Are We Taking the Wrong Approach to Financial Education?

It’s well-documented that people make simple financial mistakes that can have drastic consequences. For example, research shows that many people don’t contribute enough to their 401(k) plan to take advantage of their employer’s match, fail to choose fee-minimizing portfolios, or avoid investing in the market.

What's behind these missteps? Studies suggest that many of them may be caused by a lack of financial literacy. And, unfortunately, many traditional financial literacy programs may not be effective in preventing some of these mishaps.

Traditional Financial Education Programs Alone Aren't Cut Out for the Job

Although research has found that there is a relationship between financial literacy and better economic outcomes, few results have found that literacy is what causes these outcomes. In other words, individuals might be learning by doing, and though they eventually end up with better economic outcomes, they're still making mistakes along the way. Thus, the relationship may be reversed, in that people build financial literacy by participating in certain financial behaviors they already wanted to undertake.

Many meta-analyses have investigated the effectiveness of financial literacy programs, with mixed findings. While some find a positive effect, others do not, and still others find mixed effects based on the financial behavior in question. To sum up the existing research, it seems as though effectiveness depends on various factors, such as the intensity and length of the financial literacy program, the financial behavior being tested, the participants in the study, and the overall design of the study.

These mixed results shouldn't be seen as a sign to dismiss financial education. Instead, they mean there is more work to be done.

How to Improve Financial Education

Although these findings don't exactly provide clear guidance, there is hope. First of all, research suggests that there are some benefits to taking a general financial education class. This form of financial literacy program brings about awareness to some financial tools and topics that could be useful later. However, this should be seen as the start of the process--a first step to making more informed financial decisions in the long term.

Here are a few promising next steps from the research:

1. Incorporate rules of thumb. Easy-to-use financial rules of thumb have always been popular, but as it turns out, they can also be helpful. Existing research comparing a rule-of-thumb-based financial education program to a traditional one found that participants in the rule-of-thumb course displayed improved financial behaviors afterward. When it comes to incorporating a rule of thumb in your financial process, just make sure you choose one that fits well with your lifestyle and financial goals.
2. When in doubt, automate it. We are surrounded by technology nowadays, why not use it to our advantage? For example, if your goal is to save more every month, set up an automatic transfer from your checking account to your savings account right when you get a paycheck. Using technology to automate positive financial behaviors keeps the action "out of sight, out of mind," while still ensuring that you stick to your plan.
3. Make it a habit. If technology isn't at your disposal, the next best thing is to make the financial behavior a habit. A habit is a mental shortcut our minds take, many of which are unintentional because they've become something we do automatically. That's why building a habit out of a positive financial behavior can be a powerful tool. Pretty soon, you'll be acing financial decisions instinctively.
4. Incorporate just-in-time education. If you learn how to sign up for a 401(k) account in high school, it may not stick with you years later when you start your first job. Instead, research finds that there is promise behind just-in-time education. This technique teaches materials when a person needs to make a relevant decision. For example, providing new employees with a financial education program their first week on the job, allowing them to use what they learn right away.

In recent years, the effectiveness of financial education has been questioned by the research community. These critiques have a point: Research suggests that taking a financial education course in grade school may not help improve financial behaviors in the long term.

However, research also points to ways to improve and complement traditional financial education programs. In a modern world of advanced algorithms and ever-increasing financial complexity, it’s important that we optimize our financial literacy efforts to help individuals make informed decisions.