The Great Recession has served as a flash point for public discussion about Americans' finances, exposing their poor financial health and limited financial knowledge. In addition to systematic failures in financial regulation and misconceptions of risk, blame has sometimes been levied against individuals with limited financial knowledge for contributing to the recession. This latter explanation implies that the recession's effects would not have been as wide or as deep if individuals had had the right financial knowledge. In any case, it's a complex financial world in which responsibility is increasingly shifting to individuals to make the financial decisions today that are critical to their financial health in the future.
Financial education is proposed as a solution to Americans' limited financial knowledge and, subsequently, a way to improve their financial health. Financial education(1) refers to the passing on of financial knowledge that takes place either individually or in groups through workshops, seminars, trainings, and planning sessions in school or employment settings. The Great Recession aside, there is good reason to be concerned about the level of Americans' financial knowledge. For instance, only 9% of 15-year-olds in the United States demonstrate the type of competency on advanced financial knowledge questions that would be necessary for making informed decisions for taking out student loans, interpreting mortgage agreements, or comparing investment portfolios.(2) In other words, individuals may make healthier financial decisions and behave in more financially optimal ways when they are better educated.
If this is true, then an individual's financial knowledge gained through financial education should be a strong determinant of their financial behavior.(3) However, a recent review of over 200 studies has raised questions about the effectiveness of financial education, revealing that its influence on behavior may be relatively small and that any measurable effects disintegrate over time. Proponents of financial education explain these small and disintegrating effects by arguing that existing studies do not rigorously evaluate or consistently implement financial education, carefully match the education received to the corresponding behavioral outcomes that were originally targeted for change, or capture financial knowledge gains that develop cumulatively across the life course. These explanations and interpretations of practically null findings are indeed important. It is easy to understand why general financial education covering topics like insurance and interest rates might have little measurable effects on such behaviors as saving for emergencies, purchasing a home, or saving for retirement, for instance.(4)
Another explanation is that financial education on the whole underestimates the complicated contexts in which individuals make the financial decisions that are reflected in these behaviors. How could any one individual have gained enough financial knowledge to be adequately prepared to weather the Great Recession completely unscathed? Could even the best advisor or accountant have adequately prepared for the financial domino effect of becoming unemployed, exhausting their limited emergency savings, losing their home, and cashing out their 401(k)? In the wake of the Great Recession and the difficult and multi-layered financial decisions that ensued, a course on financial education would have likely provided little solace and in fact would have been insulting to many. For example, even older Americans who had enjoyed sufficient resources and portrayed good forethought by diligently saving for their retirement years saw dramatic declines in their nest eggs, and many postponed their retirement as a result. Moreover, it is estimated that the lost incomes of younger Americans who were blocked from entering the labor market during the recession (something beyond their individual control) will translate into thousands of dollars less in earned income and retirement savings later in life.
This is not intended to be a sweeping dismissal of financial education. Indeed, many brilliant minds are working diligently to understand the potential of and evaluate financial education. Instead, this is intended to remind us that healthy financial behavior is hard and that our environments often work against us. Consider healthy eating for a moment. Even if an individual is knowledgeable about the importance of good nutrition, it is hard to stick to a healthy diet without a grocery store in the local neighborhood. Nutritional knowledge without access to fresh fruit and healthy vegetables (or kitchen appliances to store and cook this food) would be of little practical value. Likewise, an individual's financial behavior needs to be understood in the context of their environment and that an environment with sufficient resources and opportunities can better enable healthy financial behavior -- something we are all reminded of from the vantage point of the Great Recession.
This environmental context is especially important for those whose financial health could be in jeopardy with one "wrong" financial decision. If the local bank where you cash your checks closes unexpectedly (a heightened trend during the Great Recession), what options do you have when you need your hard-earned money to pay the bills at the end of the week? All of a sudden, a cash advance on your paycheck--something you would have never considered before--may seem like the best (or only) option. From this perspective, individuals behave in financially optimal ways when they have both the knowledge and the opportunity to act on that knowledge.
Knowledge and opportunities are part and parcel of financial capability: the combination of financial education and financial inclusion via safe and affordable financial products.
Individuals need real opportunities to put their knowledge into practice and these opportunities are often available through the financial products to which they have access. Rigorous research studies (including those with experimental and quasi-experimental designs) find that the combination of receiving financial education and owning a savings account improves financial knowledge and increases accumulated savings and assets. In fact, some of my own research (generously funded by the FINRA Investor Education Foundation, for full disclosure) has found that young adults who are financially capable are 176% more likely to afford unexpected expenses, 224% more likely to save for emergencies, 21% less likely to use alternative financial services, and 30% less likely to carry burdensome debt when compared to their peers who are not financially capable. And remember that review of 200 studies on financial education? The authors were encouraged by financial education whose delivery corresponded with a financial product or decision--what they termed "just in time" financial education. In other words, financial education showed promise for improving financial behavior when individuals had the knowledge and were presented with an opportunity to act.
Considered in light of unpredictable economic conditions, interventions that focus solely on financial education may be insufficient for facilitating healthy financial behaviors; interventions should instead develop financial capability.
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(1) Here, financial education does not refer to the financial socialization that takes place within the family, which is another way financial knowledge is conveyed to young adults.
(2) It should be noted that financial education, financial knowledge or literacy, and financial competency are distinct concepts. Teaching financial education does not automatically translate into knowledge or competency of the individual receiving the information. Here, knowledge could be understood as correctly answering questions on financial knowledge questionnaires, and competency could be understood as acting out financial behaviors and making financial decisions in the real world.
(3) Much of the research and discussion on financial education makes the assumption that financial education can improve financial knowledge and that improved financial knowledge translates into financial competency. However, these are assumptions that need to undergo empirical testing. Education may or may not translate to knowledge, and knowledge may or may not translate into competency. For example, despite having taught Spanish to high school students over several decades, we still have yet to witness this teaching translate into fluency in Spanish (competency) for the majority in the United States who have received this education.
(4) It is easy to understand why there is excitement about the potential effectiveness of financial coaching and planning interventions that tailor education to individual needs around specific financial decisions and relate to improved financial behaviors. However, these interventions are labor intensive and costly, making them difficult to bring to scale. Perhaps the advent of new technologies, like online or app-based educational platforms, can bring some efficiency here in terms of time and cost.
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About the Author
Dr. Terri Friedline is an Assistant Professor of Social Welfare at the University of Kansas. She has published extensively on savings and asset building, with her recent work focusing on the reciprocal relationship between child development and Children's Savings Accounts. She is a Research Fellow at New America in Washington, DC, and a Faculty Director at the Center on Assets, Education, and Inclusion (AEDI). She can be reached for comment at tfriedline@ku.edu or followed on twitter @TerriFriedline.
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Acknowledgement
This research was supported by a grant from the FINRA Investor Education Foundation. All results, interpretations and conclusions expressed are those of the research team alone, and do not necessarily represent the views of the FINRA Investor Education Foundation or any of its affiliated companies. No portion of this work may be reproduced, cited, or circulated without the express written permission of the author.
The FINRA Investor Education Foundation, established in 2003 by FINRA, supports innovative research and educational projects that give underserved Americans the knowledge, skills and tools necessary for financial success throughout life. For details about grant programs and other FINRA Foundation initiatives, visit www.finrafoundation.org.
