How to Improve Your Financial Literacy - dummies

How to Improve Your Financial Literacy

By Eric Tyson

A continuing stream of studies has indicated that many Americans, especially younger adults, are by and large financially illiterate. The vast majority of survey respondents have “failing” scores — meaning that they answered less than 60 percent of the questions correctly.

Many folks do indeed have significant gaps in their personal financial knowledge. Though more folks have greater access today to more information than in prior generations, the financial world has grown more complicated, and there are more choices, and pitfalls, than ever before.

Unfortunately, most Americans don’t know how to manage their personal finances because they were never taught how to do so. Their parents may have avoided discussing money in front of them, and most high schools and colleges lack courses that teach this vital, lifelong-needed skill.

Some people are fortunate enough to learn the financial keys to success at home, from knowledgeable friends, and from the best expert-written books like this one. Others either never discover important personal finance concepts, or they learn them the hard way — by making lots of costly mistakes. People who lack knowledge make more mistakes, and the more financial errors you commit, the more money passes through your hands and out of your life. In addition to the enormous financial costs, you experience the emotional toll of not feeling in control of your finances. Increased stress and anxiety go hand in hand with not mastering your money.

This article examines where people learn about finances and helps you decide whether your current level of knowledge is holding you back. You can find out how to improve your financial literacy and take responsibility for your finances, putting you in charge and reducing your anxiety about money. After all, you have more important things to worry about, like what’s for dinner.

Talking Money at Home

I was fortunate — my parents taught me a lot of things that have been invaluable throughout my life, and among those things were sound principles for earning, spending, and saving money. My parents had to know how to do these things, because they were raising a family of three children on (usually) one modest income. They knew the importance of making the most of what you have and of passing that vital skill on to your kids.

However, my parents’ financial knowledge did have some gaps. I observed firsthand the struggles my late father endured handling some retirement money after being laid off from a job when I was in middle school. In subsequent years, this situation propelled me to learn about investing to help myself, my family, and others.

In many families, money is a taboo subject — parents don’t level with their kids about the limitations, realities, and details of their budgets. Some parents I talk with believe that dealing with money is an adult issue and that children should be insulated from it so they can enjoy being kids. Others readily admit the many holes in their financial knowledge and thus don’t feel comfortable teaching their kids about personal finance. In too many families, kids hear about money only when disagreements and financial crises bubble to the surface. Thus begins the harmful cycle of children having negative associations with money and financial management.

In other cases, parents with the best of intentions pass on their bad money-management habits. You may have learned from a parent, for example, to buy things to cheer yourself up. Or you may have witnessed a family member maniacally chasing get-rich-quick business and investment ideas. Now I’m not saying that you shouldn’t listen to your parents. But in the area of personal finance, as in any other area, poor family advice and modeling can be problematic.

Think about where your parents learned about money management and then consider whether they had the time, energy, or inclination to research choices before making their decisions. For example, if they didn’t do enough research or had faulty information, your parents may mistakenly have thought that banks were the best places for investing money or that buying stocks was like going to Las Vegas. (You can find the best places to invest your money in Part 3 of this book.)

In still other cases, the parents have the right approach, but the kids do the opposite out of rebellion. For example, if your parents spent money carefully and thoughtfully and often made you feel denied, you may tend to do the opposite, buying yourself gifts the moment any extra money comes your way.

Although you can’t change what the educational system and your parents did or didn’t teach you about personal finances, you now have the ability to find out what you need to know to manage your finances.

If you have children of your own, don’t underestimate their potential or send them out into the world without the skills they need to be productive and happy adults. Buy them some good financial books when they head off to college or begin their first job.

Identifying Unreliable Sources of Information

Most folks know that they’re not financial geniuses. So they set out to take control of their money matters by reading about personal finance or consulting a financial advisor.

But reading and seeking advice to find out how to manage your money can be dangerous if you’re a novice. Misinformation can come from popular and seemingly reliable information sources.

Understanding the dangers of free financial content online

In addition to being able to quickly access what we want, the other major attraction of the Internet is the abundance of seemingly free websites providing piles of apparently free content. Appearances, however, can be greatly deceiving.

