Why Financial Education Might Not Work

US News

As the major international survey known as the Programme for International Student Assessment, or PISA, recently made clear, American teens have a lot to learn about basic personal finance principles. The survey of over 29,000 15-year-olds in 18 countries, conducted by the Organization for Economic Co-operation and Development, found that about 18 percent of American students failed to demonstrate even a basic grasp of financial capability. The results suggest they would likely struggle with relatively simple tasks such as understanding an invoice or making spending decisions.

The findings have flamed an ongoing debate in the financial education community: What is the best way to teach students about money? Should schools be required to incorporate money classes into their curriculum? Should parents step up the money talk at home?

A 2012 paper from the National Bureau of Economic Research, "Financial Literacy, Financial Education and Economic Outcomes," wades through multiple studies on the impact of financial literacy and concludes that there might be more efficient ways to help people make smarter money decisions.

[Read: 5 Things to Know About Financial Literacy.]

While research has repeatedly confirmed that many Americans, and not just teens, are unable to answer basic financial questions about compound interest, real rates of return and risk diversification, the findings on how best to fix this dearth of knowledge have been mixed. Showing that financial education actually causes better financial choices is difficult to do.

"The evidence is more limited and not as encouraging as one might expect," the paper's authors, Justine Hastings, Brigitte Madrian and William Skimmyhorn, point out. Indeed, some studies have found no relationship between high school financial education courses and students' financial literacy.

Those inconclusive findings led the authors to suggest that the government might want to focus on methods other than financial education as a means of helping consumers make better financial choices. "While the logical public policy response to many observers is to increase public support for financial education, this option may not be an efficient use of public resources even if it will likely do no harm," the authors conclude.

[Read: How to Teach Teens More About Money.]

Other, potentially more efficient options include public policies that "nudge" people to make smarter choices. In their classic 2008 book "Nudge: Improving Decisions About Health, Wealth, and Happiness," economics professor Richard Thaler and law professor Cass Sunstein argue for this approach, pointing out that automatic enrollment in retirement savings plans drastically increases participation rates.

Helpful public policies also include easier-to-understand disclosures on financial services products, simplified fee structures, incentives like savings matches or automatic enrollment that inspire consumer action and stricter regulation of the financial services industry.

Still, interest in financial literacy education remains high, especially in the wake of a recession that was caused at least in part by the subprime mortgage crisis. Thousands of consumers signed up for mortgages they could not afford and did not fully understand. Americans also continue to be plagued by low retirement savings rates, poor investment choices and high levels of debt. Leaders in the financial literacy space like Annamaria Lusardi, professor of economics and accountancy at the George Washington University School of Business and academic director at the Global Financial Literacy Excellence Center, insist that financial education for students is imperative, regardless of whether studies show classes to be effective. "I don't know that teaching literature and math is effective, but nobody seems to worry about that," she says.

In the meantime, with low financial literacy scores and no clear solution in sight, Americans continue to make poor decisions about their money. The authors of the NBER paper point out that only a small portion of employees who are eligible for employer matches on retirement savings take advantage of them, and consumers often select high-fee funds, even when given the option to select lower-cost ones.

[See: 10 Things Everyone Should Know About Money.]

People also fail to balance their portfolios in a way that makes sense for their age, buy pricey whole life insurance (instead of term life insurance) and rely on high-interest rate loans, even when they have other options. Interestingly, research has found that financial mistakes happen most among young people and older people, and consumers make their best financial decisions during middle age, when they've collected sufficient life experience but haven't yet suffered from age-related mental impairments.

Part of the problem seems to be that our financial world has gotten so complicated: Consumers must sort through dozens of savings options, retirement investment choices and mortgage varieties. While people do learn from their financial mistakes, some choices happen so infrequently, such as retirement planning or student loan borrowing, that there's no room for trial and error.

The paper's authors urge better evaluation of financial education courses, since certain methods, such as focusing on "rules of thumb" rather than more abstract financial principles, seem to make more of an impact on participants. The goal, after all, isn't to create a population of personal finance experts, but to help people make better decisions with their money.



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