Montana has the lowest financial capability in the nation, according to a groundbreaking new survey, ranking last or second-to-last in three of five main aspects of financial capability measured by the survey:

Montana has the lowest percentage of residents who spend less than they earn
Montana has the second-lowest percentage of residents with emergency funds
Montana has the highest percentage of residents who have taken out non-bank loans such as payday loans

Yet Montanans scored slightly above the national average on a basic financial literacy test included in the survey. Does this indicate that financial literacy does not influence financial behavior? Or does it mean that other factors have greater influence?

If the former, it would contradict studies which have shown a strong positive correlation between financial literacy and behavior. However, analysis of data for all states yields a different result, showing a significant correlation between income and the three behaviors in which Montana trails—and explaining why it trails (analysis results are included at the end of this post). According to the survey, seventy-four percent of Montanans have incomes below $50,000. This makes it the state with the highest proportion of such residents, four percent higher than the next-highest state.

At the same time, analysis reveals that financial literacy has a significant positive effect on financial behaviors. For a state like Montana, where well over two-thirds of the population lives on less than $50,000, above-average financial literacy may play an important role in mitigating the influence of income on financial behavior.

As this surveys demonstrates, financial literacy is a timely issue for Montana, and Montanans can expect legislators to take up financial literacy in the upcoming legislative session—particularly whether to pass legislation mandating financial education in schools. MFEC will be issuing a white paper in early January to coincide with the beginning of the 2011 Legislative Session. The paper will examine evidence on the effectiveness of school-based financial literacy mandates in other states.

Analysis

Linear regression analyses were performed using data for all states, to assess the influence of both income and financial literacy on financial behaviors. To measure financial literacy, the FINRA Survey used a five-question quiz of basic knowledge, and reported average scores for each state. Survey respondents were also asked to report into which of several income brackets they fell. Responses were matched to Census data to ensure a representative sample. The percentage of the population in each state with incomes below $50,000 was used for this analysis to represent lower-income individuals. According to Census data, national median household income in 2009 was $50,221.

Regressions were conducted for the behaviors where Montana trails – savings, emergency funds, and non-bank borrowing. It was hypothesized that income would have a significant effect on these behaviors. A regression was also conducted for a behavior where it was hypothesized that financial literacy would have a greater correlation than income – comparison shopping for credit cards. This was done to confirm that income and not other factors were responsible for the correlations observed in other behaviors, and to examine the influence of financial literacy in the absence of the influence of income.

Savings

Regression against percentage of population with incomes below $50,000 indicated that the more people in a state earn below $50,000, the fewer people in that state save. The R² value of the regression was 0.369, indicating a significant correlation (the closer the R²value is to 1, the stronger the correlation).
Regression against financial literacy indicated no meaningful correlation. The R²value of the regression was 0.003.

Emergency funds

Regression against percentage of population with incomes below $50,000 indicated that the more people in a state earn below $50,000, the fewer people in that state have emergency funds. The R² value of the regression was 0.507, indicating a significant correlation.
Regression against financial literacy indicated that the higher the financial literacy in a state, the more people in that state have emergency funds. The R²value of the regression was 0.054, indicating a moderate correlation.

Non-bank borrowing

Regression against percentage of population with incomes below $50,000 indicated that the more people in a state earn below $50,000, the more people in that state engage in non-bank borrowing. The R² value of the regression was 0.498, indicating a significant correlation.
Regression against financial literacy indicated that the higher the financial literacy in a state, the less people in that state engage in non-bank borrowing. The R²value of the regression was 0.054, indicating a modest correlation.

Comparison Shopping for Credit Cards

Regression against percentage of population with incomes below $50,000 indicated no meaningful correlation. The R² value of the regression was 0.004.
Regression against financial literacy indicated that the higher the financial literacy in a state, the more people in that compared terms and costs of different credit cards. The R²value of the regression was 0.048, indicating a modest correlation.