Racial/Ethnic Disparity in Financial Knowledge: Where Is the Gap from?

Background. Financial knowledge measures are conventionally 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, political knowledge literature suggests that DK response and incorrect answers do not equally reflect absence of knowledge, and by collapsing them into one category, researchers may compromise measurement validity.

This study aims to examine the validity of financial knowledge measures through a racial lens. Blacks and Hispanics often score lower than Whites on financial knowledge measures, yet few have investigated how DK response contributes to the racial gap. Additionally, compared to Whites, racial minorities have had less experience with financial products through which to learn important financial knowledge. For example, fewer racial minorities are homeowners, and own fewer investments, yet these financial experiences can shape one’s financial knowledge. Our study disentangles DK responses and incorrect answers and explores how these two disparate responses affect the financial knowledge racial gap and considers the role of financial experiences in financial knowledge.

Method. Using 2018 National Financial Capability Studies (NFCS) state-by-state data, we examined the racial difference in responding with correct, incorrect, and DK responses to a six-item financial knowledge scale with a nationally representative sample of 27,091 American adults. The financial knowledge scale is composed of six factual questions about compound interest, inflation, bond price, loan interest, mortgage, risk diversification. 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 racial/ethnic difference in choosing DK response and incorrect answers, relative to answering with a correct answer. The financial experiences of having mortgage and investment products were included in the models.

Results. Results show that, controlling other socio-demographic variables, racial minorities, especially Blacks were more likely to respond DK than Whites across all six questions: compound interest (β=.53, p<.001), inflation (β=.71, p<.001), bond price (β=.13, p<.05), mortgage (β=.72, p<.001), risk diversification (β=.53, p<.001), and loan interest (β=.32, p<.001). Compared to those without a mortgage, individuals with mortgages were less likely to give incorrect response (β= -0.58, p<.001) and DK response (β= -0.91, p<.001) to the mortgage question. Those with investments in stocks and other securities were less likely to give incorrect response (β= -0.39, p<.001) and DK response (β= -0.84, p<.001) to the bond price question.

Discussion. By detangling DK response from incorrect response, our findings showed 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, financial experiences play a substantial role in financial knowledge, with a relatively big impact on choosing DK response and small impact on incorrect response. Our study demonstrates that financial literacy measures are capturing not just knowledge, but also relevant experiences.