As a financial researcher and aspiring financial educator, I’ve been thinking at length about the principles behind good financial teaching. These five ideas are by no means new or original. However, they are research-supported and not yet mainstream.
1. Behavior Under Management
Know when the student is not ready.
This is straight from Andy Hart’s podcast and conference, with support from a wealth of research in behavioral psychology, economics, and personal finance. Emotion, perception, knowledge, and experience all play an important role in why people make bad financial decisions.
It is widely accepted that younger people should be fully invested in stocks, because their time horizon is long. As they get older, volatility and profits should both be suppressed by divesting stocks into safer, less profitable assets such as bonds. However, young people commonly freak out when there is a bear market, selling their investments and even losing part of their principal. This is traumatic and may result in them never investing in stocks again, which is a worse outcome than if they had invested later in life with greater knowledge, experience, and resilience.
It is not fair to a student to advise an objectively superior course of action when it will lead to financial ruin because the student is not ready.
2. Educate in Arithmetic and Statistics
When the odds are in your favor, it’s only “gambling” if the consequences are disastrous.
Recent evidence suggests that mathematical education may be more important than financial education. The ability to perform mental computations is important, as well as skill with picturing compound interest and percentages. Understanding risk and reward over time is critical. Anyone with a complete understanding of gambling mathematics should know that as you gamble more, you get closer and closer to a guaranteed loss of money.
Investing in the whole global stock market, on the other hand, is neither speculation nor gambling because the odds are in your favor and the consequences of loss are temporary. Although the market declines in about 25% of given calendar years, over longer spans it almost surely increases from the starting point.
Insurance companies make money because they pay out less money than they take in. On average, the odds are in their favor. For any one individual or family, however, the consequences of losing the bet are disastrous. This is why it is wise to purchase health insurance, term life insurance, auto insurance, et cetera. You are insuring against uncommon yet disastrous events. Nonetheless, these disastrous events are much more likely to occur than winning a large lottery jackpot. On the other hand, purchasing insurance against minor losses, like a SquareTrade warranty or collision insurance on a car, is only necessary if these items are critical to you and you do not have the funds to replace them.
3. Make Choices Simpler
Don’t do business with businesses that put bad choices on the table. (Unless you are beating them at their own game.)
People often ask why one should pick Vanguard over Fidelity, Charles Schwab, or another firm for directing their investments. Although Fidelity and Schwab do offer low-cost index funds and arguably offer superior customer service, they are also determined to sell you on products and services that are very bad for your financial health, such as actively managed investments with high management fees.
It is an unpleasant and cognitively taxing experience to be required to repeatedly decline detrimental options. The extended warranties that are sold at the checkout counter at Best Buy are an awful deal. Likewise for trip “insurance” from your airline and GoDaddy’s upsells of inferior hosting services and over-priced options when all you want to purchase is a simple Internet domain name. It is bad enough when a business puts bad choices on the table; aggressive sales tactics are the coup de grâce.
This is why a hard rule of using cash instead of plastic is effective and beneficial for most consumers. The exception is if you are a “travel hacker” beating the credit card issuers at their own game. If you have to ask, you’re not a travel hacker. Simplifying the equation by avoiding the potential for making bad choices is worth losing a few benefits that are, by comparison, small. In some industries, all the major players violate this rule. However, when there an alternate option is available, it should usually be preferred (e.g., Vanguard, cash or debit cards instead of credit cards, etc.).
4. Inculcate a Habit of Inquiry
The squeaky wheel gets the grease.
There is plenty of information available easily via web search. For example, you can easily learn about investing, retirement accounts, or strategies for convincing your bank to waive an overdraft fee by searching Google. However, many people are not in the habit of seeking information nor asking for special consideration from a lender, bank, et cetera. There are differences between how subject-matter experts and novices seek information; novices may not know where to begin, and are typically unfamiliar with the jargon of personal finance, insurance, taxes, credit cards, mortgages, student loans, credit-reporting bureaus, and more. Therefore, it is unfair to blame them for failing to seek out information. Instead, we should educate them in the basics and encourage them to build a habit of inquiry, so they less likely to be shortchanged in their financial dealings.
In addition to educating others, we should lobby for laws and regulations that compel employers and financial institutions to conduct business in ways that do not unfairly disadvantage the non-wealthy (e.g., comprehension rules), and advocate for prosocial behaviors among employers, financial institutions, corporations, and governments that benefit the poor. For instance, it is unfair that many government benefits are not received by the most needy, due to being difficult to claim.
5. Focus on Long-Term Lifestyle Strategy
But, give tactical advice when appropriate.
Reducing bills, increasing income, and changing one’s habits is important. There are many forums and other websites about living frugally. In some ways this overlaps with Item 4; for example, one can save quite a bit on a car, phone or cable bill, rent, or terms of debt service by inquiring with sellers, service providers, landlords, and lenders. Responsible financial educators should encourage learners to (a) reduce expenses as a way of life (e.g., smaller living space, more roommates, no dining out, etc.), (b) focus on significantly increasing income by leveraging education, skills, et cetera, and (c) eliminate debts, save, and invest.
Financial education appears to be more effective when it either focuses on norms and general principles or is given tactically (i.e., “just-in-time“). The best time to tell someone how to write a check is immediately before they need to write a check. Financial advisers can serve as financial educators by offering key information and advice soon before significant financial events such as shopping for a house and mortgage. On the other hand, if this advice is offered many months or years in advance, it is neither remembered nor followed.
The above article is also posted on Thripp.com.