What’s the difference between stocks and bonds?
When I started asking the question, it was only idle curiosity. I assumed that anyone who was interested enough in the world of finance to sign up for a course I taught entitled “Wall Street 101” would have a working knowledge of the basic concepts. So, I calculated, perhaps three-quarters of the well-educated 20- and 30-something New Yorkers who tended to be in my three-hour classes would feel comfortable explaining what made a stock a stock, and why it was different from a bond.
Not so. Most of the time, I was lucky to have half of the students tell me that they understood the distinction. And even that ratio wasn’t bad, judging by some studies on financial literacy. (If you’re among those wondering, I’ll provide the answer at the end of this column.) A recent online survey by the Treasury Department of 30,000 Americans revealed that only 15 percent of the respondents were able to correctly answer five basic questions about financial literacy, with only about half agreeing that a stock mutual fund was generally safer than investing in a single stock, and only 28 percent understanding that when interest rates rise, bond prices fall.
That’s why it was interesting to listen to Nan Morrison, president and CEO of the Council for Economic Education, talk to a small group of journalists and others recently about the effort to make financial literacy part of the curriculum nationwide. Currently, the organization notes that only 14 states require students to take a personal finance course in high school; 22 require a course in economics. It’s not so much that Morrison wants to insist that personal finance be taught as a class, like English, math or geography. “I’m not sure there’s that much material there to justify it,” she said. Rather, she’d like states to require teachers to incorporate elements of this as part of their teaching in other subjects, starting with basic decision-making skills in elementary schools (understanding concepts like risk and return and the idea of the tradeoff) and including analysis of events like the 1929 stock market crash and the Great Depression in high school.
Part of the problem is getting state governments to agree. If anything, the trend is going the wrong way: Since 2002, the number of states that require students be tested on their economics coursework has dropped from 27 to 16. And, Morrison adds, the one element that is guaranteed to keep both teachers and their students focused on learning the concepts is some kind of assessment at the end of it. Only four states say that a one-semester course in personal finance is a requirement for high school graduation.
Morrison is correct to focus on school-aged children in her organization’s attempts to instill enough financial literacy to enable people to ask skeptical questions about “too good to be true” investment pitches or credit card and loan offers. That, along with a degree of skepticism and a good bullshit detector, would go a long way toward avoiding another financial crisis. Having the tools to realize that buying a house with no down payment and an interest-only mortgage with a variable rate is a bit like renting it from the bank, and giving the bank the right to charge 50 percent more rent after two years, may well have helped us avert the most recent crisis. Understanding how your neighbor really earned a 20 percent return in a year when the market went up 8 percent may help you avoid risky investments or even a Madoff-style fund.
It isn’t about giving kids rules, Morrison points out: Just telling them to save 10 percent of their income is about as useful as telling an overweight child to eat less and exercise more. What helps more is teaching that child to make healthy choices and discover the rewards of physical activity. Similarly, helping a child to become fiscally fit means giving them tools to make sensible decisions on a day-to-day basis, not just putting aside an arbitrary percentage of their income.
Morrison and her group – a committed and enthusiastic bunch of people – do face some uphill battles. First of all, there will likely be apathy on the part of the state legislators, more focused on first principles than on financial literacy. While some financial institutions – and individuals who run them – back the organization’s work, others (whom she won’t identify) have declined to help unless they can use her organization as a way to provide teenagers and others with their own “educational” (read, marketing) materials.
Ironically, some of the more intractable problems may demonstrate just why this kind of push is so important. Only about 20 percent of teachers the group has surveyed feel confident teaching this material – a generally high number, given the level of financial literacy nationwide and the fact that they are being asked not just to understand these concepts but to communicate them to students. But it’s too low for comfort. Also, what happens if the kids get mixed messages; if, while they are being taught at school about the virtues of saving and budgeting, at home their parents and grandparents are behaving in irrational ways? Because, as with any attempt to instill certain kinds of values or behavior – as opposed to learning or knowledge – what happens in the home can be vital. How would you react to your 12-year-old asking you what mutual funds you own, how you decided on the asset allocation in your 401(k) plan, or whether you can really afford to pay the high interest on that store-issued credit card if you buy another flat-screen television?
This won’t be a smooth and straightforward process, but it’s a vital one. Ultimately, a nation of consumers all making smarter choices about their personal finances will make as much difference to the country’s wellbeing as a collection of elected representatives bickering over fiscal policy in Washington. It may even mean – in time – that those elected representatives are themselves more financially literate and able to make wise decisions about when, whether and how to regulate financial markets.
So, to all the elected representatives in the 46 states that don’t yet require some kind of course on personal finance in order to receive a high school diploma, isn’t it time to get moving?
*The answer to my opening question: A stock gives its holder an ownership interest in the business, while a bond makes its holder a lender to the company. The former participates in the company's upside potential, as higher earnings lead to a higher share price; the bond's owner is entitled only to a string of interest payments and only if the company defaults on those can it acquire any ownership stake (via a bankruptcy proceeding) in lieu of recouping his loan and in place of the interest income.