In a piece for Slate last week, Helaine Olen took the financial industry to task for their continued push to make financial literacy a priority. She pulled no punches:
There’s only one problem: Financial literacy doesn’t work. One recent study published in the journal Management Science found that studying financial literacy has a “negligible” impact on future behavior and that within 20 months almost everyone who has taken a financial literacy class has forgotten what they learned. For a working paper, Shawn Cole at Harvard Business School, Anna Paulson at the Federal Reserve Bank of Chicago, and Gauri Kartini Shastry at Wellesley College discovered that high school classes imparting financial wisdom don’t seem to make a whit of difference when it comes to how we handle our finances. Others have found that lessons in financial literacy don’t lead to much in the way of increased test scores on the subject.
Olen thinks that consumer protection is the answer, not financial literacy. I’m not so sure that we should give up entirely on trying to instill financial knowledge in people. There just has to be a better way to go about it.
In most schools they try to get students to learn through rote memorization, but clearly that’s a poor way to get someone to actually understand something. There’s a huge difference between knowledge and understanding. Is memorizing a few facts on compound interest, credit card debt or stock market performance really going to help people improve their finances? Of course not. Facts and figures aren’t enough to change behavior, as anyone who has tried to lose weight or quit smoking can attest to.
So I don’t think writing off financial literacy is the problem here. It’s how financial literacy is taught. Most people know that debt is bad and saving is good. But you can’t focus just on the ‘what.’ The focus has to be on the ‘how.’ HOW do you to save more? HOW do you get out of credit card debt? HOW can you avoid making the same mistakes in the future? HOW do you reduce the cycle of buy high, sell low behavior. It has nothing to do with knowledge and everything to do with understanding human nature to be able to change your behavior.
In the 1960s, Yale researchers performed a study in which they were trying to influence students to get their tetanus shots. One group of students was given a lecture on the importance of the vaccine. Afterwards the students proclaimed they were convinced about the benefits after hearing the lecture and planned to get their shots. But in the end only 3% of them actually did.
The second group of students was given the same exact lecture. Only this time they were given a map of the campus to show them exactly where the health clinic was. They also had to sign up on the spot for a date and time to get their shot. The result? This group had a 28% inoculation rate.
It’s not simply motivation, trying harder or gaining more knowledge that affects change, even with Ivy League students. People need to be taught how to design systems to help reduce mental errors. They need that map to help guide them. Financial literacy must be focused not only on gaining more knowledge, but on designing systems to reduce behavioral biases such as overconfidence, decision fatigue, loss aversion, framing, fear and greed and the recency effect.
Without systems that automate good behavior by forcing people to save on a consistent basis, increase the amount they save over time, pay off debt, diversify their investments and stay out of their own way, then yes, financial literacy is a waste of time. But teaching people how to make good decisions up front can have lasting effects.
You can’t just lecture people and expect them to change their behavior. That’s never going to work. You have to show them how to build a repeatable process.
Subscribe to receive email updates and my monthly newsletter by clicking here.
Follow me on Twitter: @awealthofcs