While there are exceptions to any rule, the fact of the matter is that the vast majority of websites purporting to provide a seemingly never-ending array of “free” content are rife with conflicts of interest and quality problems due to the following:

  • Advertising: Any publication that accepts advertising has a potential conflict of interest because it may not want to publish articles that would upset its advertisers. Such a mindset, however, can stand in the way of telling consumers the unvarnished truth about various products and services. For example, credit card companies aren’t very interested in advertising someplace that publishes articles highlighting the negatives of credit cards.
  • Advertorials: Too many website owners are unwilling or unable to pay real writers for quality content and instead publish articles that are written and provided by advertisers. These pieces of “content” are known as advertorials and, in the worst cases, aren’t even clearly labeled as advertisements, which is precisely what they are.
  • Affiliate relationships: Many companies pay “referral fees” to websites that bring in new customers. Here’s how that practice causes major conflicts of interest. On a financial website, you read a glowing review of a particular financial product or service. And the site provides a helpful link to the website of the provider of that product or service. Unbeknownst to you, when you click on that link and buy something, the seller kicks money back to the “affiliate” who reeled you in. At a minimum, such relationships should be clearly disclosed and detailed in any review.
  • Insufficient editorial oversight: At most established, quality print publications, there are usually numerous editors who oversee the publication and all its articles. This structure helps ensure the accuracy of what gets into print (although bias, such as political bias, isn’t necessarily controlled). Unfortunately, the shoestring budget on which many websites operate precludes these quality control checks and balances. Thus, sites operated by non-experts proffering advice place you at great risk.
  • Lack of accountability: In part because of a lack of editorial oversight, there’s also often a lack of accountability for advice given online. This situation is especially problematic on the numerous sites that are run without disclosure of who is actually in charge of the site and/or who is writing the articles. Although such anonymity may be helpful to the site and its content providers, it’s certainly not in your best interests because it prevents you from checking out the background, qualifications, and track record of the providers.

Recognizing fake financial gurus

Back during the depths of the severe recession in 2009, a newspaper headline caught my attention: “U.S. likely to lose AAA rating: Prechter.”

Digging into the article widely distributed by behemoth news service Reuters, I read that Robert Prechter, a stock market analyst, also predicted:

“Investors’ confidence in an economic rebound fading, a trend that will drag the S&P 500 stock index well below the March 6 intraday low of 666.79 by the end of this year or early next.”

“Credit markets to clam up again as they did in the first phase of the global financial crisis and for the U.S. economy to sink into a depression.”

Pretty dire predictions from Prechter. He made them at a Reuters Investment Outlook Summit held in New York. Now, you may be wondering what type of a summit that a news service like Reuters would be holding. Here’s how Reuters defines its summits:

“Reuters Summits are your direct link to top business leaders, investors and regulators. Our journalists interview heavyweights in a particular industry, spin out hard-hitting breaking news and sharp analysis that can often move markets. If you want to understand what the insiders are thinking, look for Reuters Summits.”

Now, within the Reuters article about Prechter’s recent talk, Prechter’s credentials are cited as his being a “technical analyst” who is supposedly “known for predicting the 1987 stock market crash.”

Actually, Prechter had been making predictions for many years through his investment newsletter, Elliott Wave Financial Forecast. Newsletter tracker Mark Hulbert has been documenting Prechter’s investment trading predictions and picks since 1985 so at the time that this article appeared, Prechter had a nearly 25-year track record, which can tell you whether you should trade on his predictions or not.

Here’s how Prechter’s trading advice had done from January 1, 1985 through May 31, 2009 versus the broad U.S. stock market average (Wilshire 5000 index) according to Hulbert’s analysis:

Annualized Return:

Wilshire 5000 Index + 9.7 percent

Prechter’s Trading Advice – 15.4 percent

Total Return:

Wilshire 5000 Index + 857.1 percent

Prechter’s Trading Advice – 98.3 percent

The underperformance of Prechter’s newsletter is nothing short of astonishing and stunning. On an annualized basis, Prechter had underperformed the broad U.S. stock market Wilshire 5000 index by a whopping 25 percent per year! Here’s what Hulbert’s analysis shows would have happened to $100,000 invested according to Prechter’s investing trading advice versus the Wilshire 5000 U.S. stock market index:

