How Do You Feel About Your Financial Knowledge? A Revisit.
Note: Financial education receives a lot of attention and funding. This prior post is open to all subscribers and addresses whether literacy is economically consequential to individuals. After all, households have substitutes for their financial questions. I am curious about your thoughts and invite you to comment.
How do you feel about your financial knowledge? Need more? Want more? Christy Lee might. This year, Christy's journey moved from being a full-time Big Four consultant to a food writer. Christy has built wealth, captured a few year-end bonuses, and used inspiration from Ruth Reichl’s written word and Laura Wilson’s photography to develop a subscription-driven foodie paradise. Writing and photographs for the urban sophisticate; none of the Pioneer Woman’s flowery, advertising-driven cuteness. Hunkered down in a three-bedroom Craftsman off Orange Grove in Pasadena, Christy has found her lair. No more escapes to LAX on Monday morning with a Thursday evening return. Even has time for a round a week at Brookside Golf Course near the Rose Bowl.
Christy is ready to receive advice, not give it. The financial type. Generally confident about financial matters given her training and UCLA education, she is wise enough to know her experience advising Fortune 500 firms about their cyber risk problems may not translate to good financial decision-making. That can be outsourced, too, when time needs to be spent stylizing the next best Paella.
A couple of times a month, Christy thinks about her finances. Bills to pay and reading to be done. Like my students, Christy knows that a household’s transactional banking and investment needs can be efficiently run using an investment company’s brokerage account with a cash management feature. Bill-pay, reimbursed ATM charges, normal check-writing, a mobile app, and research tools are plentiful from good providers. Fidelity and Schwab are two of them.
Christy’s occasional need for financial guidance is a good example of what we are seeing in the economics literature about financial education decay. You may educate yourself, but financial education, like any education, needs to be revisited. Recently, I had a former student reach out to me about good spots today for high-interest savings accounts. “Jacob” had gone through a semester course in life-cycle economics: learning the language, model building, financial planning, and testing. A decent student. Even with the know-how, there can be knowledge gaps when personal finance is not your life. Come to think of it, there are a lot of knowledge gaps among financial advisors and Personal Finance Economics writers.
I asked Jacob: “ what are your intentions for saving money? “I want to save for a home and have an emergency fund, he replied.” Made sense to me. Once he expressed that preference, then he could take anticipated savings away from his present day living standard and allocate it to his two objectives. My opinion was to avoid standard bank savings accounts because inflation-adjusted returns are negative, and I-bonds should be explored for they remove any inflation risk. With the acceptance of more return risk, I suggested that a Roth IRA with funds invested in a total market index fund could be another good choice.
Financial Education Recedes
The details of these recommendations are not important to this piece. But, even a college-educated person who learned specific personal finance information had questions. Christy Lee has both sides of her brain working and she had questions. Learning moments can deteriorate. Kaiser, Lusardi, Menkhoff and Urban (2022) found in a large statistical analysis of 68 papers that while financial education positively affects financial knowledge, such education is less impactful on financial behaviors.1 After 20 months or so, the value of the financial education wanes. This result may speak to an interesting conundrum we see among the population. Individuals are much more confident about their financial knowledge than objective measures of such knowledge, like a financial literacy test. People are generally confident about their abilities, but when put to “the test,” they don’t do so well.
Answers to an at-the-moment test for which there has been no preparation are likely to be less than completely correct. Here are the results of the six (6) objective financial literacy questions set across 23,617 respondents to the 2018 National Financial Capability Study (NFCS). While there is a slight upward trend with age, an overall mean score of 2.96 correct answers out of 6 isn’t a passing grade, and the results have been generally this way since the NFCS began collecting data in 2009.
In the face of these results, confidence remains. In the chart below, respondents were asked to rank their financial knowledge on a 1 to 7 scale. I truncated the age at 80 in the chart for readability. Readers might be amazed that about 75% ranked themselves as a 5, 6, or 7. Yes, the same sample that produced the financial literacy performance. Why?
Financial Literacy and Feelings about Financial Knowledge
One obvious piece of the puzzle is that financial literacy may not matter. There are huge implications in that statement. The primary objective of the public policy push for financial literacy education is that households will make better decisions and engage in better financial behaviors. What if objective financial literacy was less related to financial behaviors assumed to be preferred and causally related to better economic outcomes? Results matter most.
Nibbling on the edge of this topic, in recently published research, we did not find a cause-and-effect relationship between higher levels of objective financial literacy and higher perceived economic outcomes.2 In this paper, we created a reflective economic perception index which rolled up into a single measure for a respondent’s answers to three questions:
1. “Overall, thinking of your assets, debts and savings, how satisfied are you with your current personal financial condition?”
2. “In a typical month, how difficult is it for you to cover your expenses and pay all your bills?”
3. “How strongly do you agree or disagree with the following statement? - I have too much debt right now.”
More financial literacy, as measured by the number of correct answers to test questions, did not result in a higher perceived economic outcome. Moreover, it is easy to imagine that if a household believes their economy is okay, their self-assessment of financial knowledge would align. At the very least, they wouldn’t be pessimistic about their plight. We think how one feels about their financial condition is important. Answers to such questions are personal judgments linked to satisfaction rather than a financial behavior a researcher may deem as bad or an objective economic output measure such as wealth, income, or consumption. A key “inside baseball” point: when researchers correlate a score on a financial literacy test to certain financial behaviors like credit card usage, they evaluate data at a precise moment in time that likely doesn’t capture the whole story. Plenty of households use their credit cards a lot and are perfectly happy with their financial condition.
How can these thoughts be reconciled with Christy and Jacob? Obtaining answers to financial questions when needed may be the best medicine. There is no decay, and quality content will be up-to-date.
Kaiser, T., Lusardi, A., Menkhoff, L., & Urban, C. (2022). Financial education affects financial knowledge and downstream behaviors. Journal of Financial Economics, 145(2), 255-272.
Puelz, D., & Puelz, R. (2022). Financial Literacy and Perceived Economic Outcomes. Statistics and Public Policy, 9(1), 122-135.
The passage makes it clear that although receiving financial education can broaden one's understanding of money matters, improved money management isn't always the result. Christy's story demonstrates how even someone with extensive financial literacy can delegate financial decisions, particularly when priorities change. Jacob's story serves as an example of how even highly educated people can have gaps in their understanding of personal finance, necessitating a review of earlier coursework. This study lends support to the notion that subjective perceptions of one's financial situation exist and that confidence in one's financial knowledge frequently surpasses actual comprehension. In the end, getting timely financial advice might be more beneficial than depending just on prior financial knowledge.
After reading this article and taking this class, I am realizing more and more about the lack of knowledge when it comes to financial literacy. The most interesting aspect of this article for me was to see how many people perceive themself as having a higher financial literacy than they actually do. This extremely detrimental as people think they are doing everything right but in reality there so much more they could do to increase their standard of living. In my opinion, awareness is the biggest issue when it comes to financial literacy and understanding the attributes of personal finances. I feel extremely grateful that I have the opportunity to take this class and raise my awareness and understanding of the topic.