A New View of Financial Competence

Financial educators often think of their task as helping people make better financial decisions. But what is a better financial decision?

It’s easy to come up with a list of good practices. Save more for retirement. Invest in a diversified portfolio. Stick to a budget. Yet these adages assume that good advice is one-size-fits-all. In a recent paper, economists Sandro Ambuehl, B. Douglas Bernheim and Annamaria Lusardi propose a different approach.

Think about financial education as helping people make decisions they would make on their own if the financial concepts and jargon were less complicated, as opposed to leading them to outcomes widely seen as the best course. The economists tested for whether financial education gets people to conform to externally imposed norms or if it gives them the tools to better think for themselves. Here’s a video of Bernheim discussing the research.

One group received training in how compound interest works. Another received no training. Those who received the training scored better on questions that measured how well they understood the concept of compound interest. They also better applied the lesson of compound interest to reaching certain goals. Yet there was no evidence that the training led them to think more about their personal situation. Rather, they tended to embrace widely accepted best outcomes.

What’s the take-away for financial educators? Knowing what people actually want—what would most boost their subjective welfare, as the researchers put it—can be a big challenge. But a good first step is not assuming that the precise financial goals that you see as obvious are right for everyone. And then ask if your lessons equip students to think for themselves–or simply lead them to widely accepted best outcomes. Real financial competence is the ability to understand accepted norms and adapt them one’s own situation.

Posted in Bank of Dad, Latest Research on November, 2016