The Fallacy of Financial Education

By James Kwak

In White House Burning, there is a section on the rise and political influence of the conservative media. At one point, I looked up the top ten talk radio shows by audience. Nine of them were unabashedly right-wing, politically oriented shows. The tenth was Dave Ramsey. Ramsey has plenty of conservative elements: religion, moralism, glorification of wealth. But his show isn’t about conservative politics. It’s about personal finance.

Ramsey is a huge success because—in addition to his charisma and marketing skills—he is peddling one of the huge but popular illusions of American culture: that people can become rich by making better financial decisions. He’s also one of the characters skewered by Helaine Olen in her recent book, Pound Foolish, which describes the fallacies, hypocrisies, and borderline-corrupt schemes of personal finance gurus like Ramsey and Suze Orman. It’s a fun read—a bit repetitive, but that’s largely because all personal finance “experts” are pushing a small handful of myths.*

The “sham” of the financial literacy movement—the idea that all of our financial problems would be solved if Americans were better educated about money—is the subject of Olen’s article in Pacific Standard. More than a dozen states require personal finance classes in high school, even though the evidence is that they have no impact. In short, people who consume financial education behave no differently from people who don’t.

There is a whole hierarchy of reasons for this. One is that people tend to forget what they learn in class—no matter what class you’re talking about. One is that at the moment of making the financial decision—say, to take out the subprime mortgage—anything they may remember from class is overwhelmed by the sales pitch of the mortgage broker sitting in front of them. One is that people make financial decisions on irrational grounds.

There are a couple of structural reasons, as well. Financial education content has to come from somewhere—and overwhelmingly it comes from the asset management industry itself, which has the incentive to teach people many of the wrong things. Financial education courses are often designed by financial institutions themselves; financial “education” available on the Internet is even more likely to be a type of marketing above all else.

Beyond that, it’s not even clear—to me, at least—that there is a scientific basis of agreement on how people should make financial decisions. Sure, there are some obvious things that any informed expert should know: buy index funds (for liquid, near-efficient markets) and minimize fees, for example. But when it comes to asset allocation, for example, there are reputable people like Ian Ayres who say that young people should invest more than 100% of their assets in the stock market, and reputable people like Zvi Bodie who say that the minimum amount of money you need for retirement should be invested in inflation-indexed Treasuries. Similarly, you could get a spectrum of reasonable opinions on the wisdom of taking out loans to go to college. (Up to a point, most of the opinion would be in favor because of the expected earnings boost you get from education, but it depends on a lot of factors like where you go to college, what you study, etc.).

Olen’s book shows in entertaining detail that the way most financial education is done is a joke. (Ramsey, for example, advises people to pay down their debt in increasing order by principal amount—not descending order by interest rate, which is obviously better from an, um, financial perspective.) But it’s not clear to me how much of it could even be done right. The bottom line is that it’s no panacea—not for poor financial decision-making, let alone for the income inequality and threadbare safety net that are the underlying cause of most serious personal financial problems.

* I’m about a third of the way through at this point. I only read it during Tuesday morning “family reading” with my daughter at school. She sits next to me and reads historical fiction.

26 responses to “The Fallacy of Financial Education

  1. Brian Kesten

    Thank you for this post- I am inclined to agree. I taught for two years in a high school were financial literacy was taught and was really disappointed in how little students got out of the class. Wells Fargo partnered with our school and caused more disruption than anything else. I was very frustrated.

    Could you point me to more information regarding this section of the post?: “(Ramsey, for example, advises people to pay down their debt in increasing order by principal amount—not descending order by interest rate, which is obviously better from an, um, financial perspective.”

    Thank you very much. I read 13 Bankers last summer before enrolling in law school, where I hope to study securities and financial regulation. Your book was very instrumental in that decision.

    Thanks!

  2. James, would you be including the financial education within the MBA programs? Many of the top schools have finance professors who are either employed directly or indirectly by investment banks, hedge funds or institutional investment firms. For what it is worth, I found the some of the efficient markets content to be quite self-serving. You could even argue out of much financial regulation based on the premise supporting efficient markets.

  3. This missed point here is that our brains don’t fully develop until well into adulthood of 25-30 years. And by then, we have absorbed so much nonsense and stereotyped so many people, that rational decisions get left behind or trickery comes to fore to manage lives. History certainly repeats it’s self, but it never rhyme’s with reason.

