Why Financial Literacy Isn't Enough, and What to do About it?

Originally posted on www.youthsave.org

A new blog post, “Why Financial Literacy Fails (and What to Do About It)” takes a strong jab at the efficacy of financial literacy interventions saying “Time and again, [its] efforts have failed. They don’t make any noticeable difference in the way we spend and save.” While mixed results from studies measuring the impacts of financial education indicate that the jury is still out on its effects on individuals’ financial behaviors, the author goes on to make a valid point with which I whole-heartedly agree: “financial literacy isn’t enough.” That is, financial success is not necessarily determined by how well individuals can calculate interest rates, but how well they are able to delay gratification for immediate consumption, control their emotions, and overcome other psychological barriers that prevent most human beings from making rational choices, such as saving. 

In a recent paper, “Accelerating Financial Capability among Youth: Nudging New Thinking,” my co-authors and I outline psychological barriers, or biases, that prevent individuals from making sound financial decisions even when they have the education, access to savings accounts, and full intentions to save. What we call “the last mile problem to behavior formation,” is a phenomenon observed in our everyday lives. For example, one may understand the health benefits of exercising, have easy access to a gym, and really intend to exercise, but when push comes to shove, choose the couch over a treadmill.

In our paper, we draw on insights from behavioral economics and suggest mechanisms, or nudges, to overcome the last mile challenge to saving. One of our proposed nudges includes reminders to save. Reminders can bring saving to the top of one’s mind, serving as a continual flag for why the individual wanted to save in the first place. It helps individuals get over their well-documented tendencies toward “smaller sooner” over “larger later” rewards. For a real world example of how this bias (technically referred to as hyperbolic discounting) works, watch this famous experiment testing four year-olds’ ability to delay eating one marshmallow immediately for two 20 minutes later.

Economists Dean Karlan, Margaret McConnell, Sendhil Mullainathan, and Jonathan Zinman, tested the impacts of reminders on bank client’s savings behaviors and found they “increased the likelihood of reaching a savings goal by 3 percent and the total amount saved in the reminding bank by 6 percent.” The potential of bank reminders to nudge savings sparked YouthSave’s interest in offering the same service for its youth clients in Colombia as part of the Project’s financial capability efforts there. YouthSave is in the process of developing the reminders, which will be delivered next year via text messaging to participating youth aged, 12-18.

So if reminders are powerful in impacting behavior change, then let’s close with a poignant one for financial literacy practitioners: “to truly be successful, financial education has to address the behavioral side of money because that is absolutely the biggest piece of the puzzle.”