Financial literacy – the most misunderstood and abused good intention.
It is alarming how we love simple solutions for complex problems. We want politicians to solve our ills in a soundbite and we want money problems to go away with a class. The reality is neither of those solutions is ever going to work.
I once said, “Blaming a lack of financial literacy for our economic ills is like saying that people don’t understand diet, exercise and moderation for obesity.”
Yet people continue to drone on an on about how if we just pushed more financial education classes down the throats of youngsters it would somehow eliminate the need for the Consumer Financial Protection Bureau, stop all debt problems, and make people smarter about money.
It’s my opinion that financial education alone will not work as a single source solution. In fact, it might even hurt more than help. The jury is still out if people who take financial literacy classes do better than those who don’t. They might feel they know the information better but that doesn’t mean they really do. Confidence is not knowledge. And some tests of student who just completed financial literacy classes actually showed they scored lower than students who did not take the class.
Giving consumers more information through financial education may only produce the “illusion of knowledge.” When people are given more information about investments, for example, they become overconfident in their ability to invest well, believing that the information gives them more knowledge even when it does not. – Source
I already know what people think when I mention the illogical nature of the fallacy of financial literacy. They give me that head cocked look and think I have no idea what is coming out of my mouth. How can financial literacy not be our simple savior to rescue people from future money troubles?
Well the complex answer to such a simple question is that financial literacy is not about the money. The way we make financial decisions has more to do with our money personality (take the money personality test here), our math skills, logical thinking, the ability to investigate, the confidence to ask questions and spot BS answers, and recognizing the unconscious influences in ourselves that have long been studied studied by behavioral scientists.
So I turned to some of the brightest people I know who understand these issues. If you don’t want to believe me, then let’s see what others have to say on this subject.
Consumer debt expert Bob Sullivan said, “I just got into an argument with one of my clients about this recently. All the behavioral studies are clear: financial education hasn’t really worked on a large scale. What we really need is to design our economy so people don’t get ripped off, so there is a baseline of fairness. Beyond that, if someone seeks out smarts and does even better than average, becomes a jedi master of credit cards and loans rewards programs, that’s great. But anyone who thinks a nice pamphlet is going to stop the next housing market collapse is kidding themselves.”
Bob is a smart author and puts out a very nice weekly email about his new articles. You should subscribe to it.
I was lucky to have met financial author Healine Olen a while ago. Healine said, “And, sure. Bashing financial literacy feels like bashing apple pie. It sounds so logical. We’ll teach people about money and — well, they’ll get it right! It doesn’t work that way, of course. The studies show people don’t remember much — if any — of it after a few years. In fact, the group financial literacy works best for are the financial institutions that push it. This way, they can blame people when they don’t get their finances right and head off substantive legislative and regulatory reforms of predatory products. Think of it this way — what helps more? The CFPB or a financial literacy curriculum? And, of course, many financial problems aren’t because of poor financial literacy at all. They are because we live in society with inadequate safety nets and other protections. Medical debt — not financial illiteracy — is a leading cause of bankruptcy.”
Others looked at this subject more dispassionately. The brainiacs at the Federal Reserve Bank of New York said, “In marked contrast to the estimated impacts of mathematics and financial literacy education, we see that economic education leads to an increase in the likelihood of having outstanding debt, and significant increases in both delinquency and bankruptcy.”
“The “theory” of financial education goes something like this: holding all else equal, financial education leads to greater financial knowledge, greater financial knowledge then leads to better financial behavior, and better financial behavior ultimately leads to improved consumer outcomes. Indeed, the cornerstone for the argument in favor of financial education rests squarely upon the validity of these links. However, largely, to our knowledge, these links have merely been assumed as given by financial education programs.” – Source
Dan Airely, a well known behavioral economist and a smart guy to be around, he’s over at Duke University, said, “Look, the sad result is that we can teach people something and they can sometimes remember. But the question is, will they act and will they act consistently. And a couple of things are important to remember. One is that, I think, our financial lives are becoming incredibly more complex, right? So think about 40 years ago, what did you need to know about the financial market and what did you need to know about annuities and what did you need to know about insurance and disability insurance. And now, we need to do lots of things. And even mortgages all the sudden have points, which makes things much more complex; and a car purchasing have leases.
