“Just as it was not possible to live in an industrialized society without print literacy – the ability to read and write – so it is not possible to live in today’s world without being financially literate. Financial literacy is an essential tool for anyone who wants to succeed in today’s society, make sound financial decisions and – ultimately –be a good citizen.”

-Annamaria Lusardi (2011)

The Denit Trust Distinguished Scholar
and Professor of Economics and Accountancy at
The George Washington University School of Business

Financial Literacy Research

There has been some very important research on “financial literacy” in America since the financial crisis in 2008.  The key takeaway from this is work is that, unsurprisingly, financial literacy as achieved through education and continuing education matters to one’s success at meeting financial goals and investing to achieve those goals.

Two pieces of research in this arena stand out:

  1. Navigating the Market by the Consumer Financial Protection Bureau – which looks at the information sources consumers are exposed to when making financial decisions.
  2. Financial Literacy, Financial Education and Economic Outcomes by J. Hastings, B. Madrian and W. Skimmyhorn for the National Bureau of Economic Research (working paper). – which reviews the literature on financial literacy, financial education and, most importantly, the finacial outcomes consumers generate.

These are good pieces of research for IOI because we are very interested in the state of financial education from a market development standpoint, but this is also VERY GOOD research for you as an investor and consumer of financial products.  You must be aware that things are changing rapidly in this arena and you should be thinking through how you will deal with those changes and what you can do to prepare yourself to make sound financial decisions in this new, what we would define as “riskier”, environment.

What’s Happening?

The financial product landscape is becoming more complex.

  • Prior to the 1990’s financial consumers in the retail investing space were concerned primarily with corporate stocks and bonds, government bonds and municipal bonds. That was pretty much the playing field of financial instruments.  To understand those instruments, one had to know a bit about compounding, the inverse relationship between yields and bond prices, inflation, mortgages and diversification.
  • Since that time the growth of retail investing instruments has been exponential. The proliferation of ETFs, ETN’s, equity options and forex futures combined with access to these products through online accounts have materially changed the investing landscape.
  • Variable rate debt (both revolving and not), Home Equity credit lines and Reverse mortgages have all changed the landscape for consumer credit in ways that are hard to pin down for the average person.

Financial product institutions are spending 25x more money to MARKET their products and services than is spent to EDUCATE consumers about those products and services.

  • Net, while marketing for these products and services make them appear attractive, there is 25x less money spent to educate consumers/investors on HOW to use them.
  • Financial products from credit types to loan terms to investment vehicles all have a sweet spot where they are designed to perform well for the purchaser. Some do not even have that.  Buyer beware.

Individuals have more control than ever before over their financial wellbeing and ability to achieve financial stability.

  • Some of that control has been pushed onto investors as defined contribution retirement plans have replaced pensions and other defined benefit approaches.
  • The growth of online account management and investment allows individuals an unprecedented level of information on and control over investing and speculating actions.

Research has documented widespread and avoidable financial mistakes by consumers

  • These mistakes include low levels of stock market participation, inadequate diversification, individuals’ preferences to sell assets that have appreciated in value while holding onto assets whose value has declined (even when future return prospects are the same)* and failing to refinance debt in periods of declining interest rates.
  • Much of this is due to poor understanding of the instruments involved and our behavioral biases as humans that can lead us to unsound decisions.

Research shows we must be careful about looking to financial intermediaries exclusively as arbiters of financial education

  • Intermediaries’ (brokers, banks, etc.) incentives can be, but are not always aligned with ours as investors. This work clearly shows that given the asymmetric information in client / advisor relationships, there is both a principal / agent problem and an incentive for advisors to compete by reinforcing biases versus providing recommendations that are in the best interest of the clients.

What Can We Do for Ourselves and for our Clients?

Unbiased financial education, ideally from multiple sources, is paramount. Financial education is shown, repeatedly, to improve financial outcomes for individuals.

According to the NBER Working Paper mentioned above:

“Consistent with the notion that financial literacy matters for financial optimization, a sizeable and growing set of literature has established a correlation between financial literacy and different financial behaviors and outcomes.”

How does one go about finding education like this? Experts suggest several ways to do this:

Look for subject matter experts you can trust. The internet provides unparalleled access to unbiased, expert for-profit, government and non-profit resources in a variety of financial and investment fields.

Find advisors and experts who don’t have a vested interest in how you invest or what instruments you use.

Take investment and personal financial classes. These are offered by a variety of resources on a variety of topics both online and in person.  Do you know how an ETF works?  Do you know that inherently you take on a chunk of liquidity risk by using some of these products?  This is just one example of the fun facts out there when you start to ask questions and get in the classroom.

Keep your mind agile and work on solving challenging problems. Competency with numbers and general problem solving skills also is linked to improved financial outcomes.

  • Services like Lumosity, Neuronation and Brainmetrix all provide ways to work out your minds.
  • Do puzzles, play boardgames, GO TO SCHOOL for something challenging.

Develop the discipline to READ. Reading financial press, education materials and, simply, your monthly statements from your financial service providers takes time, but can make all the difference in the world to your financial outcomes.  When something doesn’t sound right to you, it probably at least deserves some questioning or, maybe a second opinion.

Taken together, you can develop a plan and an ever-growing set of knowledge for you to draw on when making financial decisions.  This WILL improve your financial decision-making process and the OUTCOMES of those decisions.

At IOI, we don’t care how you invest, we just want you to be as smart as possible about doing it.  So, make some time and get in the classroom with us.  Let us help you understand investing from the ground up and provide you the skills and knowledge to navigate our capital markets.

NOTES:

* We discuss this, an outcome of Prospect Theory called the “Disposition Effect” in IOI 101 classes.

RESOURCES:

Navigating the Market (November 18, 2013) by the Consumer Financial Protection Bureau.

Financial Literacy, Financial Education and Economic Outcomes (September 2012) by J. Hastings, B. Madrian and W. Skimmyhorn for the National Bureau of Economic Research (working paper).

CONTACT US TO INCREASE YOUR FINANCIAL LITERACY!