$100,000 Invested (January 1, 1985 to May 31, 2009):

Wilshire 5000 Index $957,100

Prechter’s Trading Advice $1,700

A year later (2010), Prechter made news again for his newest and even more extreme predictions. In a New York Times article entitled, “A Market Forecast That Says, ‘Take Cover’,” stated the following:

“Mr. Prechter is convinced that we have entered a market decline of staggering proportions — perhaps the biggest of the last 300 years… . The Dow, which now stands at 9,686.48, is likely to fall well below 1,000 over perhaps five or six years as a grand market cycle comes to an end, he said. That unraveling, combined with a depression and deflation, will make anyone holding cash extremely grateful for their prudence.”

So, Prechter was calling for U.S. stocks to plunge about 90 percent!

Unfortunately, the New York Times reporter and editors failed to accurately report on Prechter’s terrible track record. The Times article states:

“Since 1980, the advice in his investing newsletters, when converted into a portfolio, has slightly underperformed the overall stock market but has been much less risky, losing money in only one calendar year, according to calculations by The Hulbert Financial Digest. Mr. Prechter said he disagreed with the methodology used in these measurements, but offered none of his own.”

This is precisely how charlatans with lousy track records continue to be quoted in the news because lazy or inept reporters fail to ask the right questions and get the facts straight.

The passage of more time has been most unkind to Robert Prechter and his crazy predictions. In fact, among the dozens of gurus’ stock market predictions tracked by CXO Advisory, Prechter’s calls were the least accurate — with a paltry 21 percent accuracy.

As you may already know, the Dow continued to rise from 2010 onward and smashed through the 20,000 level in early 2017 so Prechter’s predictions really look awful to go along with his horrible long-term track record. Yet, Neil Cavuto on Fox hyped a Prechter March 2012 appearance on his show by saying Prechter is an investing legend and one of the all-time best!

Before you take financial advice from anyone, examine her background, including professional work experience and education credentials. This is true whether you’re getting advice from an advisor, writer, talk show host, or TV financial reporter.

If you can’t easily find such information, that’s usually a red flag. People with something to hide or a lack of something redeeming to say about themselves usually don’t promote their background.

Of course, just because someone seems to have a relatively impressive-sounding background doesn’t mean that she has your best interests in mind or has honestly presented her qualifications. Forbes magazine journalist William P. Barrett presented a sobering review of financial author Suze Orman’s stated credentials and qualifications:

“Besides books and other royalties, Orman’s earned income has come mainly from selling insurance — which gets much more attention in her book than do stocks or bonds… . The jacket of her video says she has ‘18 years of experience at major Wall Street institutions.’ In fact, she has 7.”

When the Forbes piece came out, Orman’s publicist tried to discredit it and made it sound as if the magazine had falsely criticized Orman. In response, the San Francisco Chronicle, which is the nearest major newspaper to Orman’s hometown, picked up on the Forbes piece and ran a story of its own — written by Mark Veverka in his “Street Smarts” column — which substantiated the Forbes story.

Veverka went through the Forbes piece point by point and gave Orman’s company and the public relations firm numerous opportunities to provide information contrary to the piece, but they did not. Here’s some of what Veverka recounts from his contact with them:

“If you want your side told, you have to return reporters’ telephone calls. But alas, no callback.

“Orman’s publicist said a written response to the Forbes piece and the ‘Street Smarts’ column would be sent by facsimile to the Chronicle… . However, no fax was ever sent. They blew me off. Twice.

“In what was becoming an extraordinary effort to be fair, I placed more telephone calls over several days to Orman Financial and the publicist, asking for either an interview with Orman or an official response. If Orman didn’t fudge about her years on Wall Street or didn’t let her commodity-trading adviser license lapse, surely we could straighten all of this out, right?

