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Financial education not helping consumers make better money moves

Even with new regulations put in place after the financial crisis, we still have a pretty caveat emptor (let the buyer beware) approach to finance in this country.

Americans are mostly free to take out an adjustable rate mortgage with a crappy rate that will leave them eating ramen every night, or invest all their retirement savings in high-risk foreign stocks if they want to, based on the premise that consumers themselves are the best judge of what financial products are right for them.

Financial education and efforts to increase financial literacy have been held up by many in the government and the press (myself included) as a way to limit the colossal damage people can inflict on themselves with bad financial products. But what if financial education, at least as we know it today, doesn’t actually work?

A massive study to be published in the journal Management Science seems to suggest exactly that. Researchers from Erasmus University in the Netherlands, the University of Colorado and the University of Virginia analyzed 201 previous studies on whether financial education led people to make better financial decisions down the line. They found that financial education did have a positive effect, but one so small it’s barely noticeable.

Let that sink in for a moment: All the financial literacy education out there, from high school programs on the local level to the 15 financial literacy programs run by the federal government, probably aren’t really doing anything.

Don’t get rid of financial education, fix it

So does that mean we should throw up our hands, shut down all the financial literacy programs out there and use the $30 million budgeted for financial literacy by the federal government on monster truck rallies and fireworks instead? Not at all, says Richard Netemeyer, Ralph A. Beeton professor of free enterprise and senior associate dean of UVA’s McIntire School of Commerce, and one of the authors of the study.

“We didn’t want to be misinterpreted (as saying), ‘Forget about financial literacy, forget about financial training’; not at all,” Netemeyer says. “We’re as much for financial training as anybody else who studies this topic.”

But the study results suggest we do need to take a look at how we’ve traditionally done financial education and make some major changes, Netemeyer says.

“Is there a more efficient way to deliver it such that it is going to have the desired effect on a financial behavior?” Netemeyer says. “Let’s look at something that may work a little bit better.”

One way to do that is concentrate more on putting financial knowledge in people’s hands “just in time” as they’re actually making a financial decision, Netemeyer says.

Most kinds of knowledge decay over time if they’re not used. For instance, giving high school students a bunch of financial education on mortgages, when kids probably aren’t going to be dealing with the prospect of buying a home for years, isn’t very useful.

Instead, it might be better to provide classes on the ins and outs of financial products “just in time,” for people who are right about to make a major financial decision such as how they’ll invest their retirement or what car to buy and how to finance it. For high schoolers, that might mean concentrating personal finance education on the likely payoff of different types of college topics and the ins and outs of student loans, Netemeyer says.

“If I lived in a state where my kids would be required to take a financial education course, I’d just as soon see at least half of the curriculum be around those topics,” he says.

Putting financial decisions on autopilot

Another way to help people make better decisions overall is to frame it so the choice that’s better for most people is the default. For example, it might make sense to automatically enroll people in a 401(k) at work so if they specifically don’t want to do that, they’ll have to opt out, Netemeyer says.

What do you think? Is financial education, as we know it, a good way to help people make better financial decisions? Or is knowing what you should do not quite enough?

(Photo: Steven Depolo)