Unbanked But Not Unwise

Tribal Finance

Lisa Servon has written a clever, accessible and pin-point clear piece of ethnographic research. It looks at how an underserved and underappreciated tribe, without access to regular financial services, has developed ways and means of coping in their absence. It's also a damning indictment of the organizations that claim to offer them these services.

The tribe, of course, is middle class America, and the organizations are the banks that fail to serve them.

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Investing In Our Children

Live Long and Prosper

Statistically, a child born today is more likely to reach 100 than someone who is already 96 years old. And this is happening at a time when government resources are increasingly stretched and retirement ages are creeping upwards, when the populations of the developed nations are aging and the borders are increasingly closed to younger people from poorer countries.

As parents the one thing we can do for our children, to prepare them for this dystopian future, is give them the skills they need to survive and, hopefully, prosper. And chief of those skills, in a world dominated by the ideology we call capitalism, is a proper understanding of how to manage money: because the alternative is that money will manage them.

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Thatcherism: The Irony of Economics

Nuance-onomics

We’ve previously looked at some of the evidence that suggests Studying Economics Makes You Mean.  The general idea is that learning about the market economy and the benefits of natural selection tends to make us less generous and less empathetic towards the travails of others.

However, like so much research quoted here this only offers up part of the story. It’s possible that we’re looking at a false correlation – it may be that it’s not studying economics that makes you a nasty grasping son-of-a-bitch but that you study economics because you already are one.  And, as usual, the truth is, at best, nuanced.

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Things Investors Should Hate 5/5: Themselves

We can blame many things for the state of our retirement savings plans – economists, bankers, politicians, the Chinese, globalization, sunspots, socialists, capitalists, journalists, investment analysts, financial advisors or even just bad luck.  But in the end the only person that’s really responsible is the one staring back at us in the mirror in the morning.

Personal responsibility is the adult basis for grown-up investing.  Unfortunately our infantile brains resist our every attempt to train them.

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The Wrong Way To Use An Index Tracker

Sedate and Inept

Index tracking is supposed to be a sedate affair, a quiet contemplation of the tempestuous dynamics of market forces from an appropriate distance.  A passive approach to investing, if you will.

Instead it seems that people who use index trackers either don’t understand that they’re simple commodities or simply trade them like any other instrument available to private investors: frequently, ineptly and in a manner calculated to abrogate their inbuilt advantages.  Nothing new there, then.

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The Tyranny of Numeracy

Count the Errors

It seems that numeracy is the next big idea because important people, whoever they are, have suddenly woken up to the fact that having a workforce that needs to understand linear regression, but which actually can’t count the number of shoes it needs to find in the morning, is probably going to be a drawback in a world where math is increasingly going to differentiate the haves from the have-nots. Although the have-nots won’t be able to figure this out, other than they’ll notice that other people aren’t stacking shelves and flipping burgers for a living.

The solution to this, obviously, is to improve numeracy skills to make sure people can do enough maths to get through the average day. Unfortunately while this may help them not get ripped off by their next waiter and ensure that they can check they’ve got all their children with them at home-time, it’s quite likely that it won’t be anywhere enough to help them make the important financial decisions being required of them. 

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Freedom Of Financial Choice Is A Myth

Finance Isn’t Child’s Play

As we’ve navigated the nether regions of investing folklore like a drunken Frankenstein’s monster in search of a late night high cholesterol snack you may have formed the opinion that this author is somewhat sceptical of all investment processes that don’t explicitly guard against human psychological perversity and highly doubtful that those that do can overcome ingrained biases and an industry dedicated to causing us to do exactly the wrong thing at exactly the wrong time. Still, scepticism isn’t cynicism, and along the way we’ve found one small chink of light in the gloom; the finding that if you give people a financial education early enough in life it improves their money management.

Well, for all you folks out there preparing to send little Jimmy and Jemima to financial summer school don’t bother, because you’d be better off giving them your credit cards and dropping them at the nearest mall for a day. Sadly educating our kids about money doesn’t improve their investing decision making. In fact there’s a pretty strong argument that nothing does and it’s time to stop blaming people for allowing themselves to be exploited: the idea that everyone can be a financial expert is a myth. Time for a different approach?

Does Educating the Under 16’s Help?