“Still, no answer. Nada … I called yet again. Finally, literally on deadline, a woman who identified herself as Orman’s ‘consultant’ called me to talk ‘off the record’ about the column. What she ended up doing was bashing the Forbes piece and my column but not for publication. More importantly, she offered no official retort to allegations made by veteran Forbes writer William Barrett. I have to say, it was an incredibly unprofessional attempt at spinning. And I’ve been spun by the worst of them.”

You can’t always accept stated credentials and qualifications at face value, because some people lie (witness the billions lost to hedge fund Ponzi-scheme-man Bernie Madoff). You can’t sniff out liars by the way they look, their Résumé, their gender, or their age. You can, however, increase your chances of being tipped off by being skeptical (and by regularly reading “Guru Watch”).

You can see a number of hucksters for what they are by using common sense in reviewing some of their outrageous claims. Some sources of advice, such as Wade Cook’s investment seminars, lure you in by promising outrageous returns. The stock market has generated average annual returns of about 9 percent over the long term. However, Cook, a former taxi driver, promoted his seminars as an “alive, hands-on, do the deals, two-day intense course in making huge returns in the stock market. If you aren’t getting 20 percent per month, or 300-percent annualized returns on your investments, you need to be there.” (I guess I do, as does every investment manager and individual investor I know!)

Cook’s get-rich-quick seminars, which cost more than $6,000, were so successful at attracting people that his company went public in the late 1990s and generated annual revenues of more than $100 million. Cook’s “techniques” included trading in and out of stocks and options after short holding periods of weeks, days, or even hours. His trading strategies can best be described as techniques that are based upon technical analysis — that is, charting a stock’s price movements and volume history, and then making predictions based on those charts.

The perils of following an approach that advocates short-term trading with the allure of high profits are numerous:

  • You’ll rack up enormous brokerage commissions.
  • On occasions where your short-term trades produce a profit, you’ll pay high ordinary income tax rates rather than the far lower capital gains rate for investments held more than 12 months.
  • You won’t make big profits — quite the reverse. If you stick with this approach, you’ll underperform the market averages.
  • You’ll make yourself a nervous wreck. This type of trading is gambling, not investing. Get sucked up in it, and you’ll lose more than money — you may also lose the love and respect of your family and friends.

If Cook’s followers were able to indeed earn the 300 percent annual returns his seminars claimed to help you achieve, any investor starting with just $10,000 would vault to the top of the list of the world’s wealthiest people (ahead of Bill Gates and Warren Buffett) in just 11 years!

Publishers pandering to advertisers

Thousands of publications and media outlets — newspapers, magazines, websites, blogs, radio, TV, and so on — dole out personal financial advice and perspectives. Although some of these “service providers” collect revenue from subscribers, virtually all are dependent — in some cases, fully dependent (especially the Internet, radio, and TV) — on advertising dollars. Although advertising is a necessary part of capitalism, advertisers can taint and, in some cases, dictate the content of what you read, listen to, and view.

Be sure to consider how dependent a publication or media outlet is on advertising. I find that “free” publications, websites/blogs, radio, and TV are the ones that most often create conflicts of interest by pandering to advertisers. (All derive all their revenue from advertising.)

Much of what’s on the Internet is advertiser-driven as well. Many of the investing sites on the Internet offer advice about individual stocks. Interestingly, such sites derive much of their revenue from online brokerage firms seeking to recruit customers who are foolish enough to believe that selecting their own stocks is the best way to invest. (See Part 3 for more information about your investment options.)

Keep in mind that you have virtually zero privacy on “free” websites because they make money by selling access to website visitors like you to companies and people with something to sell.

As you read various publications, watch TV, or listen to the radio, note how consumer-oriented these media are. Do you get the feeling that they’re looking out for your interests? For example, if lots of auto manufacturers advertise, does the media outlet ever tell you how to save money when shopping for a car or the importance of buying a car within your means? Or are they primarily creating an advertiser-friendly broadcast or publication?

Jumping over Real and Imaginary Hurdles to Financial Success

Perhaps you know that you should live within your means, buy and hold sound investments for the long term, and secure proper insurance coverage; however, you can’t bring yourself to do these things. Everyone knows how difficult it is to break habits that have been practiced for many years. The temptation to spend money lurks everywhere you turn. Ads show attractive and popular people enjoying the fruits of their labors — a new car, an exotic vacation, and a lavish home.

