The Financial Education Fallacy

By Lauren E. Willis∗

For presentation at the American Economics Association 2011 Annual Meeting

In the wake of the Great Recession, financial education has received renewed political

support. Although it is difficult to believe that mortgage-backed securities investors or Lehman

Brothers’ top brass would have benefitted from more financial education, apparently the logic is

that ordinary consumers would have made better mortgage choices and would have accumulated

sufficient precautionary savings to weather the recession if they had received financial education.

Objective observers generally admit that research to date does not demonstrate a causal chain

from financial education to higher financial literacy to better financial behavior to improved

financial outcomes (Shawn Cole and Gauri Kartini Shastry 2008; Ian Hathaway and Sameer

Khatiwada 2008; Lauren E. Willis 2009; William G. Gale and Ruth Levine 2010), in part due to

biases, heuristics, and other nonrational influences on financial decisions. Yet the search for

effective financial education continues.

But it is time to ask whether the entire enterprise is misguided. Do we want to live in a

society where ordinary consumers are left to navigate one by one through an ever-changing

cornucopia of financial products armed only with education? What would “education” to

counteract the nonrational determinants of financial behavior look like? If we could create a

society in which financial education functions effectively as financial regulation, would we be

better off?

Two reasons we might not want to create such a world are discussed here. First, the time,

expense, and invasion of privacy that would be required, if it were possible at all, would be
                                                            
∗
Loyola Law School Los Angeles, 919 Albany Street, Los Angeles, CA 90015 (e-mail: [email protected])

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enormous. Second, living in such a world would entail, paradoxically, a decrease in individual

autonomy. Alternative tools should be explored that could potentially increase household

financial welfare and security at lower social and individual expense. A review of the research on

financial literacy education reveals a slew of fallacious arguments (Willis 2009), but the

fundamental fallacy may be the assumption that this is the path we should take at all.

I. The Costs of Effective Financial Education

I have argued elsewhere that, realistically, we will never find the effective financial

education for which many search (Willis 2008), but let us assume here that we can. What would

it take to make financial education effective? Studies of existing programs have shown that even

semester-long high-school courses (Jump$tart Coalition 2006, 1; Louis Mandell and Linda

Schmid Klein 2009) and eighteen months of adult credit counseling (Jinhee Kim, E. Thomas

Garman and Benoit Sorhaindo 2003, 85) have not been enough.

A number of factors would make effective financial education extremely costly. First,

there is the abysmal state of most consumers’ financial literacy. Over 40% of baby-boomers

approaching retirement could not divide lottery winnings among five people and over 80% either

did not understand the meaning of compounding or lacked the math skills to calculate compound

interest on $200 over two periods (Annamaria Lusardi and Olivia S. Mitchell 2007). Millions of

Americans fall prey to fraudulent credit repair schemes each year (Federal Trade Commission

2005). As a result, effective financial education would need to be very extensive, imparting skills

ranging from performing basic math to assessing the reliability of information sources.

A second source of expense is the complexity of financial decisions and the heterogeneity

of consumer financial circumstances and values. A rule-of-thumb to spend no more than 28% of

monthly income on a mortgage was straightforward to apply when mortgages had payments that

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were level. But today consumers face mortgages with variable and uncertain future monthly

payments. Further, the “right” answer for one consumer will not be the right answer for another,

because households differ dramatically. Paying all bills is welfare-enhancing for some, but

defaulting on an underwater mortgage can be financially advantageous. In light of this

complexity and heterogeneity, mass public education campaigns would not be effective financial

education. Instead, intensive, audience-tailored instruction would be required.

The speed with which product offerings and industry practices change is a third hurdle

for financial education. Yesterday’s new product was the option ARM, today it is the medical

credit card. It was once “common wisdom” that people should save 10% of their annual income

for retirement, but projections about longevity and health care costs indicate that 10% is not

enough. The consumer financial marketplace is dynamic, yet major personal finance decisions

are episodic, so consumers do not keep up with changes in the ordinary course of walking down

the grocery aisle. Due to its short shelf life, financial education would need to be given

repeatedly throughout the lifecycle.

Fourth, industry has substantial resources with which it can outmaneuver education.

When public education campaigns blasted warnings about predatory mortgages, lenders of every

stripe quickly adapted their marketing to proclaim their trustworthiness. Financial services firms

engage in so much marketing because it works. Given the ubiquity of advertising, effective

education would need to reach people at the point of financial decisionmaking.

The ultimate challenge for financial education is that even those who are financially

knowledgeable and skilled make poor financial decisions surprisingly often. Logical

decisionmaking can be trumped by a host of biases, heuristics, and emotional states, all of which

have been extensively documented in the personal finance realm.

