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By Mark Henricks

Nobody Is Born Knowing How To Manage Money

From simple tasks like making a household budget or balancing a checkbook, to evaluating life insurance and selecting an investment vehicle to fund a comfortable retirement, people have to learn about personal finance in order to be successful overseers of their incomes and assets.

But mere knowledge of financial matters isn’t enough. Nor is simply having greater raw intelligence.

As a recent study by researchers from Harvard Business School, the Federal Reserve and Wellesley College noted, having more financial literacy and cognitive capability does produce better financial decisions, from savings to picking stocks.

“Yet, there is little evidence that education intended to improve financial decision-making is successful,” the researchers wrote.

This doesn’t necessarily mean that understanding finance doesn’t make you a better personal financial manager.

Indeed, another recent study, this one of households in the United Kingdom, found that people with lower financial literacy were more likely to take out payday loans and have other high-interest consumer loans than those with more financial literacy.

Low-literacy individuals didn’t show as much understanding of credit terms. “They are also less likely to engage in behavior which might help them to improve their awareness of the credit market,” the researchers wrote in the February 2013 issue of the Journal of Banking and Finance.

Why Financial Literacy Education Fails

So the question is not whether knowing about finance doesn’t help, but whether teaching people about finance helps.

This question is highly relevant in the wake of the recent financial crisis, as noted in a paper Canadian researchers published in a recent edition of the Journal of Education Policy, because governments have increasingly embraced financial literacy education as a potential way to avoid future debacles.

Unfortunately, according to these researchers, the popularity of state-mandated personal financial education is based more on politics than evidence.

Why doesn’t financial literacy education necessarily make us better personal financial managers?

One reason is that people’s emotional and psychological relationship with money is as powerful or more powerful than their intellectual grasp of how to manage it wisely.

The study of this relationship is called behavioral finance. It tries to explain why, even when we know better, we make bad financial decisions.

So, What Does Work?

Of course, while knowing why we make bad decisions is interesting, it would be a lot more interesting to learn what, besides formal personal financial education, could help us be smarter about money.

Recent research from South Africa suggests one possibility: Rather than making us sit in classrooms listening to lectures about the effects of compound interest, embed financial messages in soap operas.

The South African researchers examined behavior of people after watching two different television shows about leading characters who gamble, buy items on installment plans and wind up deeply in debt.

One show featured messages about financial literacy while the other did not. Watchers of shows without messages were more likely to make bad financial decisions.

A less-entertaining conclusion was reached by the Harvard, Wellesley and Federal Reserve researchers.

Looking at evidence of effects of personal finance and mathematics courses some states require for high school graduation, these researchers found that, while finance courses did not lead people to make better financial decisions, math courses did.

Former math students, they found, declared bankruptcy less often and had fewer foreclosures.

This subject is likely to generate much more study, given the concern about consumers’ role in avoiding future financial debacles. But for now the conclusion seems to be that we should do our math homework, and then relax in front of the TV to watch a show about a good money manager.

Image: Stockbyte

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  • http://frugalguruguide.com/articles/ Jenny @ Frugal Guru Guide

    Excellent post! “I didn’t know” often really means “I chose not to think about it.” There is still some room for improvement in financial literacy education–more role-playing to get teens to grasp things on a practical rather than theoretical level. But no matter what, attitude will be a huge determiner of outcomes.

  • Justice

    As long as there are move media messages to consume (buy) than there are to save; as long as credit cards and loans are touted as necessary and a normal part of life; as long as those who profit from these messages are in control, we will never, ever achieve a level of financial behavior (to know and not do is not to know – confucius) that will enhance the lives of people and nations. The carpet baggers are in charge!

  • Pingback: The Financial Education Our Kids Deserve | RocketNews()

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