit pensions to employee-directed defined-contribution plans such as 401(k)s and Individual Retirement Accounts (IRAs).
Credit markets have expanded rapidly, and most households now rely on car loans, student loans, and mortgages to finance major purchases, and credit cards for smaller expenditures.
Government policies have introduced tax-advantaged savings vehicles, placing greater responsibility on individuals to make informed financial decisions.
Households are now legally obligated to purchase home, auto, and health insurance.
Inflation and interest rates that directly affect the value of savings, the cost of borrowing, and the burden of debt are not well understood.

Taken together, these changes mean that no matter one’s profession, earning a living in today’s world requires working knowledge of basic economics. Yet surveys consistently show that many adults lack basic economic literacy. For example, only about one-third of Americans could answer the following three questions correctly (Lusardi and Mitchell 2014).

Financial Literacy Quiz

Suppose you had $100 in a savings account and the interest rate was 2% per year. After 5 years, how much would you have if you let it grow?
- More than $102
- Exactly $102
- Less than $102
- Do not know
Imagine the interest rate is 1% per year but inflation is 2% per year. After one year, what could you buy with the money?
- More than today
- Exactly the same
- Less than today
- Do not know
True or False: “Buying a single company’s stock usually provides a safer return than a stock mutual fund.”
- True
- False
- Do not know

If you’re playing along at home, the answers are [1.] more than $102; [2.] less than today; and [3.] false. While the third question can be misinterpreted (what does “safe” mean here?), the first two are basic math. That these questions are not well understood by a majority of people, coupled with the fact that individuals are now much more responsible for their economic outcomes, suggests a need for additional financial literacy.

Unfortunately, human nature also works against us. In Thinking, Fast and Slow, Nobel laureate Daniel Kahneman describes how our minds toggle between fast, intuitive thinking (System 1) and slow, analytical reasoning (System 2). Financial decisions require System 2 to weigh risks and rewards, yet anxiety often pushes us toward System 1, leading to errors and poor outcomes.

Consider two examples — present bias and loss aversion. Present bias drives people to prioritize short-term gains, such as spending now, over long-term needs like retirement savings. Loss aversion makes losses feel more painful than equivalent gains, prompting irrational behavior like selling stocks at market bottoms or avoiding diversified investments altogether.

Figure 1.1: Mean vs. Median Net Worth by Age Group, 2022 dollars (thousands). Source: U.S. Survey of Consumer Finances, 2022.

In this book, I will argue that two factors — inadequate education and irrational behavior — combine to erode household wealth substantially. One illustration appears in Figure 1.1, which reports both the mean and median of household net worth by age of head of household, using data from the 2022 Survey of Consumer Finances (SCF).¹ Both the mean and median are measures of the average household. In a normal situation (pun intended), both would be close in value. It is the significant difference between them that stands out. The mean is pulled upward by the very wealthiest households; the median identifies the middle household. If Elon Musk walks into a bar, the mean wealth jumps tremendously while the median barely moves. The gap between mean and median thus provides a direct measure of inequality within each age group.

Figure 1.1 shows this wealth gap is substantial and widens with age. For households headed by someone under 35, mean net worth is about $183,000 while the median is only $39,000 — a difference of roughly $144,000. Among households aged 65–74, the mean reaches nearly $1.8 million but the median is only $410,000 — a gap of more than $1.3 million.

Figure 1.2: Household Net Worth by Percentile Group, 2022 dollars (thousands). Source: U.S. Survey of Consumer Finances, 2022.

Figure 1.2 is even more sobering. It traces household net worth over time and across percentiles. The bottom quartile have consistently had near-zero or negative net worth across the sample period, while families in the 90–100th percentile group have seen their wealth climb dramatically. Taken together with Figure 1.1, wealth inequality is pervasive and worsening over time.

1.1 Everyday Institutions and Policies

The book emphasizes the institutions and financial instruments that all adults encounter in daily life.

Credit markets: credit cards, auto loans, student loans, and mortgages.
Inflation and interest rates: how they shape borrowing and saving.
Taxes: the role of taxes in household budgets.
Retirement savings: how Social Security, IRAs, and 401(k)s work.
Insurance: protecting against risk, from health to auto to life insurance.

The objective of this book is not to train professional economists, but to give readers practical tools to make better decisions.

Data and Code

The figures in this chapter are fully reproducible. Download the script and data:

Lusardi, Annamaria, and Olivia S. Mitchell. 2014. “The Economic Importance of Financial Literacy: Theory and Evidence.” Journal of Economic Literature 52 (1): 5–44. https://doi.org/10.1257/jel.52.1.5.

The SCF is the benchmark triennial survey of household finances in the United States, drawing on a nationally representative sample and oversampling high-wealth households. Net worth is total assets — financial holdings (stocks, bonds, retirement accounts) and non-financial assets (homes, vehicles, businesses) — minus total debts (mortgages, credit cards, other loans).↩︎