Optimal Financial Knowledge and Wealth Inequality

We show that financial knowledge is a key determinant of wealth inequality in a stochastic life cycle model with endogenous financial knowledge accumulation, where financial knowledge enables individuals to better allocate lifetime resources in a world of uncertainty and imperfect insurance. Moreover, because of how the US social insurance system works, better-educated individuals have most to gain from investing in financial knowledge. Our parsimonious specification generates substantial wealth inequality relative to a one-asset saving model and one in which returns on wealth depend on portfolio composition alone. We estimate that 30–40 percent of retirement wealth inequality is accounted for by financial knowledge.