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 Financial decisions can be strongly affected by even transitory emotions related to

nothing more than the weather. But the decisions themselves also present triggers for nonrational

responses. The number of product choices and amount of information needed to fully assess each

are overwhelming, leading some consumers to oversimplified decision strategies and others to

paralysis. The stakes involved produce stress, and stress occupies mental resources, for many

people resulting in a failure to consider all pertinent dimensions of the decision. Financial

decisions require an assessment of the probabilities, timing, and costs of a host of misfortunes,

from job loss to health problems, to which some consumers respond with either denial or

overoptimism. The consequences of financial behaviors today often will not be known or felt for

many years, but in making decisions people often place too little weight on delayed or uncertain

outcomes, although at widely varying discount rates. Willpower is also taxed, as choices

producing immediate gratification often have long-term financial costs, but willpower and

cognitive effort consume the same finite resource in the brain; if one is being exercised, the

capacity for the other goes down. Many financial products are sold in one-on-one settings, and

consumers frequently place too much trust in salespeople. Finally, some consumers are plagued

by overconfidence in their own abilities, and others by underconfidence. In one study, over 16%

of respondents who assessed their own financial literacy as being at the highest level objectively

tested in the bottom quartile, and over 8% who self-assessed their literacy at the lowest level

tested in the top quartile (Annamaria Lusardi and Olivia S. Mitchell 2007, 23).

Attempts to train people so as to “debias” decisionmaking have largely failed, but provide

clues about what would be needed to do so. Several techniques to reduce overconfidence have

been tried. Having subjects consider reasons a decision or the assumptions on which it depends

might be incorrect sometimes reduces overconfidence, but only for subjects who can easily bring

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many such reasons to mind (Norbert Schwarz, Lawrence J. Sanna, Ian Skurnik and Carolyn

Yoon 2007, 135-137). Financial education would need to frequently and vividly remind

consumers of reasons that their assumptions could be incorrect to ensure that these reasons

would be brought easily to mind. Giving subjects immediate, unambiguous, and accurate

feedback over a series of repeated games has been found helpful in reducing overconfidence, but

only overconfidence about making decisions taking the same form as the game. Because

educators could never predict and simulate every form of major financial decision a consumer

could face, to use this debiasing technique educators would need to intercede at the point of

actual decisions and engage in repeat play simulating the decision at hand.

Alternatively, financial education might train consumers to engage in practices aimed at

reducing triggers for nonrational decisionmaking. Using psychotherapy, people might be trained

in techniques to distance themselves from their emotions or reduce stress when making financial

decisions. For time and uncertainty discounting, visualizing future or uncertain outcomes as if

occurring in the present might increase the decision weight placed on them.

Heterogeneity as to whether or when people experience nonrational influences means that

debiasing techniques cannot be applied uniformly throughout the population. Trying to reduce

overconfidence in an underconfident consumer could impair financial behavior. Asking some

consumers to visualize uncertain future events – job loss or medical expenses, for example –

could lead to paralysis rather than accurate weighting. Educators would need to analyze each

individual’s psychology to know which biases are present and to what degree, adapt the training

session accordingly, and then engage in one-on-one training.

Collectively, these realities mean that effective financial education would need to be

extensive, frequent, and personalized for each consumer. The government money and time

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required would outstrip any public education campaign ever attempted. The price to individuals

in time spent on education – rather than, for example, earning more income – would be

enormous, such that on net, financial education might decrease wealth. For the government to

behaviorally track consumers so as to match industry’s influence would not only be expensive,

but also invasive. Even more invasive would be the psychological analyses needed to

individualize debiasing measures. Are these costs we are willing to bear?

II. Paradoxical Effects on Autonomy

Financial education is often advocated over other methods of regulation on autonomy

grounds. However, effective financial education would require substantial incursions on

individual autonomy.

First, many people do not want to spend their time or effort on receiving financial

instruction. Voluntary financial education is widely available today, yet seldom used. In one

study where credit card issuers warned thousands of credit card holders that they were at risk of

delinquency and offered them a free online financial literacy course, only .4% attempted to log

onto the website, and only .03% completed the course (Amy Brown and Kimberly Gartner 2007).

Ironically, those who participate voluntarily already have more financial knowledge, better

budgeting and planning skills, and more patience conducive to good money management than

those who decline. Therefore, effective financial education would need to be mandatory, forcing

those who would not have autonomously chosen to participate to do so. This imposition on

people’s lives would not be trivial, given the extensiveness and frequency of the education that

would be required.

Second, the effectiveness of many debiasing techniques hinges on changing people’s

thought processes, feelings, motivations, and ultimately their values. Overconfident people must

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be trained to be less confident, and underconfident to be more. Impatient people must have their

discount rates altered. Trusting people must be made less trusting. The emerging field of

financial therapy, in which financial professionals and licensed mental health professionals

counsel individuals together, is premised on the idea that changing financial behavior requires

changing people’s emotional responses to money. Changing people in these ways may be good

for them, but for mandatory financial education to require people to engage in this sort of therapy

intrudes upon their autonomy.

