Racial Disparity in Financial Knowledge: How Real Is the Gap?

Financial knowledge has been linked to wealth accumulation and financial stability, with scholars devoting increasing effort to study individuals’ financial knowledge and its determinants. One determinant of financial knowledge levels is race. Studies have shown racial minorities score lower than the whites on financial knowledge measures, which are often constructed by summing respondent’s correct answers on a series of factual items and collapsing incorrect answers and “don’t know” (DK) response into a single absence-of knowledge category. However, it is possible that DK response and incorrect answers do not equally reflect ignorance about financial matters, and by collapsing them into one category researchers may compromise measurement validity. This study aims to disentangle DK responses and incorrect answers and to explore how these two disparate responses affect the racial gap in financial knowledge.

Using 2012 National Financial Capability Studies (NFCS) state-by-state data, we examined the racial difference in responding with correct, incorrect, and DK responses to a 5-item financial knowledge scale. The NFCS is a large national survey of U.S. adults and households, and its state-by-state survey was conducted in 2012 among a nationally-representative sample of 25,509 American adults. The financial knowledge scale is composed of five factual questions concerning knowledge about compound interest, inflation, bond price, mortgage payment, and financial risk. Questions are in a multiple-choice format, and each has one correct answer, two incorrect answers, a DK answer, and “prefer not to say” answer. We employed grouped-data multinomial logistic regression to examine gender difference in choosing DK response and incorrect answers, relative to answering with a correct answer.

Results show that, controlling other socio-demographic variables, racial minorities were more likely than the white to have incorrect answers on all five questions: compound interest (β=.34, p<.001), inflation (β=.43, p<.001), bond price (β=.32, p<.001), mortgage payment (β=.57, p<.001), and financial risk (β=.59, p<.001). Results also show that racial minorities are more likely to respond DK than whites across four questions: compound interest (β=.24, p<.001), inflation (β=.32, p<.001), mortgage payment (β=.49, p<.001), and financial risk question (β=.26, p<.001). The race difference in giving DK response to the bond price question was not significant (β=.02, z=.44, p=.66).

Our study challenges the conventional measures of financial literacy by demonstrating the racial disparity in DK response and incorrect answers. The findings suggest that financial knowledge levels of racial minorities can be substantially higher than most studies have shown, and the racial gap may not be as large as it seems. In addition, racial disparity in choosing incorrect answers appears domain-specific, with relatively big impact on mortgage payment and financial risk questions, and small impact on compound interest and bond price questions. Our study demonstrates that financial literacy measures are capturing not just knowledge, but other things (such as risk propensity, self-confidence). To measure financial knowledge precisely, future research should consider constructing measures that discourage DK response.