Back in Financial Education Doesn’t Work we looked at the research showing that training in financial matters doesn’t improve peoples’ money management. Indeed, sometimes it makes things worse. However, some of the research in this area suggested that if you can give under 16’s some economics education the long-term effects of this are strikingly beneficial.

The key research in this area was from Bernheim, Garrett and Maki who showed that mandates requiring schools to provide personal finance education were correlated with higher levels of savings later in life. Teasing this information out wasn’t easy because we’re talking about periods of decades between the education being provided and the savings being accumulated. Such long term research, known as a longitudinal study, is notoriously difficult to run simply due to the elongated periods over which it must be conducted and the likelihood of the participants doing odd and unreasonable things like dying or developing an obsession about the end of the world and hiding out in a mountain cave with enough baked beans to float a balloon.

Education Doesn’t Help Financial Literacy

In contrast to the Bernheim, Garrett and Maki findings the Jump$tart Coalition for Personal Financial Literacy has run surveys of US high school seniors since 1997 and have shown a distressing fall in financial literacy. In essence, the financial education which is supposedly fresh in the minds of those groups of young people about to launch themselves into adulthood doesn’t seem to have stuck. This is a replication of a finding seen in other contexts – most notably that the financial understanding of economics students declines following financial training. The summation of the findings is provided in this report by Lewis Mandell, who also provides a much more detailed review of the work in this area than I have space for.

Now the Jump$tart findings clearly matter because if we can’t find a way of educating people about financial matters then we’re pretty much stuck when it comes to improving the financial services industry. If humans can’t understand the basics of compound interest, credit card costs, index tracker fees and variable rate mortgages then they’ve absolutely no chance of grasping the essence of mean reversion, stock valuation and exotic derivatives. Although, to be frank, it’s not actually clear that anyone really understands the latter: the suspicion is that many of these acronymic weapons of wealth destruction are generated by a computer programmed to spit out random numbers and are fronted by actors with weird hair who specialise in misdirection. Seems to have worked so far.

Financial Education Can’t Work

In fact there’s worse to come, because if we can’t find a way to educate people and we can’t overcome the implicit biases within the financial advisory industry then we’re more or less forced to go back to the drawing board and start redesigning financial products so that people can’t make mistakes. Lauren Willis in Against Financial Literacy Education puts it thus:

“The gulf between the literacy levels of most Americans and that required to assess the plethora of credit, insurance, and investment products sold today—and new products as they are invented tomorrow—cannot realistically be bridged. Educators would need to impart a sophisticated understanding of finance because rules of thumb are not useful for decisions about complex products in a volatile market. Further, high financial literacy can be necessary for good financial decision making, but is not sufficient; heuristics, biases, and emotional coping mechanisms that interfere with welfare-enhancing personal finance behaviors are unlikely to be eradicated through education, particularly in a dynamic market. To the contrary, the advantage in resources with which to reach consumers that financial services firms enjoy puts firms in a better position to capitalize on decision making biases than educators who seek to train consumers out of them.”

Bascially, the average human being doesn’t stand a chance in today’s complex financial markets and financial education isn’t going to solve the problem. Willis’ paper is brutal about the financial education model believing that it enshrines a myth about consumer self-reliance that then allows those self-same consumers to be blamed for their greed when everything goes wrong. If this model is fatally flawed because people can’t learn this stuff then the whole idea of consumer self-sufficiency in financial markets needs to be rethought, which ultimately leads to some pretty serious questions about the nature of those markets and their regulation. Perhaps most cuttingly Willis observes:

“That [the financial] industry supports financial literacy education is, while indirect, perhaps the strongest evidence that this education is not effective in improving consumer financial decisions”

Factors in the Failure of Financial Education

Four main factors preventing the success of financial education programs are identified:

1. Information Asymmetries and Chasing Moving Targets. Put bluntly, there’s simply too much choice in the marketplace, and the development of niche targeted products worsens the problem as they’re marketed to people outside of their original niches. No one can possibly cope with the complexity of the range of financial products in the market.
2. Insurmountable Knowledge, Comprehension and Numeric Skill Limitations. People simply don’t have the basic skills needed to even begin to understand the nature of the products that they’re being offered. For example, Willis quotes the research showing that after 40 years of use only 10% of consumers have any understanding of what an APR is.
3. Poor Conditions for Debiasing. Cognitive biases, as we’ve repeatedly seen, drive people into wealth destroying behaviours and the nature of financial markets provides a poor environment for overcoming these. Indeed, financial education can create an illusion of control and lead to unwarranted overconfidence in financial decisions, with predictable results.
   
