In this edition of our “Ask the Experts” series, we discuss the effectiveness of personal finance education as we know it with Dr. Shawn Cole from Harvard Business School, Professor Lauren Willis from Loyola Law School – Los Angeles, Dr. Olivia Mitchell from the University of Pennsylvania’s Wharton School of Business, Dr. Douglass Bernheim from Stanford University, Dr. Richard Serlin from the University of Arizona’s Norton School of Family & Consumer Sciences, and Annamaria Lusardi from The George Washington University School of Business.
Is there actually a case to be made against personal finance education? While that might initially sound about as foolish as buying a house you can’t afford with an interest-only loan, there’s actually a group of pretty smart people out there who are arguing something along those lines.
Dr. Shawn A. Cole, an MIT grad who now teaches finance at Harvard Business School, and Professor Lauren Willis, who will join the Harvard Law School faculty as a visiting professor next fall after teaching at Loyola (Ca.) Law for eight years, are two of the most outspoken champions of this cause, if you will.
Their argument centers around research which indicates that little or no correlation exists between the type of state-mandated personal finance education programs we’ve seen pop up across the country in the last 15 years or so and improved consumer performance later in life.
“It doesn’t work,” Willis said. “Basically, all the research shows that people have no better outcomes after they take these classes than before. It seems there are a few things that account for that.”
- “The information that folks learn in these classes tends to degrade very quickly in that the market changes quite quickly and the laws change quite quickly. So, you might teach someone a lesson at one point in time and then they try to apply that later and it leads them in the wrong direction.”
- “The marketplace has so much more information and is so much closer to the consumer at the time of the consumer’s decision. The consumer doesn’t have their teacher sitting there while they’re making their decision; instead, they have the marketing and the sales force there.”
- “The reasons people make bad decisions are often not due to a lack of knowledge. I mean, that’s one issue, but another big issue is that people tend to make these decisions emotionally, impulsively based on things other than their own knowledge base.”
- “The distance between where people are now and where they need to get is just too vast. I mean, people know incredibly little. Oftentimes, people say well, ‘the people know so little, so if they just knew more, they would do better.’ But it doesn’t turn out empirically that that’s the case.”
The aforementioned research in question stems, in part, from a pair of “working papers” that Cole co-authored with Anna Paulson – an economist with the Federal Reserve Bank of Boston, and Gauri Kartini Shastry – an assistant professor of economics at Wellesley College. They found that while increased mathematics requirements and additional years of general education do improve ultimate financial performance, personal finance-specific content has no quantifiable impact. Instead, they argue that overall cognitive development is the most important byproduct of continued education.
“My view is that the evidence that they’re effective is not compelling so far. So that means if we’re to spend money on financial literacy education, we should spend money on figuring out what would actually work rather than scaling up programs that don’t have demonstrable effects,” Cole said. “Teaching simple guidance can be effective. I think another promising area is the decision to support, which would mean giving people real-time advice and guidance, rather than training them in high school and hoping that 20 years later when they’re making a mortgage decision they remember what they learned.”
So, the question is: Do you buy it?
Before you answer, it’s important to note that Cole and Shastry aren’t against financial literacy programs per se, but rather that they find fault with the practice of blindly funding them in the absence of evidence that they’re truly helpful. That’s obviously sound reasoning, but you also have to consider that Cole and Shastry’s findings are directly at odds with previous research on the topic.
The Counter-Argument & Research Behind It
One notable study – from Dr. Douglass Bernheim at Stanford University – did indeed identify a correlation between financial education and improved money management, finding that students who went through state-mandated financial literacy programs saved significantly more than those who did not, primarily because the courses served to demystify the often daunting subject of personal finance. While Cole’s research mostly discounts these findings, largely due to the contention that Bernheim’s analytical approach was off-base, Bernheim is quick to offer a retort.
“In the work I know about, Shawn used US Census data, whereas I used a specially designed survey fielded by Merrill Lynch,” Bernheim told Card Hub via e-mail upon a request for comment on Cole’s research. “The main reason for using the US Census is that there is a LOT of data, which can improve precision. But when we did our study, we looked at the Census data and rejected it in favor of designing a survey specifically tailored to the task. The Census simply does not collect the kind of information needed to do the study properly.”
To be fair, Cole says that his research team was able to replicate Bernheim’s results using a variety of different data sets – including Census data, data from the government’s Survey of Income and Program Participation, and credit bureau records – yet these results disappeared when the “proper” analytical controls were factored in.
The Steps We Can Take
Data sets and research rivalries aside, the most important question of all still remains: What do we do to address our collective lack of financial know-how?
