Does Financial Literacy Work?

piggy-literacyI listen to the Freakonomics podcast every week. I love it. I would listen to it daily, if it was produced that often. Recently, I decided to go back and listen to some back episodes and came across one from January of 2012 that talked about financial literacy.

The podcast shared some data (as they always do– it’s about economics, which is all about data) and had a few guests on to talk about the big question of the episode, which was: Does financial literacy work?

It got me to thinking: Does it? Does financial literacy (or education actually) change anything for people on its own?

Annamaria Lusardi might think so. Dr. Lusardi is a professor of economics at Dartmouth University and she is a stalwart supporter of increasing financial education nationwide to lead to financial literacy. Stephen Dubner is one of the authors of Freakonomics and hosts the podcast series based on the book. He also writes for the Freakonomics website. Mr. Dubner has written about Dr. Lusardi a few times before, including this article.

That article, in particular, was interesting to me. In it, Mr. Dubner shares some of Dr. Lusardi’s research. At the time of the article, Dr. Lusardi, along with Olivia Mitchell of Penn, had been using the following three questions in a variety of major U.S. surveys in an effort to gauge the financial literacy level of the country:

1. Suppose you had $100 in a savings account and the interest rate was 2 percent per year. After 5 years, how much do you think you would have in the account if you left the money to grow?

a. More than $102
b. Exactly $102
c. Less than $102
d. Do not know

2. Imagine that the interest rate on your savings account was 1 percent per year and inflation was 2 percent per year. After 1 year, would you be able to buy more than, exactly the same as, or less than today with the money in this account?

a. More than today
b. Exactly the same as today
c. Less than today
d. Do not know

3. Do you think that the following statement is true or false? “Buying a single company stock usually provides a safer return than a stock mutual fund.”

a. True
b. False
c. Do not know

I’ll give you the correct answers to those questions a little later in this post.

One of Dr. Lusardi’s working papers is titled “Financial Literacy: An Essential Tool for Informed Consumer Choice?” (abstract here, download here, if you’d like to read it.) In that paper, she concluded that among respondents age 50 and older, only half of them got the first two answers right and only one-third of them got all three answers right. Dr. Lusardi was troubled by the results, if for no other reason, because by age 50, the respondents to the survey had likely already experienced a lot of transactions in their financial lives. With the average life expectancy around 80 years old, those respondents had lived about 62% of their lives without having gained some (what Dr. Lusardi would likely think is) crucial education. Not only that, it means that those same respondents are passing along that education (or lack thereof) to the next generation, too. Dr. Lusardi’s concerns were validated through later surveys, as she discovered that young adults, women, and minorities also had financial literacy shortcomings. Dr. Lusardi sees the data and the data tells her that education is the answer. People need to learn more.

But there is a counterargument out there to be made, as well. Another podcast guest, Lauren Willis, is a non-supporter of financial literacy education. This article from CNN Money sheds some light on some of her opinions. The nuts and bolts of it are this: Willis thinks that the financial world, with its policies and regulations, changes too fast for people to keep up with all the new knowledge. She thinks that sellers of financial products try to drown out well-meaning messages to the consumer from nonprofits and government agencies. In the Freakonomics podcast, Willis also talked about how complicated investments and mortgages and other things can be– especially to the lay person. She also said that education can give folks a false sense of security, thinking that they know more than they actually do. I think all of her points make some sense, actually. Policies and regulations do change quickly. There are a lot of mixed messages about there about what’s “good” for you (and for-profit companies and businesses primarily are wanting to make money off of you.) Investments are complicated (I have a 401k and a Roth IRA and I even own some individual stocks just as a hobby– but I’m not sure how “educated” I am in regards to the details of any of them. I invest primarily through our Members Financial Services representative, who knows what he is doing.)

But one thing in particular struck a chord with me: Willis believes that there isn’t enough evidence out there that shows education is effective. She has said that studies show that sending people to either high school personal-finance classes or adult retirement seminars doesn’t actually result in better financial behavior. The people liked the classes and the post-class surveys were positive– but then those folks went home and didn’t experience significant or lasting change. Willis sees the data and the data tells her that education doesn’t help.

As a counselor, I can relate to her data on people liking the info but not implementing change. I have met with members who had to take financial education classes because of bankruptcy or through some other financial educational program only to revert right back to the habits and choices that got them into trouble in the first place. I’ve even heard members say that they knowingly don’t implement anything they’ve learned from financial education(!) Sometimes I have an appointment, myself, and the member seems like they are excited, they are hopeful, they are picking up everything I’m laying down– and then they leave and I never hear from them again. And then I later hear that they are having delinquency problems or are in danger of repossession or I see their checking account is grossly overdrawn. I’ve seen it, all too often: I pack as much education into an appointment as I can only to not see it bear any fruit. Hopefully Willis wouldn’t think that’s just because I’m a bad teacher. I think she’d be more likely to say that education simply isn’t the answer– and, to a degree, I think she’d be right.

The podcast tells a story about Cedars-Sinai Hospital in L. A., where doctors once had a fairly serious issue with hygiene. Doctors weren’t washing their hands as much as they should. In fact, doctors were washing their hands about 65% of how much they should have been washing. Now, they make the point in the podcast that doctors are the smartest people in the hospital. They know full well how important it is to wash your hands and to not carry bacteria around– bacteria in the hospital setting can sometimes even kill people once infections set in. Those doctors all know what they were supposed to be doing. But for whatever human reason, they weren’t. Who knows why? That’s a question for research psychologists to figure out. But the point that I want to focus on is that we don’t always do what we know we should. (As an epilogue, Cedars-Sinai fixed the problem and the percentage of doctors who could pass hygiene standards is now always around 100%. The hospital came up with some strategies that increased awareness and accountability and things turned around. If you end up as a patient at Cedars-Sinai, don’t fear unclean hands. 😉 )

So here’s what I think, and I’ve posted a little about it before: The fact of the matter is that education is not the only answer. It can’t be. Nelson Mandela once said, “Education is the most powerful weapon which you can use to change the world.” I like that one. But inherent in his quote is that you use education to change. It requires action. So I think it all lies somewhere in the middle. Education is no good without action. But action without education isn’t much good, either.

I do think it’s important to have a basic understanding of personal finance principles but I also think it’s important to have an understanding of the limits of your knowledge. I think you should lean on resources that you trust to steer you in the right direction regarding those complicated aspects of your financial life that you don’t fully understand. Most importantly, once you have an education and you know where to go to get help for the complex stuff, it’s up to you to take control of your financial life. Do your part. Put in the work. Take action. Figure out the necessary motivation to do so. Ultimately, doing or not doing what you know you should is a choice that you make– and you are responsible for your choices. But I think a super encouraging thing to remember is that you can make new choices, too. Your financial life doesn’t have to stay in turmoil. You can take ownership. You can both get an education and you can apply that education, all through your own choice.

Here are the answers to those questions from earlier: In order, they are a, c, and b.

Did you pass? Did you get all three answers correct? If not, what are you prepared to do about it?

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