4. Reaching Consumers at Teachable and Vulnerable Moments. A “teachable moment” is one at which a person is particularly receptive to the education on offer. For financial education this would normally be when an important decision is being made – buying your first house, acquiring your first credit card, etc. Willis argues that these moments are the points at which lifelong preferences are generated and then that they’re more likely to be set by the deep pockets of the financial services industry than by educators.

Don’t Bother With Financial Education

The conclusion is depressing:

“Given the foregoing, the failure to find any empirical evidence that the financial literacy education model works is not surprising. In light of the velocity of change in the consumer credit, insurance, and investment marketplace, the innumeracy of much of the population, the prevalence of decision making biases, and the financial advantage held by sellers of financial products, financial literacy education should not be expected to work.”

Given all of this what should we do? Well that’s a question for another day, but if interested parties want to avoid blaming the financial industry for the screwing up of pretty much everything then their only route out is through financial education – because only then can they continue to censure individuals for their mistakes, rather than acknowledging the widespread deceit that lies at the heart of the problem. Fact is, swamping people who have low levels of financial literacy – which is the majority of us – with a vast array of over-complicated products designed to feed their innate biases is just a cast iron way of ensuring another financial crisis is lurking just around the corner.


Related Articles: The Lottery of Stockpicking, Financial Education Doesn’t Work, Save More … Tomorrow

Intelligence Can Seriously Damage Your Wealth

Cerebral Investors

In most walks of life intellectual superiority is generally viewed as something that gives the possessor an advantage over their fellow humans. Admittedly measuring intelligence is a pastime fraught with difficulty and hedged in contradiction but, even so, there are a few easy ways in which we can distinguish people who have better than average analytic abilities. Whether that’s the same as being clever is another matter, but it’ll have to do for the current considerations.

As investing itself is often viewed as a cerebral occupation, an area where the spoils fall to the smartest, we ought to expect to find a good correlation between intellect and returns. After all the calculation of alphas, betas, coupons, coefficients, efficient frontiers, adjusted earnings and the rest of the paraphernalia beloved of market gurus is pretty complex stuff. Of course this is a myth: simply being smart isn’t anywhere near sufficient to succeed in stocks.

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Financial Education Doesn’t Work

Education? Slowly Does It

Many people, myself included, have felt that a good dose of financial education may be just what the world needs to save itself from monetary predation. After all, the nature of capitalism is that companies will seek to maximise their profits at the expense of the ill-prepared: so training people seems like a sensible counter to this position.

Unfortunately it seems we’re wrong and that educating people about money works slowly, if it works at all. That doesn’t mean we shouldn’t make the effort, but for the majority of people it’s not an answer because they forget all they’ve been taught just as soon as some spiv in a suit comes along waving around cheap money. Most people just can’t help themselves from helping themselves to new stuff now, no matter what the future cost.

Money Dumb

The level of financial innumeracy in developed nations is quite staggering if we’re to believe the research. 80% of people in the UK, for instance, have no idea what the true cost of a loan is. Mostly they just look at the initial cost; which of course is why teaser rates on mortgages are so effective – it’s just the psychological bias of discounting the future cost of things in favour of getting hold of something you really want now appearing in a different form.

Research on US consumers by Lusardi and Mitchell (2006) simply backs up the evidence from elsewhere. They find that only a third of older Americans – those who should be most concerned about retirement savings – are able to answer these three relatively simple but important questions.

1. Suppose you had $100 in a savings account and the interest rate was 2% per year. After 5 years, how much do you think you would have in the account if you left the money to grow: more than $102, exactly $102, less than $102?
2. Imagine that the interest rate on your savings account was 1% per year and inflation was 2% per year. After 1 year, would you be able to buy more than, exactly the same as, or less than today with the money in this account?
3. Do you think that the following statement is true or false? “Buying a single company stock usually provides a safer return than a stock mutual fund.”
   

