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Treating Financial Literacy: Promising Alternatives to Financial Education

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  1. Treating Financial Literacy:Promising Alternatives toFinancial Education Jonathan Zinman Dartmouth College November 14, 2007

  2. Do We Need Financial Education? Our panel’s intro: “The importance of financial education is universally held….” Not true.

  3. 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

  4. 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 gambles And…

  5. 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

  6. 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

  7. 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

  8. 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

  9. 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)

  10. How to Treat Financial Literacy? Some lessons/ideas from social science research: • Social marketing of survival skills • Savvier marketing of savings products • Improve loan disclosures • Develop new products that: • Appeal to consumers • While neutralizing their biases

  11. How to Treat Financial Literacy? • Social Marketing of survival skills • On mass basis Who has incentive to do this? • Government • Nonprofits • Mutual fund retailers • (Commercial banks)

  12. 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

  13. 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

  14. 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

  15. 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