So our financial lives have become much, much more complex. And because of that we kind of need to know much more. But we don’t just need to know, we need to know and we need to execute. So on one hand, you know, our financial lives are much more complex. On the other hand, we also get tempted much more. If you think about the frequency by which we’re tempted to buy X Y and Z; new cars, homes, and so on, that the amount of temptation is just increasing and increasing and increasing. And because of that, knowing something is no guarantee for behaving better.
And if you think about all kinds of ways in which we kind of have improved our behavior: think about something like wearing seat belts, or reducing smoking from 40% to 20%, and so on. Very little of it came because of information, right? Because information means that you learn, you know, you remember, you understand. But then that you also execute every time. And executing every time is very hard. So it means that every time you go to buy coffee, and food, and to the movies, and online, you remember all the lesson you learned in this financial literacy class, and that’s just exceedingly hard to do, which means that we don’t do it. Anyway, so that’s – that, I think, is the reason. Now, I would not expect people who took financial literacy to do worse, but I certainly expect them to know a bit more but not to do much better.”
So That’s It
Will people let go of this notion that simply making every kid take a financial literacy class will help them do better? No.
The financial literacy industry and the assumption a class alone will inoculate people is far too intrenched. The simple absurdity that a financial literacy class I might have take 40-years-ago would have any influence on the complex financial choices of today, is crazy.
In no way am I suggesting that we give up on helping people to do better but what I am suggesting is that financial literacy in its current format will not work, does not work, and has not worked as a simple solution. What would be much more effective would be somehow to teach children to learn and retain critical thinking, dispassionate logic, consumer math skills, inquiry into complex terms and conditions, and awareness about the risks of arbitration, contact law, how to investigate a company before hiring them, etc.
Financial blogger J.D. Roth once wrote in Time, “Ultimately, if we want Americans to be smarter with their money, we need to encourage them to consume less media — to avoid advertising — and we need to teach them to master the emotional side of personal finance. We need to show them how to change their behavior. We need to appeal to their self-interest. We need to help them find intrinsic motivation to save. That is, each of us needs to dig deep inside to find what it is that’s important to us, what it is that brings us joy, and we need to prioritize that instead of all the other garbage.”
And he is exactly right.
So what’s the ultimate solution until we figure this all out — more consumer protection. We simply need to bake more security into financial transactions so that the default options available to consumers provides the most protection from ourselves. Concepts like forced savings, or retirement trickle investing would not be bad options to prevent future financial disasters.
But market forces push against that logical solution. Even as I write this there are high paid lobbyists trying to help annihilate the Consumer Financial Protection Bureau to remove financial oversight and consumer protection.
Lauren Willis Professor of Law at Loyola Law School, said it with better bigly words than I did. About financial literacy education she said, “This education is widely believed to turn consumers into “responsible” and “empowered” market players, motivated and competent to make financial decisions that increase their own welfare. The vision created is of educated consumers handling their own credit, insurance, and retirement planning matters by confidently navigating the bountiful unrestricted marketplace.”
Willis added, “Although this vision is seductive, promising both a free market and increased consumer welfare, the predicate belief in the effectiveness of financial-literacy education lacks empirical support. Moreover, the belief is implausible, given the velocity of change in the financial marketplace, the gulf between current consumer skills and those needed to understand today’s complex nonstandardized financial products, the persistence of biases in financial decision making, and the disparity between educators and financial-services firms in resources with which to reach consumers.”
But the cherry on the top from Willis has to be, “For some consumers, financial education appears to increase confidence without improving ability, leading to worse decisions. When consumers find themselves in dismal financial straits, the regulation-through-education model blames them for their plight, shaming them and deflecting calls for effective market regulation. Consumers generally do not serve as their own doctors and lawyers and for reasons of efficient division of labor alone, generally should not serve as their own financial experts. The search for effective financial-literacy education should be replaced by a search for policies more conducive to good consumer financial outcomes. – Source
The ultimate irony about financial literacy as a tool is we’ve known for decades what we need to do to better protect consumers from bad financial mistakes and yet we just don’t do it.
Learn more about why knowing your money personality is important.
Have a few more minutes? Read “Why Smart People Are Stupid.”
Have more time available? Listen to this NPR story on financial literacy.
If you have a credit or debt question you’d like to ask, just click here and ask away.