Well, doing nothing isn’t really an option given the scope of the problem. U.S. consumers now owe more than $800 billion to credit card companies, at least $70 billion of which we incurred in the past two years alone despite the Great Recession’s wake-up call. Then there’s the more than $1 trillion in outstanding student loans, widespread mortgage defaults, and so on. When you think about it, we’re also risking another economic meltdown by not addressing the issue head on.
“We know that Americans don’t understand compound interest, based on our surveys,” Dr. Olivia Mitchell, a professor of business economics and public policy at Wharton, told Card Hub via e-mail. “This helps explain why they take on more and more credit card debt, student loans, mortgages with variable interest rates, car loans, etc. We know that Americans don’t understand risk diversification, again from our surveys. This helps explain why people tend to over-invest in their employers’ stock, put too much of their money in a single house, and fail to invest enough in their human capital – their own skills, as well as mental and physical health. While the Financial Crisis was due to far deeper problems than financial literacy, it seems clear that peoples’ lack of understanding of finance and economics made the problem worse.”
Ok, but if the current personal finance education framework merely represents a money drain, what can we do to foster a more financially capable populous?
Mitchell offers the following suggestions:
- Strongly encourage financial education in high school and college (not necessarily through state-mandated programs as they currently exist).
- Perhaps require passing a short financial understanding test before allowing people to take out credit cards and loans or mortgages.
- Encouraging employers to help provide financial education in the workplace.
That course of action, of course, necessitates identifying an effective and financially-efficient way to teach personal finance. We’ve obviously yet to come to a consensus on how to do that, but the good news for all of us is that a lot of really bright people are working on it.
Dr. Richard Serlin – a budgeting expert and professor of personal finance at the University of Arizona – says that we can start by adjusting the subject matter of financial literacy programs as well as establishing some requirements for the folks who teach it.
“So much of it isn’t very good, or bad. A lot is very vague and petty.” Serlin told Card Hub, adding that simply explaining basic ideas like what a checking account is or attempting to teach overly-complicated strategies doesn’t do much good. “All the complicated risky things like single stocks, commodities, options, you should never suggest that laypeople dabble in. But a lot of the people that give personal financial advice don’t even have bachelor’s degrees in finance or economics, let along graduate degrees.”
Cole himself also has a few ideas of what Americans can do to drastically improve their personal financial performance.
“If you just asked me to say what do I think would be the best way for consumers to improve their financial decision-making and financial health, I would be tempted to say limiting borrowing. I think a mortgage for a home makes a lot of sense, but the evidence shows that people do a lot better when they get a 30-year fixed mortgage and shop around than when they try to get something more complicated,” he said. “But after that, being sure to always maintain no credit card balance, limiting other debts, and having a buffer savings stock seems to be the way the majority of the American population could improve their financial state.”
The Global Center for Financial Literacy
One particularly interesting initiative to identify the best way to teach personal finance and thereby make it more likely that people will naturally heed Cole’s advice is taking shape just a few blocks from Card Hub’s offices, at The George Washington University.
After 20 years at Dartmouth College, Dr. Annamaria Lusardi recently came to GW with big plans. She is working to establish the Global Center for Financial Literacy
“We are very much born out of the recognition that financial literacy is an important and global problem,” Lusardi said. “So we have, for example, published an informational comparison, we do ECD, and we just got a big grant from the European investment banks to put together research centers in nine different countries. Last year, we also organized a global financial literacy summit held in the Netherlands which brought together people from different countries and also different groups – from practitioners to the financial industry to academics to policy makers – to look at effective strategies for improving financial literacy.”
It’s with this background that Dr. Lusardi offers the following three reasons for why teaching personal finance is important:
- “We need people to be financially literate before they engage in financial contracts, and that’s why financial literacy in school is essential because we can reach people before they go into the market.”
- “We want people to be financially literate before they make one of the most important decisions in their lifetime, which is whether or not to invest in education. With college costs becoming so high and with the college premium we see in the market, it is more important than ever to acquire financial literacy in high school. It’s much more important today than in the past to choose which college to go to and how to finance that education. These decisions have to be made in high school and we need to equip people with the knowledge necessary to make them.”
- “If you look at the individual – and we have quite a bit of research now to document who the financially literate students are – they are disproportionately white males from college- educated families. So if we don’t have financial literacy in schools, we are starting unequal and we will grow even more unequal.”
This is obviously a lot to think about and decisions about how to address the global financial literacy pandemic must be made in the very near future in order to right the economic ship and keep it from taking on water in the years to come. We at Card Hub will certainly keep an eye on the progress, and the experts whose insights we’ve shared in this article will surely be in the thick of things as well.