By Joanne Yoong
What happens when regular people need to navigate an increasingly complex financial landscape?
401(k) plans, 403(b) plans, mortgages, pay-day loans, auto-title loans, savings accounts, checking accounts, credit cards, and debit cards represent just a handful of the many financial instruments that ordinary consumers may be handling at any one time. The ever-growing array of financial products and services that have to be dealt with on a daily basis can be confusing to people with little or no financial knowledge, leading to less-than-optimal decisions (or outright mistakes) about money.
Enter financial education – or is it that simple?
While encouraging more training in financial matters may seem to be a natural response, to date there has been surprisingly little consensus about the impact of financial education and how best to deliver it.
As part of a broader research effort to understand what works in financial education, a team of researchers funded by the Social Security Administration, including economists at CESR, developed and tested a program called Five Steps to Financial Success (“Five Steps”).
Five Steps aims to improve understanding of five core concepts that are key to successful retirement planning:
- Compound interest (video)
- Inflation (video)
- Risk diversification (video)
- Tax treatment of retirement savings vehicles (video), and
- Employer matches of defined contribution savings plans (video).
(This paper about the program provides a detailed explanation of why each of these concepts is important to successful retirement planning).
The program was designed using psychological principles to increase its appeal and motivational strength, while remaining technically simple and brief. To encourage vicarious learning and role modeling, the researchers developed five short stories about financial decisions in ordinary life (going out, getting married, shopping, starting new jobs). In each setting, the characters use the five core concepts to accomplish their desired goals even in the face of challenges. The stories were delivered either in the form of a written narrative or as online videos, both considered relatively cheap and easy to disseminate.
Using a representative sample of the U.S. population, the researchers then conducted an experiment to measure the effects Five Steps might have on the financial knowledge and self-efficacy (belief in one’s own ability to achieve a goal) of ordinary Americans.
The results of the experiment were encouraging. People who had been randomly chosen to watch the videos or read the written narratives improved their knowledge of the five core concepts immediately after the experiment, relative to a control group that received no intervention. Five Steps appears to have increased self-efficacy across all the core concepts. The video format was found to be more effective at doing so than the written narratives. While Five Steps was initially developed with young adults in mind – using stories and characters that resonate with the experiences of those aged 18 to 40 – the study team found that the program also positively affected older people. The team also found important gender effects: gains in knowledge were greater for women than men.
So can financial education help people make better decisions about their financial lives, and what else do we need to learn?
The jury is still out on whether financial education programs can in fact change people’s financial behavior. The team responsible for Five Steps is conducting additional research to assess whether the program also has a positive effect on actual decisions. Such changes may however require additional reinforcement: eight months after the experiment, the study team found that such gains appeared to fade away with time. In addition, Five Steps only addresses one (albeit very important) aspect of a person’s financial life, namely retirement planning.
In spite of these open questions, the results from Five Steps are promising, in that they demonstrate that simple but thoughtfully-designed financial education programs have the power to be effective. The next challenge for researchers is therefore to figure out how to sustain these effects on knowledge and motivation, and translate them into financial health and well-being over the longer term.