U.S. Household Financial Capability and Economic Hardship: A Structural Equation Model

Background. Households with limited income and wealth often lack the financial capability to overcome economic hardships. One third of adults reported that in the year of 2016 their households experienced one or more economic hardships (Federal Reserve Bank, 2017). Financial capability is increasingly gaining attention from policymakers and social work practitioners given the financialization of everyday life. Additionally, the American Academy of Social Work and Social Welfare (AASWSW) identifies “Build Financial Capability for All” as one of the Grand Challenges for Social Work. To date, no research has empirically investigated the underlying mechanisms and systematic components of financial capability framework using a national representative data. 

Guided by the financial capability theory (Sherraden, 2013; Birkenmaier & Huang, 2013), this paper used a national survey to investigate the underlying determining mechanisms of financial capability and the how financial capability influences economic hardship in the general U.S. population. First, we measured financial capability using three latent variables: financial access (opportunity to act), financial literacy (ability to act), and financial functioning (financial behavior). Second, we looked at how financial education and financial socialization are associated with financial capability. Third, we examined the extent to which financial capability was associated with economic hardship. 

Methods. This study used data from the 2015 National Financial Capability Study (N=27,564). Confirmatory Factor Analysis was used to create four latent constructs: financial literacy (measured by three subjective assessment questions and six objective questions), financial access (measured by bank account, credit card, retirement accounts, and investments), financial functioning (measured by save for rainy days, planning ahead, and setting financial goals), and economic hardship (measured by difficulty in covering expenses, debt situation, and count of medical hardships). Structural Equation Model was used to test the relationships among financial education, financial socialization, and those four latent constructs. WLSMV estimator was used to handle ordinal and dichotomous indicators.

Results. Model fit indices showed the final model had a reasonable fit (CFI=.937; TLI=.921; RMSEA=.047). We found financial socialization was significantly associated with both financial access (β=.13, p<.001) and financial literacy (β=.29, p<0.001). Surprisingly, we found that financial education was significantly associated with financial literacy (β=.34, p<.001), but not with financial access (β=.01, p>.05). Additionally, financial access and financial literacy were significant associated (β=.41, p<.001). Both financial access and financial literacy were associated with financial functioning (β=.78, p<.001; β=.24, p<.001). And finally, financial functioning was negatively associated with economic hardship (β= -.74, p<.001).

Implications. Our findings showed that financial capability lies in both the opportunity to act and the ability to act, and financial capability is strongly associated with household experiences of economic hardships. By investigating determinants and underlying mechanisms of financial capability and examining the association between financial capability and economic hardships, this research paves the way for researchers, policymakers, and practitioners to improve financial capability of the general population by enhancing effective financial education and guidance as well as by providing accessible and affordable financial products to promote financial inclusion.