In the last few months I’ve had a bit of a financial awakening. You might say it could be an ideological and philosophical shift in my thinking about education and investing. This is major given my practice revolves around teaching and mentoring people to become better investors. Despite this, I still don’t have a firm grasp on how this shift will impact my work.
My shift revolves around the whole concept of financial literacy. I’ve always held the view that making successful investment decisions is a product of one educating themselves to be more knowledgeable about various financial disciplines such as borrowing, saving, spending, and investing. I’ve always believed that as a society we need to educate ourselves as early as possible about personal finance. The earlier we can become comfortable with the value of money and respecting money, the better we can be in making life decisions that will allow us to have the things that are important to us. I continue to believe that personal finance is just as valuable skill as learning to read, write, and crunching numbers. There are all kinds of people and organizations, at both the private and government level that have committed time, money and resources to developing programs to promote financial literacy. I think it is very noble and in my own mind I think I am trying to contribute in my own part to the cause with my practice.
What I have been very slowly coming to grips with is that these initiatives really don’t seem to work. It’s not just an eyeball thing. There seems to a great deal of research that calls out financial literacy programs as being a waste. Here’s a few.
A study published in the journal Management Science by John Lynch, a consumer psychologist at the University of Colorado’s Leeds School of Business and marketing experts Daniel Fernandes and Richard Netmeyer, compiled the results of more than 200 studies of financial literacy programs, adjusting for subjects’ family background and personality traits that had been ignored in the previous research. The study found that studying financial literacy has a “negligible” impact on future behavior and that within 20 months almost everyone who has taken a financial literacy class has forgotten what they learned.
In a working paper, Shawn Cole at Harvard Business School, Anna Paulson at the Federal Reserve Bank of Chicago, and Gauri Kartini Shastry at Wellesley College discovered that high school classes imparting financial wisdom don’t seem to make much of a difference when it comes to how we handle our finances.
Others have found that lessons in financial literacy don’t lead to much in the way of increased test scores on the subject. A whopping 75 percent of American adults say they're pros at managing their money. But only 16 percent could answer five basic financial literacy questions on FINRA's National Financial Capability Study.
As I kept reading these snippets of research that seem to methodically and empirically take down financial literacy, I kept saying to myself, “I think they’ve got it wrong.” Knowledge equals confidence which equals power and that is what the process of making people more financially literate can do. I felt like someone who was in denial. I refused to take these observations seriously.
In the last while, I have had a chance to digest these ideas and I’ve come to a conclusion that they are “mostly” right.
So what happened? Where did financial literacy programs fail?
Most financial literacy programs focus on information transfer. They revolve around disseminating information via seminars, workshops, newsletters, fairs, blogs, brochures, interactive websites and the like. These initiatives are good at presenting the facts and concepts, but where it goes off the rails is when the person receiving the information goes home and tries to figure out what to do with it.
The other factor that beats down financial literacy programs is the quantity and complexity of information. To be financially literate is not a catch all. The reality is that the disciplines of being financially literate: learning to save, spend, paying down debt, making investments are all on their own extremely complex disciplines to master. The problem with many programs is they try to lump them all together and it can be too much to handle. I recently went to a financial planning seminar in my condo that was given by a financial planner. It was a very nice gesture to offer and she was competent enough. Unfortunately, the topics ran the gamut from RRSP’s, life insurance, mortgages, budgeting. It was all over the place and personally I was getting a headache trying to figure each concept out. It can be very overwhelming and when you get hit with such a diverse level of information in such a short period of time there’s no way you can digest it properly.
What works: Technology in your pocket
We're increasingly turning to our phones for money matters. Pew reported that 35 percent of Americans are engaged in mobile banking in 2013—up from 18 percent less than two years earlier.
In 2013 the Federal Reserve issued a paper entitled, "Use of Mobile Phones in Financial Decision-Making." It found that people who received helpful information on their phones (such as a text reading "low balance") reduced their spending.
The authors hypothesized: "Because many consumers have near constant access to their mobile phones, these devices have the potential to provide just-in-time information that can influence consumer financial behavior and help them to make different, and perhaps smarter, financial decisions."
What works: A whole lot of hurt
Apparently life altering events can go a long way to getting people focused on their finances. It appears major market or economic shocks are quite conducive to motivating people to get their financial houses in order. According to a study by Fidelity Investments, the 2008 meltdown spurred "both positive and permanent behaviors -- from increasing retirement savings rates to decreasing debt and building emergency funds." This was quite evident in the younger generations who have gravitated to saving more and delaying long term purchases by leveraging the Sharing Economy (Uber, AirBNB,ZipCars etc).
What could work: Changing the discussion to focus on behaviour
We are constantly be distracted by images and messages that are influencing how we behave and consequently how we will spend, save, and invest. These messages play on our emotions and will ultimately impact how we make our financial decisions. I’ve seen this in full effect in my time as an investor. I remember back in the time of the dot com boom, I was crunching numbers on these companies and the numbers showed that these companies were not creating any tangible wealth, yet I felt that pressure to jump in because “everybody was doing it and it was the place to be”. It was very tempting, but my analysis was telling me there were better opportunities to be had. My emotions were at times being thrown for a loop. At the end I decided to stay true to my strategy and analysis and fortunately I was able to sidestep that Dot Com debacle despite feeling that I was missing a party. Learning how to crunch numbers is very linear. Acting on that analysis in an unemotional way is much harder. Peer pressure plays a factor in our decision making. When we see or hear our social network making successful decisions, you can easily get influenced to throw caution to the wind to keep up. We act on reflex instead of sound logic.
As I’ve grown older, I’ve grown more convinced that behavior is just as critical a component to being responsible with money than understanding black and white rules and financial models. An appreciation of the scarcity of money, which is fundamental to our capitalist society can go an extremely long way to framing better investment decisions. The number crunching part is easier, especially now with online tools available. Understanding the emotions and behaviours of the key players we interact with in making financial decisions as well ourselves, is just as critical and as an investment coach I find myself spending more time with protégés on developing this competency.
The thing about these messages that hit us every day is that they are not going away. In fact we will probably see more of it. The trick is for us to be able to better synthesize and filter out the noise from the substance.
J.D. Roth of the Get Rich Slowly blog expressed this very concisely,
“…Ultimately, if we want Americans (or anyone for that matter) to be smarter with their money, we need to encourage them to consume less media — to avoid advertising — and we need to teach them to master the emotional side of personal finance. We need to show them how to change their behavior. We need to appeal to their self-interest…. I’m not suggesting that we abandon financial literacy completely. But I think a constant push for more financial education is a waste of time if it’s only going to focus on mechanics, to stick to facts and figures. To truly be successful, financial education has to address the behavioral side of money because that is absolutely the biggest piece of the puzzle…”
So perhaps the financial literacy wonks need to do a bit of rebrand.
I myself have decided take a lead in that I have decided to change the Raison D’Etre of Sage Investors. Up until now, the mission statement of my practice has been,
“Mentoring investors to make successful investment decisions through improved financial literacy.”
I’d like to announce the new Mission Statement for Sage Investors will now be:
MENTORING INVESTORS TO MAKE SUCCESSFUL INVESTMENT DECISIONS BY IMPROVING THEIR FINANCIAL LITERACY AND BEHAVIOUR TOWARDS MONEY
I think this makes more sense. The financial literacy part is about the information transfer and filtering of the numbers, formulas, and model which lay a good foundation for making investment decisions but it doesn’t really cover all the bases. It is that secret sauce of understanding and being aware of one’s own behaviorial quarks towards money that binds everything and will put you over the top.
When I look at this way I feel better what I'm trying to accomplish with my practice.