Third, the education programs would need to decide what lessons to teach against a

background in which we lack technical and normative consensus on what constitutes correct

financial behavior. For example, saving and investing for retirement today require predictions

about which experts routinely disagree, such as the returns that can reasonably be expected on

various investments over various future time periods. Like most financial decisions, selecting

investments also requires tradeoffs between risk and return that present a normative question:

how much financial risk should an individual or household take on? Financial education cannot

be effective if it sidesteps these issues. Although the Department of Labor’s retirement planning

guide instructs consumers to “select” a rate of return on each of their assets “depending on how

much you believe each … will increase in value,” (U.S. Department of Labor 2010, 47), a

consumer who can choose her rate of return has not been given sufficient tools to plan for

retirement. Telling a consumer that as her mortgage debt-to-income ratio goes up her risk of

foreclosure also increases, and then leaving her to decide what mortgage payment and risk of

foreclosure to take on, is not helpful. Most educators know this, and routinely teach students

what mix of investment products to select and what percentage of income to spend on a

mortgage. These lessons might be the right ones, but their selection reflects technical judgments

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and normative decisions. Students who behave as taught are not exercising autonomy, but are

held accountable for outcomes as if they were.

Most fundamentally, financial regulation through education is premised on the idea that

forcing each individual to make each financial decision in life for herself is autonomy-enhancing.

But many people do not enjoy financial planning and believe it takes too much time and effort

(Employee Benefit Research Institute 2009, 10). They fear regret if their choices turn out badly

and would rather not bear the responsibility of doing it themselves. Left to their own devices,

many consumers choose not to choose. Some avoid it by hiring financial advisors, others by

relying on advice from friends, family, and colleagues (Mariko Lin Chang 2005), and others by

doing nothing at all, sticking with the status quo. To enhance true autonomy, to give people more

ownership and control over their own daily lives and ultimate destinies, requires regulatory

interventions that support consumers’ desire not to make all of their own financial choices.

III. Alternatives to Financial Education

Financial education advocates may respond that their aim is not to create a world in

which financial education supplants regulation, but merely to provide some help to consumers at

the margins. But if the aim is merely to increase retirement savings and improve the manner in

which these savings are invested, it is unclear why financial education is the lowest cost path to

this result. Beefing up social security could produce the same result less expensively, and with

greater certainty. If the aim is to increase the likelihood that consumers would select mortgages

they will be able to afford, the cheaper path is likely to be regulation that aligns mortgage seller

incentives with long-run mortgage affordability. Even improving basic math skills might be

achieved more efficiently through prenatal nutrition or adult physical exercise programs than by

using mandatory financial education to repeat math instruction throughout adulthood. For each

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goal, the costs of reaching that goal via financial education versus alternative paths should be

examined. Once the true time, money, privacy, and autonomy costs of financial education are

examined, alternatives are likely to look preferable.

What are some alternatives to using financial education to regulate the consumer

financial market? One is to provide consumers with pro bono professional assistance to help

them navigate the market. Given that effective education would need to be individually-tailored

and given in a one-on-one setting, replacing the educators with professional advisors seems a

more cost-effective route. Regulating professional advisors well would be expensive, but

regulating financial educators well would be no less expensive. We do not ask people to be their

own doctors, lawyers, auto mechanics, food safety inspectors, etc., and, given the current

marketplace, we should not ask them to be their own financial advisors.

Another possibility is to abandon trying to change people and instead harness their biases

to work in favor of welfare-enhancing financial “decisions.” Retirement savings defaults have

been more effective than retirement savings education and cost little to put in place. Exploiting

consumer preferences not to make decisions might be expanded to other realms, although

ensuring that firms do not undermine these defaults may prove difficult in many contexts.

Substantive prohibitions (for example, on investing a 401(k) in the employer’s stock) or

mandates (for example, requiring consumers to buy health insurance) would reduce consumer

choice, but it is unclear that having the option to invest this way or to fail to buy insurance

provides any welfare benefits to consumers. Substantive regulation will sometimes ban products

that would help some consumers or require actions that do not benefit some consumers, but these

costs must be weighed against the costs of effective financial education.

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 Regulation of sales incentives so as to align seller and consumer interests is another

possibility. Doing so well would require intrusion into the internal affairs of firms, but this seems

less problematic than the degree to which effective education would intrude into the personal

lives of consumers.

IV. Conclusion

The final salvo of financial education promoters is usually that education is the only

politically feasible path to improving consumers’ financial lives. Once the true costs are

considered, however, effective financial education looks much less politically palatable. A

society that is unwilling to pay for a K-12 education system that produces a populace that can

perform basic math is not going to pay for one that can do this and far more. Mandated adult

financial education has been unpopular; opposition quickly shut down an Illinois program to

require high-foreclosure-risk mortgage applicants to engage in counseling prior to borrowing.

The type of psychological counseling that would be required to debias consumers to enable them

to use financial knowledge and skills effectively is almost certainly a political nonstarter.

One clue that financial education is not the only politically feasible path is the amount of

money that industry spends on advocating for and funding financial education programs, even

though consumers who exercise welfare-enhancing personal financial behaviors typically are less

profitable for industry. Firms sometimes support these programs so as to use them as marketing

opportunities. But firms also support programs when they have no control over the content. Why?

Firms fear the other forms of regulation they believe they would face if they could not point to

financial education as the cure for consumer financial woes. But if the inefficacy of current

programs were known and the costs of effective financial education were truly understood, other

forms of regulation would move to the fore.

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