  4. Heath White

    This post needs to separate some issues.

    (1) Financial difficulties of average people are at least as much features of our economy, as they are of bad personal decisions. True: but from the point of view of a person in financial trouble, or who wants to do better in life, it makes more sense to focus on what you can control than what you can’t. That is the market Ramsey et al are catering to, and it is rational.

    (2) Improved financial decision-making is not best served by giving people education, i.e. information about finances. Probably true again. But Ramsey at least understands this; that is why he recommends paying down small balances first, rather than high interest rates. It gives you a psychological “win” factor when you pay off a debt in full, and keeps your motivation high. Think of him more as a behavioral psychologist/motivational speaker about money, rather than an investment counselor. Most regular people need the former not the latter.

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  7. Seniors shouldn’t watch tv ads about investing and the post office should play a bigger role in banking to protect us from the sharks.

  8. richardhserlin

    It’s not clear that all, even relatively cursory, personal finance education does not work. Here, you see Stanford Economist Douglass Bernheim pointing to research showing it having a significant effect:

    http://www.cardhub.com/edu/the-argument-against-financial-literacy-programs/

    I’ve taught personal finance at the University of Arizona for almost 10 years. My opinion is that it really depends. The quality of the course or material can vary tremendously, as can the students. It’s one thing to have a little mini-course, or spend a few weeks on this with high school students. It’s another to have a 15 week course for college students at a major selective university, for their GPA, with the most important material well taught.

    I have a post on this here:

    http://richardhserlin.blogspot.com/2013/10/personal-finance-education-can-be-good.html

    And if you’d like to see my syllabus and other materials, or even take my course for free (but not for official credit), just email me.

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  10. Every investment advisor I hear in the media begins with the assumption that their caller has assets and employment and a stable revenue stream. They have a deployment problem, not a resource problem. Pay your debts! Save and invest! Make large purchases wisely! Well, duh. Sounds perfectly sensible, but not on this planet.

    We saw what happened over the past forty years, and especially after 2007. People who invested and saved were gutted. People who had “invested” decades of employment for the sake of a pension were suckered as whole industries shed their obligations through mergers and structured bankruptcies.

    Financial advisors may depict themselves as Moses, come to lead people out of the desert. But instead, they function as Judas goats, confidently leading people up the ramp to the slaughterhouse. Of course THEY can be confident, they get to go back down the ramp.

    Noni

  11. I would encourage you to look directly at Dave Ramsey’s advice instead of relying on another’s interpretation. His philosophy focuses on elimination of debt, whereas the finance industry focuses on asset accumulation. One of Dave’s key messages is that financial literacy is overwhelmingly based on emotion and psychology, rather than the math of finance. That’s why he recommends paying of small debts first – because the psychological power of seeing a debt retired will encourage you to keep going. I don’t agree with everything Ramsey says, but I do believe he cares more about helping people than padding his pocketbook.

  12. What’s the old saying, People who live in glass houses….

  13. ‘We saw what happened over the past forty years, and especially after 2007. People who invested and saved were gutted.’

    You might want to take a look at a chart of, say, the S&P 500’s performance since 1974, and re-think that.

  14. The CFPB is working on some good financial education tools: http://www.consumerfinance.gov/paying-for-college/

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  16. @Noni – I’m just going to take all their money – claw back – at the poker table :-))

    It’s the American way to settle disputes. Keep it flowing….

    The psychological pretense is that there is no consensus about what comes next….what are Judas’s handlers going to do to get rid of the one among them who betrayed another for them….?

    When communication is reached between a man and a woman, on what did they agree? That, in itself, is a momentous occasion, no? That every human being has the right to make their lives less miserable through honest work.

    The trick with this bunch is to deliver criticism of their fragile egos through an institution devoted to the philosophical and artistic works of man’s imagination. But they de-funded that stuff 40 years ago, go figure.

    Grandma never wavered from he war plan, which was always – “First get rid of the drug dealors. Yikes, right? Part of the legend that is coming out about Putin, he went in and leveled the opium organization of production and distribution. We have no economic protection like that in the USA. The banks threw good money over to their accounts with cynicism….scum bags…worse than goats.