Maybe you felt deprived by your tightwad parents as a youngster, or maybe you’re bored with life and you like the adventure of buying new things. If only you could hit it big on one or two investments, you think, you could get rich quick and do what you really want with your life. As for disasters and catastrophes, well, those things happen to other people, not to you. Besides, you’ll probably have advance warning of pending problems, so you can prepare accordingly, right?

Your emotions and temptations can get the better of you. Certainly, part of successfully managing your finances involves coming to terms with your shortcomings and the consequences of your behaviors. If you don’t, you may end up enslaved to a dead-end job so you can keep feeding your spending addiction. Or you may spend more time with your investments than you do with your family and friends. Or unexpected events may leave you reeling financially; disasters and catastrophes can happen to anyone at any time.

Discovering what (or who) is holding you back

A variety of personal and emotional hurdles can get in the way of making the best financial moves. A lack of financial knowledge (which stems from a lack of personal financial education) can stand in the way of making good decisions.

But I’ve seen some people caught in the psychological trap of blaming something else for their financial problems. For example, some people believe that adult problems can be traced back to childhood and how they were raised.

I don’t want to disregard the negative impact particular backgrounds can have on some people’s tendency to make the wrong choices during their lives. Exploring your personal history can certainly yield clues to what makes you tick. That said, adults make choices and engage in behaviors that affect themselves as well as others. They shouldn’t blame their parents for their own inability to plan for their financial futures, live within their means, and make sound investments.

Some people also tend to blame their financial shortcomings on not earning more income. Such people believe that if only they earned more, their financial (and personal) problems would melt away. My experience working and speaking with people from diverse economic backgrounds has taught me that achieving financial success — and more importantly, personal happiness — has virtually nothing to do with how much income a person makes but rather with what she makes of what she has. I know financially wealthy people who are emotionally poor even though they have all the material goods they want. Likewise, I know people who are quite happy, content, and emotionally wealthy even though they’re struggling financially.

Americans — even those who have not had an “easy” life — ought to be able to come up with numerous things to be happy about and grateful for: a family who loves them; friends who laugh at their stupid jokes; the freedom to catch a movie or play or to read a good book; or a great singing voice, a good sense of humor, or a full head of hair.

Developing good financial habits

After you understand the basic concepts and know where to buy the best financial products when you need them, you’ll soon see that managing personal finances well is not much more difficult than other things you do regularly, like tying your shoelaces and getting to work each day.

Regardless of your income, you can make your dollars stretch farther if you practice good financial habits and avoid mistakes. In fact, the lower your income, the more important it is that you make the most of your income and savings (because you don’t have the luxury of falling back on your next big paycheck to bail you out).

More and more industries are subject to global competition, so you need to be on your financial toes now more than ever. Job security is waning; layoffs and retraining for new jobs are increasing. Putting in 30 years for one company and retiring with the gold watch and lifetime pension are becoming as rare as never having problems with your computer.

Speaking of company pensions, odds are increasing that you work for an employer that has you save toward your own retirement instead of providing a pension for you. Not only do you need to save the money, you must also decide how to invest it.

Personal finance involves much more than managing and investing money. It also includes making all the pieces of your financial life fit together; it means lifting yourself out of financial illiteracy. Like planning a vacation, managing your personal finances means forming a plan for making the best use of your limited time and dollars.

Intelligent personal financial strategies have little to do with your gender, ethnicity, or marital status. All people need to manage their finances wisely. Some aspects of financial management become more or less important at different points in your life, but for the most part, the principles remain the same for everyone.

Knowing the right answers isn’t enough. You have to practice good financial habits just as you practice other good habits, such as brushing your teeth or eating a healthy diet and getting some exercise. Don’t be overwhelmed. As you read this book, make a short list of your financial marching orders and then start working away. Throughout this book, I highlight ways you can overcome temptations and keep control of your money rather than let your emotions and money rule you.

What you do with your money is a quite personal and confidential matter. In this book, I try to provide guidance that can keep you in sound financial health. You don’t have to take it all — pick what works best for you and understand the pros and cons of your options.