Optimal Financial Literacy and Saving for Retirement

Annamaria Lusardi, Pierre-Carl Michaud, and Olivia S. Mitchell

Abstract — Recent studies show that financial literacy is strongly positively related to household wealth, but there is also substantial cross-sectional variation in both financial literacy and wealth levels. To  explore these patterns, we develop a calibrated stochastic life cycle model which features endogeneous financial literacy accumulation. Our model generates substantial wealth inequality, over and above what standard lifecycle models produce. This is due to the fact that higher earners typically have more hump-shaped labor income profiles and lower retirement benefits which, when interacted with the precautionary saving motive, boosts their need for private wealth accumulation and thus financial literacy. We show that the fraction of the population which is rationally “financially ignorant” depends on the level of labor income uncertainty as well as the generosity of the retirement system.