    It’s all just a different way to get things going in a more worthy way. For instance, you would have to be stoned on pot to work on an “app” that will clean a dirty diaper if you wave the diaper over the cell phone. “…See, through this lens that works as your camera….” blah blah blah…

    Yeah, they argue, that it took discovering how to direct the micro beam of the blaster to get the bacteria – it’s trillions of beams challenging trillions of bacteria – one on one – need an algorithm to do that – LOL.

    See? It’s all how you combine the massive political efforts – pot and math.

    Yeah. I don’t see it either.

    The re-direction of resources – “technology” for meta data collection needed to link health care to the IRS – resulted in no one being able to use the new law. Brilliant, one has to admit.

    If they’re off the data collection, must be 2 different economies in play. Or maybe just double-entry bookkeeping. Like, duh.

    They stole 50K from 40 million and that’s how they did it – they always used our money as their leverage.

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  23. Ken, Toronto

    (Noni – great comment)

    slightly different perspectives…

    #1 – I have always been amazed (disappointed) that high-school education does not in my experience (some 40 years ago) contain ANY info on the finances of everyday life. We got nothing about what wages to expect for various careers, how much housing and food would cost and what 5 to budget for it, what %-age to sock away for retirement, how do loans and mortgages work, how do credit cards work, etc etc. You have to take history… but it’s perfectly ok to kick out financially naive new consumers.

    I have always thought this is somehow deliberate, as if a sea of ignorant new consumers is somehow necessary to the economy.

    #2 – This is a central question for this time in our history: does the market serve society or vice versa? Stated from another angle – does the average person in a prosperous country have the right to expect reasonable opportunities for employment that will support raising a family and a reasonable if modest lifestyle, or are citizens simply runners in a global economic race, and if you have a crappy race… too bad Charlie.

    It seems that if you’re not either well paid, and/or financially sophisticated… you’re toast these days.

    tl;dr version – everyone should get enough financial smarts to lead a normal life as thoughtful consumers, but we also need to confirm or deny once and for all whether the economy is intended to serve all citizens, or the economy is a casino, everyone must play, and there’s gonna be winners and losers.

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  25. Pay down debt by principal amount, not by highest inerest rate? Assuming the minimum payment can be made on each debt, that srikes me as financial malpractice.

  26. Kumar Nanjundaiya Ramesh

    In this context, today, one should look at India and emulate the efforts done by the country’s Central Bank of India (RBI). They have done an excellent initiative in this field to address the growing need in this sector and their plan of action essentially touches upon the current global economic scenario and its impact in India on local financial education, financial inclusion and customer protection. This is with the objective to help the country not only achieve stability but also pave way for sustainable and a balanced growth. RBI wishes to ensure that on a pan India basis Financial education should be directed to provide the population necessary skills and attitudes to become financially literate and money management practices with respect to earning, spending, saving, borrowing, and investing. They are essentially driving the message that financial education will eventually help individuals (in a developing country such as India with growing population of 1.25 billion) think and plan their financial goals by proactive decision-making and work towards fulfilling these goals. By this way, there will be a change in the attitudes of the customers to judiciously use financial products and services, in such a way so as to effective use this scarce resource. We are talking here about financial inclusion which will bringing people (below the poverty line ) to the mainstream, linking them to banks so that they become customers of Banks and are able to access the full range of services as loans and deposits offered by the banks. Banks in India level of penetration to tier 3 towns and villages should be about 35 % which if doubled will be a great boon economically. For this to happen, financial education at grass root levels is essential so that customer protection is achieved. In this regard it is worthwhile to state that financial service providers (banks) have a responsibility to understand their customer, market and provide error free and timely service . They should respond with a range of appropriate and affordable services, including savings and credit accounts, payment services, insurance products and the ability to send and receive remittance payments at competitive and affordable pricing. RBI has embraced financial education to protect consumers from fraud and abuse. At the micro level, financial literacy helps poorer households to use scarce resources more effectively, choose the financial products that best meet their needs and become pro-active decision makers. At the macro level, the institutional level, informed customers definitely make for better clients; they help lower institutional risk and contribute to a stronger bottom line. At the market level, financially literate consumers are a key element in effective consumer protection; placing pressure on financial institutions for services that are both appropriately priced and transparent.