Teaching People About Money Doesn’t Seem To Make Them Any Smarter About Money
Teaching People About Money Doesn’t Seem To Make Them Any Smarter About Money
From Market Watch Oct 12, 2018 By Philip Fernbach & Abigail Sussman
Teaching people about money doesn’t seem to make them any smarter about money – here’s what might
Making Financial Decisions is hard, but three promising ideas are helping Americans Overcome Barriers
If the average American went in for a financial checkup, he or she might get rushed to the emergency room.
Forty-four percent of us can’t cover a $400 out-of-pocket expense, and 52% of American households have no retirement savings. We seem to be chronically poor at making financial decisions. We commit costly mistakes across all areas of personal finance including decisions about savings, investing, budgeting and borrowing.
Diagnosing the problem is easy: We make mistakes because financial decision making is hard, and we lack an understanding of the decisions we face. Finding a cure is much more difficult. To many, the obvious treatment is financial education, but recent research suggests that financial education is not effective.
Some promising new ideas such as “just-in-time” education and “nudges” to help us make better decisions are starting to emerge as alternative approaches.
Ineffective Programs
Governments around the world have invested huge resources in initiatives aimed at improving financial literacy, such as the Federal Deposit Insurance Corp.’s My Smart program, which helps low-income individuals develop financial skills.
Unfortunately, research into the effectiveness of these programs paints a grim picture. A recent meta-analysis looked at every known study examining whether a financial-education intervention — such as training sessions, classes or one-on-one counseling — improves positive financial behaviors and financial health. Across all those studies, there was almost no benefit. Those participating in financial education were essentially no better off.
If we want to come up with better solutions, we need to understand the psychological barriers to financial education. Why is it so hard for people to learn?
Challenges To Learning
The first reason is relevance. The mind is not like a computer that can store arbitrary amounts of information. Instead, we tend to retain only what is useful for navigating our current circumstances.
For example, if you learn the abstruse mathematics of car leases to prepare for a negotiation at the dealership, you might be surprised to find how little you remember when renewing the lease years later. Financial education tends not to stick if it is not useful right away. Many curricula are flawed in precisely this way, teaching high schoolers about mortgages or debt management.
The second challenge is that the financial domain is a particularly complex one. You could call it a perfect storm. Many of the most important financial principles are highly counterintuitive. Take compound interest. Compounding is a nonlinear function.
The more you save, the more the savings accelerate, because the interest accrued in one period earns additional interest in the next period. In one study, participants were asked to guess how much money they would have after 40 years if they put $400 a month into a savings account that made a 10% annual return. The median guess was $223,000. The correct answer: $2.5 million.
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