Low Standards, Globally

You might well feel that being able to answer these questions constitutes a pretty low standard for financial literacy – the ability of a consumer to make financial decisions in their own best interests – but these findings have been replicated across other developed nations. An OECD study in 2005 showed that people acting dumb when it comes to money is a truly globalised phenomenon across Europe, Australia and Japan in addition to America. Still, it’s nice to know we all have something in common apart from global warming.

Anyway, unsurprisingly, it seems that those people who can’t calculate compound interest very well are far less likely to save enough to retire on being apt to spend any money they can get their hands on as quickly as possible on nice, shiny new things. They’re also less likely to invest any money in the stockmarket which, of course, may not be a bad thing: if you’re too dumb to figure out the real cost of your new TV you’re probably not going to be very smart at stock picking. Frankly, it’s a wonder they can figure out how to use the remote.

So Educate Them?

One solution to this, you might think, is to provide financial education. From a government perspective this might have a couple of beneficial effects. Firstly future pensioners would save properly and be less of a burden, so that the legislators would have more money to pay themselves gold-plated, index-linked retirement benefits. Secondly, it would obviate the need to enact laws to make financial institutions behave themselves, which is difficult when they’re likely to be your next employer, such is the revolving door between governments and the money men. Unfortunately the evidence suggests that not only are we not very good at doing our investment sums but also we’re not very good at learning about doing our investment sums either.

Some decent research shows that basic education is a determinant of financial literacy. Van Rooij, Lusardi and Alessie (2007) carried out a complex study of these issues in the Netherlands. In amongst a wide set of findings, many of which are seriously thought provoking – including the possibility that the higher levels of stockmarket investments in older age groups is a facet of the fact that richer people tend to live longer – they show that an economics education in under 16’s, but not after, is predictive of higher levels of financial literacy and greater investment in stocks.

Lab Rats

The evidence from various studies on whether targeted financial education on adults improves financial literacy is, at best, inconclusive. As Mandel (2009) reports:

“In four of the surveys [from 2000 to 2008], including the 2008 survey, students who took a full semester course in money management or personal finance actually had slightly lower mean financial literacy scores than all students. “

Which is depressing, even if it’s not definitive.

There is one type of training that does seem to improve the situation – the so-called stockmarket game in which students actively participate in their learning approach. This produces a 6 to 8% improvement. Researchers seem to be puzzled by why this might be the case but there’s plenty of psychological research around that shows how active involvement in learning situations improves student ability to use the training afterwards.

Regardless, the stockmarket game success turns out to be a pyrrhic victory because the successful students then go on to save less than their peers. The (unsubstantiated) hypothesis is that they learn that they can make up for failing to save by taking additional risks on the markets. Which is of course, what happens when you treat people like lab rats – they figure out how to get the cheese for as little effort as possible: proponents of ‘Nudge’ techniques beware.

The Epistemological Puzzle

There is another possible answer to some of the puzzles in this area related to epistemology – the study of knowledge. Psychologists generally make a distinction between two types of ‘knowing’. There’s ‘knowing about’ things: so we know that Washington is the capital of the USA and that 2 + 2= 4. However, there’s also ‘knowing how to’ do things – such as how to operate a word processor or how to calculate compound interest.

Mandel’s research suggests that the most financially literate college students are not economics or business graduates who ‘know about’ financial matters but engineers and scientists who ‘know how’ to solve problems. Which suggests you’d be better off taking financial advice from the guy who designed your tax return software rather than the one that filled it in for you.

The Dangerous Trap of Financial Education

The research also notes that, although financial literacy doesn’t seem to be improved by education, financial behaviour – in terms of saving, for instance – is. Which, of course, may actually make things worse: financially illiterate but savings oriented consumers are the perfect fodder for the next Ponzi scheme merchant, a dangerous trap if there ever was one.

Broadly speaking, then, financial education appears to only have a marginal effect on people’s financial capability, although it does seem to promote more efforts to prepare for the future. This being the case, however, it’s unlikely that we can rely on better training to improve the global problems with financial literacy. With less and less government retirement provision and less and less generous company pension schemes (not to mention ever decreasing job security) this is no longer a looming problem.

It’s already loomed, and we’ve now got to figure out how to deal with it.


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