Treating Financial Literacy:Promising Alternatives to

Financial Education

Jonathan ZinmanDartmouth CollegeNovember 14, 2007

Do We Need Financial Education?

Our panel’s intro:

“The importance of financial education is universally held….”

Not true.

Does Fin Ed Work Well?

Evidence suggests not:• Choi et al Brookings PEA 2005• Benartzi and Thaler Journal of Economic

Perspectives 2007

In the most convincing studies:• Randomized trials find small effects• Event studies (Enron, etc.) find small effects• And of course takeup is low

Consumer Debt Crisisand Financial Ed

But doesn’t: “the recent proliferation of mortgage defaults and foreclosures show how difficult it is to reach those who need financial education at the right time with the right information”

Not necessarily: risk vs. return/reward• Financial contracts are gamblesAnd…

Back to Square One:Objectives?

• Info, comprehension ~= “education”

• Financial literacy vs. financial education– Ed. as a “treatment” for literacy– There are alternative treatments that are

probably more cost-effective– And more feasible mass-produce in real time

What’s Financial Literacy?

• “Financial survival skills”

• Simple rules to live by

• Not = profound understanding per se

• Medical analogy– Seek preventative care vs. take biochem.– Get expert answers vs. DIY– Comply (take your meds) vs. backslide

Examples ofFinancial Survival Skills

Process and planning:

• Make a plan– For contingencies– Retirement

• When in doubt get expert advice

• Regular check-ups

• Avoid company stock

Examples of Survival Skills

Dealing with prices/offers:• If revolving on a credit card, do it on the lowest

rate card you have/can get• When considering very short-term loans, ignore

the interest rate and focus on costs vs. returns• Medium-term loans: double simple interest to get

the APR• Saving: Rule of 72 tells you how fast money

doubles• Seriously consider 401k when there’s a match,

even if strapped

Do We Need To TreatFinancial Literacy?

• Probably yes.• Mounting evidence that literacy lacking

– Many (most?) consumers make mistakes– Many mistakes economically serious

• Most pernicious: consumer have biases that get exploited in market– And exploited more in unregulated/informal markets

• Bias = mistake in a particular direction– Overborrowing– Undersaving– Underplanning– Undertracking (spending)

How to Treat Financial Literacy?

Some lessons/ideas from social science research:

1. Social marketing of survival skills

2. Savvier marketing of savings products

3. Improve loan disclosures

4. Develop new products that:• Appeal to consumers• While neutralizing their biases

How to Treat Financial Literacy?

1. Social Marketing of survival skills• On mass basis

Who has incentive to do this?• Government• Nonprofits• Mutual fund retailers• (Commercial banks)

How to Treat Financial Literacy?

2. Savvier Marketing of savings products

• Future values not yields

• High-frequency feedback when savings rate plausibly inadequate– Consumer sets goal at beginning

• Target markets– Low-yield savers– Discretionary borrowers

How to Treat Financial Literacy?

3. Improve loan disclosures– Board and FTC efforts laudable

• Approach: painstaking experimentation– Need more research based on actual

decisions

• Disclosures complement dissemination of survival skills– Consumer need to know how to interpret

How to Treat Financial Literacy?

4. Product Development• Commitment products

– For spending control– For savings goals– For self-control more generally

• Planning products– Mass-producing expert advice a challenge

• Tracking products– E.g., for credit card spending

Big Lesson

• Research matters– “Retail financial engineering” from behavioral finance– Researchers as “financial doctors”

• Theory, programs, and policy far ahead of knowledge of what actually works

• We have the tools and expertise to identify what works now

• Just takes a bit of effort, time, and $$– But just a small fraction of the resources we spend on

ineffective programs and capricious policy changes