Like many other people, I have always been firm in the belief that financial education is one of those obvious good things that everybody needs to have access to. This belief has also resulted in the somewhat unconscious conclusion in my mind that once people have access to financial education, then this must logically lead to better decisions and financial behaviors on their part. So we should all support more financial education and for more people, right?
I came across a brilliantly argued paper that sets this notion on its head and lays out the case that not only is financial education (and by implication, financial literacy) not a precursor to sound financial decisions and behavior, but that it may actually be harmful.
This is a seriously provocative view that I instinctively rejected at the start. However, the author, Prof. Lauren Willis, a Stanford-educated law professor with stints at Harvard and the University of Pennsylvania, lays out a highly compelling case why this is so. In this post I will summarize the main arguments she makes in her paper so you can decide for yourself.
The backdrop: universal support for financial education
Financial education has had increasing support from industry, from policy makers and other nonprofit groups. The argument is that as the number and complexity of financial products particularly across the credit (cards, mortgage), investment and insurance industries increase, greater disclosure of product terms coupled with increased consumer education will put consumers in the position to understand, evaluate, decide and act in a way that best serves their interests.
The key elements of this worldview are detailed seller disclosures , unlimited consumer choice, supported by “financial education” of consumers that will theoretically equip them to make the choices best suited for them.
In other words:
Financial education -> Financial literacy -> Good financial decisions and behavior
Is this the case?: the evidence is not reliable
Financial education aims to achieve behavior that maximizes the welfare of the person being educated. For someone to take the education they receive and translate it into positive actions, they must not only be educated, but also have the right level of self-confidence in their own abilities to be able to decide what decision to take and how to take it (e.g., deciding to hire a skilled financial professional, for example).
The research on the effectiveness of financial education is flawed because of significant research shortcomings:
- They use biased data collection techniques, for example, relying on self-assessments by participants of financial education courses. A truly rigorous test would look not only at self-assessed score but actual behavior. Also, the research should look not only at people who had financial education, but should also look at comparable groups who did not receive education to see if the education was truly the differentiating factor, and if it did make any difference to the target behaviors
- Many education programs bundle education with direct assistance (such as debt management programs). Because the “education” comes packaged with direct assistance, it’s hard to say how much of any observed behavior change was due to these assistance steps versus owing to education alone
- There is a self-selection bias in terms of people who take financial classes because participation is usually voluntary (unlike assistance programs with mandated education we talked about in the previous point). The people who really need them are typically unlikely to take them, and the people who take them tend to be those already willing and able to take care of their finances. There’s one more interesting twist to this: people reported higher self-confidence after taking a personal finance course but this increased confidence was not correlated with actual increase in capabilities!
The prognosis: 4 reasons why financial education is unlikely to work
We could argue that it is merely poor execution that has made education ineffective. If done well, perhaps education still has a chance.
Prof. Willis solidly debunks this hypothesis, highlighting four reasons why financial education alone is highly unlikely to lead to better financial decisions, and in fact, may even be counterproductive.
Reason 1: Information imbalances and moving targets
In simple English, sellers and manufacturers of financial products will always have more information not only about the products themselves, but also of customers’ usage of them. They also create a huge array of products, many meant for a very specific niche: think ARM’s or adjustable rate mortgages for example, or insurance policies with the option of adding from dozens of “riders” or special features.
It’s difficult and even impossible for the lay person to know or hope to master the intricacies of this dizzying array in time to be able to make a sound decision on them, among all the other things they have to deal with in their lives. It’s a bit like asking them to figure out what ails them and be their own doctor, understanding and selecting from a constantly expanding pharmacological offering.
Reason 2: Insurmountable knowledge, comprehension and skill limitations
To make a decision today about even a basic product like an insurance policy or mortgage, a consumer needs to understand a huge variety of concepts: credit, probabilities, etc.
They then need to be able to extract information from the jargon-heavy terminology used throughout the sales literature and voluminous disclosures.
Third and most significantly, they need to be able to then apply these concepts, use the numeric skills to their own individual circumstance to come up with the right decision for them.
Even if this were possible in today’s busy and chaotic world, new products are developed and launched so fast in the name of product innovation that it would be a fool’s errand to even try to keep pace.
Reason 3: Inherent human bias and the difficulty of overcoming bias
Two Nobel prizes have testified to the importance of behavioral economics to date: human behavior is not rational and will never be. The unfortunate part is that these biases seem to play an extra-heavy role when it comes to financial behavior and decisions. Not only that, it is extremely difficult to negate the impact of these biases even after we become aware of them. So it is difficult to make the case that financial education will even start to make a dent on these challenges to sound financial behavior. Here are some particularly noteworthy instances of bias:
- Evaluation and decision making for financial matters usually requires significant mental and even emotional resources that are invisible on the outside but cast a significant drain on the person. It’s not just the numbers, it’s also the uncomfortable prospect of facing your own mortality, for example. Rather than paying this heavy price, it’s much easier and more attractive for people to bypass this altogether, and rely instead on simple rules of thumb to make their choices. No amount of financial education can remedy that.
- Personal finance decisions are extremely prone to decision-making biases. For example,
- An overwhelming array of choices in every product category makes it more likely that consumers will avoid making any decisions at all. When you are offered six 401k options versus two, it’s much less likely that you will even invest in a 401k. Alternatively, you may simplify the choices so it bring the effective choices down to three or fewer, which is about all the human brain seems to be able to handle effectively. Counter-productively, giving consumers more financial education and information will only worsen the problem
- Financial product decisions and choices typically have high financial and emotional stakes attached. These are not just related to the actual outcomes, but also to the decision-maker’s accountability to his or her near and dear ones if poor decisions are made. This stress results in a lot less actual brainpower being available to make these tough decisions, leading to the likelihood of poorer choices. Education cannot help with this problem.
