The Poverty of American Financial Education
Why true financial education requires the four foundations of financial literacy
When I was in Sunday School, I learned the phrase, "Out of the mouths of babes." This meant that young people who have not been conditioned by society are often the ones to say the true things most respectable adults don't want to say aloud.
This week, I came across an article of just that sort by a young woman named Jessica Ferrarelli entitled, "I cannot balance a checkbook but mitochondria is the powerhouse of the cell".
"If you were to ask me right out of high school about the Pythagorean theorem I could tell you with confidence that it is used to find the sides of a right triangle: a²+b²=c²," writes Farrarelli. "If you asked me how to take out a loan or balance a checkbook, I would have no idea."
The sad state of financial education
"Personal finance classes should be a requirement for high school students to graduate so they are prepared for when they go to college and start in the work force," she concludes.
As part of her article, Farrarelli cites one study that shows only 17 out of 50 states require personal finance classes in high schools, and another study that said of 455 surveyed undergraduate and graduate students, 51 percent felt they were "barely keeping up" financially.
What would be a good financial education?
I think Farrarelli is right to be distraught about the state of financial education in the US. Unfortunately, however, her idea of financial education is one that produces a "responsible, money-saving adult."
This is, of course, a function of the very sad system she is writing against. For years, I've written about how savers are losers. In the new rules of money, saving money is not financially intelligent…and teaching kids to save is not true financial education.
I previously published 15 essential lessons that should be taught regarding financial literacy. But here I want to cover the four foundations of financial literacy that these lessons would be based on.
These foundations, and the lessons that are built on them, are what I believe would be the answer to Farrarelli's call for financial education, one that would prepare young people to not just survive but thrive in the world as adults.
Foundation of Financial Literacy #1: The difference between an asset and a liability
Many people think they know what an asset is. For instance, you probably think your house is an asset-but it's not. The truth is that just as there are two definitions of an asset.
Accountants use one definition that requires lots of financial calisthenics to make people and companies feel richer than they really are. This keeps them employed and their clients blissfully ignorant.
The rich use another definition grounded in simplicity and reality. An asset is anything that puts money in your pocket and a liability is anything that takes money out of your pocket.
Your house is not an asset because it takes money out of your pocket each month. Even if you own your house outright, you still have to pay for the taxes, maintenance, and more out of your own pocket.
But if you own a rental property, that can be an asset-if it puts money in your pocket each month in the form of cash flow. When your tenant pays rent, they cover your mortgage, maintenance, taxes, and more.
A true financial education would teach students how to tell the simple difference between an asset and a liability, and why it's so important to have as many assets as possible under your ownership.
Foundation of Financial Literacy #2: Cash flow versus capital gains
Most people invest for capital gains. The rich invest for cash flow.
Simply put, investing for capital gains is like gambling. You invest your money and hope the price goes up. For instance, many people buy a house hoping they'll be able to sell it for more money later. In the meantime, they have to pay their mortgage and home expenses. Money goes out of their pocket. It becomes a liability.
The problem is that when you invest for capital gains you have no control over whether the price goes up or down, and the bigger issue is, if you do make a profit, you pay the highest rate in taxes.
Conversely, the rich invest for cash flow. So, for instance, they buy investment real estate with other people's money, find tenants to pay the expenses, and collect rent each month. It becomes an asset. And if there's capital gains, that's a bonus.
By investing for cash flow instead of capital gains, the rich have control over their income and pay the lowest rate in taxes-and sometimes nothing in taxes.
But investing for cash flow, while a simple concept, requires a strong financial education in order to make your own financial decisions.
A true financial education would teach kids how to make passive income rather than to be passive about their investments.
Foundation of Financial Literacy #3: Using debt and taxes to get richer
Your financial adviser will tell you that debt is bad and taxes are inevitable. But the rich understand that both debt and taxes can be used to create immense wealth.
When it comes to debt, there are two kinds-bad and good. When your financial adviser tells you to stay out of debt, she means stay out of bad debt.
Bad debt comes in the form of borrowing money for liabilities such as using credit cards to buy TVs and take vacations, borrowing a line of credit on your personal home, and more.
Staying out of bad debt is good advice, but the problem is that your financial adviser won't tell you about good debt.
Good debt is debt used to purchase assets like rental property.
When you use the bank's money to purchase cash-flowing real estate, you use less of your own money to secure an asset by paying only a down payment instead of full price, and your tenant's rent pays off your debt while you own the asset and pocket the profit.
When it comes to taxes, the rich understand that governments write tax codes to encourage specific types of behavior. If governments want you to build affordable housing, they give you a tax cut. If they want to encourage oil exploration, they give you a tax cut. If they want to see higher employment, they give you a tax cut.
The secret is that most tax benefits are made to help entrepreneurs and investors. With the right financial education, you too can utilize the tax code to not only get richer, but also pay nothing in taxes.
Utilizing good debt and getting richer through taxes takes a high level of financial intelligence. But everyone can learn and put these principles into practices.
A true financial education would teach students the many ways both debt and taxes can be used to get rich.
Foundation of Financial Literacy #4: Making your own financial decisions
When you're not confident about your knowledge of money, you let others make your financial decisions for you.
You let your broker decide how your money should be invested. You let your bank tell you what interest rate is worthy of your money. You follow whatever investing trend is popular in the news.
The rich don't follow the crowds. They set the trends and are gone by the time the trends become mainstream. What's their secret? They think for themselves about money and make their own financial decisions because they have a high financial intelligence.
The key to building great wealth is having great knowledge to act on and great wisdom to know which course of action is the best.
This kind of knowledge and wisdom only comes through a high financial intelligence gained from applying yourself to financial education.
A true financial education would teach young people how to think critically and for themselves about money and investing.