- There is a need to confront unpleasant and discomforting realities when making financial decisions and choices. Consumers typically cope with this stress by either denying their reality (“Everybody dies, except me”), or by perceiving their actual risk as much lower than it is. This sense of overoptimism and overconfidence in their personal financial decision-making cannot be corrected by mere financial education.
- A significant amount of future uncertainty about a whole host of variables outside the individual’s control must be addressed. To do this effectively, people need to be able to visualize alternative and future scenarios equally vividly to make sure they are not over-weighting the present at the cost of the future, for example. But this is notoriously hard to do, even for highly aware and informed individuals – we are simply not wired this way. A related bias is called the certainty bias – this means that consumers tend to favor options with more certain outcomes, even if these are likely to make them worse off than other, less certain options.
- Some attributes of products are invisible to consumers (a.k.a. , “the fine print”), or require trade-offs between apples and oranges, that the consumer may not feel equipped to make. The typical coping mechanism is to ignore, in the case of the former, or reduce to one or two that are comparable (e.g. reduce loans to their APR’s), even if other factors should weigh more in the decision.
- Last but not least, because there is nothing forcing a consumer to make a decision that will best serve their long-term interests (think of investing for retirement or buying an insurance policy, for example), inertia and status quo will trump everything else unless there is active, powerful and opposing force to trigger action. In practice, this means just letting things be, and resorting to the “free advice” of non-experts such as friends and family even though consumers are aware that these are not the most competent or even advisable sources of advice and information.
Reason 3: De-biasing is extremely difficult, and hasn’t proven to be effective
We have just seen the extent and power of personal behavioral biases in the context of personal finance. Is it possible to de-bias ourselves to escape their damaging impact? Unfortunately, the answers aren’t encouraging.
The paper outlines six possible de-biasing techniques, concluding that while many of these are effective, it is difficult to provide for them in a personal finance decision-making context. The six possible options reviewed:
- Repeat play with clear-cut, objective and immediate feedback: Think of this as like a sort of game where you go through multiple facets of financial decisions repeatedly and get immediate feedback on how you fared. This method has proven to have limited efficacy in real-life situations.
- “Consider the opposite” method, where you are encouraged to consider the opposite choice to what you prefer. While it looks appealing, the challenge in personal finance is coming up with a suitable “opposite”. For example, if you are considering investing in a mutual fund, is the opposite to not invest at all, invest in bonds instead, or just a different brand of the same type of mutual fund?
- Consider the pros and cons: This is the good old Ben Franklin method, and needs no explanation. The biggest risk with this method is that if there is an important factor the consumer isn’t yet aware of, it will never make it to the list of pros and cons, and there is nothing in the process that triggers them to look for what they’re missing, either.
- Construct your list before you shop: Also known as the “never shop without a list” method. While this mitigates somewhat the risk that you will omit an important factor, it still asks too much of the consumer in terms of evaluating what each “feature” of the product on the shopping list to be, let alone how heavily it has be weighted relative to the others.
- Time and space: Known as “cool off before you buy” method. The risk here is that if you have been swayed by the emotional or persuasive appeals of a great sales process, all the cooling off period does is to further cement your already-formed preferences, rather than to encourage you to actively seek dis-confirming evidence. Human wiring is very hard to break.
- Individual differences: In addition to the above, other, specific de-biasing or counter-biasing strategies could be implemented. But they will work only with specific individuals who have a specific set of conditioning factors or worldviews and could backfire in other cases.
Bottom-line: de-biasing is very hard to do in personal finance.
Reason 4: Reaching consumers at teachable and vulnerable moments
There is broad-based consensus that education works best at key turning or inflection points in consumers’ lives, called “teachable” moments. This is when they have just experienced a major life change, whether good or bad, or are revisiting their identity and are thus most open to doing things differently. Can finance education be effective if provided at those moments?
The paper points out that given the sheer difficulty of predicting when individual consumers will hit these teachable moments, and the limited resources available, coupled with the tailored and individualized nature of the need and the situation, it will be practically impossible to effectively deliver financial education in this way. The institutions most interested in doing so simply do not have resources at that scale to deliver on this task
Is all lost? – Green shoots of hope
Reading this paper, you might be tempted to adopt a bleak view of consumers’ financial future, as I initially was. The author offers seven possible solutions, with varying levels of feasibility and viability, to correct this imbalance. These range from affordable access to expert financial advice and optimized defaults all the way to stricter provider licensing and greater regulation
What then is the answer? The paper makes a very compelling argument that merely providing voluminous seller disclosure coupled with financial “education” can hardly be expected to provide the kind of expertise and support even a typical customer needs to make wise and prudent financial choices. Doing so would be akin to giving a sick patient access to a lot of drugs, the best medical textbooks and the scientific literature pertaining to the formulation and effects of a vast range of pharmaceutical products minus the benefit of medical training.
Personally, the effect this paper had on me was to make the most compelling and almost irrefutable argument that I have seen to date, that access to solid financial advice is an absolute necessity to ensure financial well-being for everyone.
Obviously there are huge caveats and challenges with that view: the scalability of good service delivery models being the least of them. However, with increasing advances in technology, particularly with artificial intelligence, deeper insights into behavioral science, and more platforms and delivery formats, it is completely possible that such advice or at least behavioral and cognitive support can and must be provided to enhance overall financial well-being and prosperity.
Willis, Lauren E., Against Financial Literacy Education. Iowa Law Review, Vol. 94, 2008; U of Penn Law School, Public Law Research Paper No. 08-10; Loyola-LA Legal Studies Paper No. 2008-13. Available at SSRN: https://ssrn.com/abstract=1105384