Should we make financial literacy less necessary?

One disadvantage of a defined-contribution world compared to a defined-benefit world is the burden it puts on personal financial decision-making.

I just ran across this James Surowieki essay published last summer. It makes three straightforward points:

– Financial illiteracy is rampant.
– That’s bad news in a world in which ordinary folks are called on to make complicated financial choices: about retirement investments, about home mortgages, about consumer debt, and about health insurance.
– It turns out not to be very hard to improve financial literacy, for example in high-school classrooms.

Therefore, Surowieki argues, programs to improve financial literacy deserve support.

Quite an elegant argument, and, I think, clearly right, on its own terms.

But now let’s add one more fact: the happiness literature demonstrates that the trait of caring about and thinking about money is strongly negatively correlated with happiness. Do programs to improve financial literacy make people care more and think more about money? I have no idea; it could go ether way, or there might be no correlation. But if financial literacy comes at a cost in happiness, the emotional losses ought to be weighed against the financial gains.

Of course, there’s an alternative to requiring that everyone become a low-grade financial expert. We could instead have a social and economic system that puts less strain on individual financial decision-making. Instead, as Surowieki points out, we’ve been moving in the opposite direction, for example with the defined-contribution plan replacing the defined-benefit plan.

That’s one big advantage of Social Security over other means of providing retirement income: in addition to spreading risk, it eliminates the need for 150 million amateur Warren Buffets.

Footnote In considering this problem, the most important fact is that half the population has an IQ of under 100. The average reader of this blog is probably two standard deviations above the mean, and so are most of the people she knows. So this is not one of the public-policy problems for which introspection is a useful research technique.

Author: Mark Kleiman

Professor of Public Policy at the NYU Marron Institute for Urban Management and editor of the Journal of Drug Policy Analysis. Teaches about the methods of policy analysis about drug abuse control and crime control policy, working out the implications of two principles: that swift and certain sanctions don't have to be severe to be effective, and that well-designed threats usually don't have to be carried out. Books: Drugs and Drug Policy: What Everyone Needs to Know (with Jonathan Caulkins and Angela Hawken) When Brute Force Fails: How to Have Less Crime and Less Punishment (Princeton, 2009; named one of the "books of the year" by The Economist Against Excess: Drug Policy for Results (Basic, 1993) Marijuana: Costs of Abuse, Costs of Control (Greenwood, 1989) UCLA Homepage Curriculum Vitae Contact:

22 thoughts on “Should we make financial literacy less necessary?”

  1. the happiness literature demonstrates that the trait of caring about and thinking about money is strongly negatively correlated with happiness

    That may have something to do with the first two points that Surowieki brings up.

    the most important fact is that half the population has an IQ of under 100

    Yeah, but IIRC most of those below average cluster around the 100 mark*. I don't know if there's a significant practical impact on non-rocket-science-work that having an IQ of, say, 92 has vis-a-vis personal financial planning of a working/middle-class family.

    *Which is the most recent authoritative survey on IQ distribution within a developed country?

  2. daksya – Steve Sailer put up a post on exactly your question a few days ago:…. The Army gives IQ-like tests, to classify its recruits, and has found that an IQ of less than 94 generally means you just cant make it as an artilleryman – I'm not too sure what that has to do with personal financial planning, though.

    I'm inclined to think that two things are important – one is a long-term future orientation, the other is being fairly smart. If you lack either, you will do things that get you into trouble.

  3. I think the most important point is that many (most) people aren't temperamentally suited to investing. People may invest badly because they are unintelligent, but they almost certainly will invest badly if they become euphoric or panic.

  4. My friend, the financial advisor, says "Oh, lawyers are the WORST for that" (investing badly out of overconfidence and an overly optimistic view of whether they themselves can beat the market's average performance).

    Lawyers are mostly what, probably two standard deviations above the mean, about?

  5. So many of the political problems we debate on this blog come down to risk management.

    Managing risk means worrying less. When they're not worried, people are more productive. Business startups and expansion are more likely to happen in a setting of manageable risk. (ie if you go out on your own with a new idea, you don't put your whole family's health insurance on the table)

    AOTBE, the economy would probably be more productive with a strong safety net.

    Fear doesn't make people excel.

  6. Even the 2-standard-deviation-over-100 crowd makes lots of mistakes. I have many friends in this category (or even 3+ standard deviations.) Some of them play the stock market. Only one of them, to my knowledge, plays it well–i.e., about 1 percentage point over an index fund over a long-term period. (Betsy, he happens to be an engineer.)

  7. Seems to me that even if everyone was indeed a financial genius, it would be mathematically impossible for everyone to score big in the stock market. Or even break even.

  8. Well, yeah! Thanks, Ohio Mom.

    What if instead of engaging in chrematistics (rent-seeking), we all just focused on doing a pretty good job at work, and quietly saving a bit at a time, and voting ourselves a decent safety net so that we don't have to acquire millions just to self-insure against every .01% catastrophe.

    A whole society like that, or a whole society of speculators, leveragers, and rent-seekers? I can tell you which culture I'D buy stock in.

  9. The analogy, a la Elizabeth Warren, is consumer protection. We don't require high school students to learn how to assess the electrical safety of consumer electronics. We just require that they be safe. The same idea could be applied to consumer financial instruments.

    While I'm pretty sympathetic to this argument, I still think education in personal finance is essential to deal with such basic concepts as living within your means, the power of compound interest, etc. I don't see how you can make the market safe enough to dispense with these basic ideas.

  10. An illustration:

    I buy lottery tickets rationally. When the expected value is above the odds of winning, I play the game. There is no happiness is this approach, but I did get a nice dinner out when I won $100 one time.

  11. We had some downtime during naps on Saturday, and found a sort of reality TV how that followed around a family that had declared bankruptcy and had to move their 7 kids out of a house and make ends meet. It was horribly tedious and fascinating at the same time, and these adults had very little financial intelligence-training-literacy, and this lack was their impediment and impetus for their problems. And since they were stuck in Phoenix and the dad was in the construction industry, they were scr*wed. I got the feeling there were a couple million families in our country, just like them, and the points in this post kept coming up over and over. Ugh.

  12. There´s plenty of evidence, not least from the subprime crisis, that very clever people can get things very wrong just as much, and on a larger scale, as dimmer bulbs. Business school students think they can beat the market; they even fail to choose the cheapest index fund in a simulation, a no-brainer (can´t trace this one). There are errors like over-confidence in mathematical models that only the clever can make. And see my <a href="//¨" rel="nofollow">last post.

    I´d like to see financial literacy education address cognitive limitations and limiting anxiety.

  13. The [IQ of the] average reader of this blog is probably two standard deviations above the mean

    I can say with extremely high confidence that the average (read: median) reader of this blog believes him/herself to have an IQ higher than 97.8% of the population, although that's by no means unique to this blog. I'm a little skeptical of the claim that was actually made, flattering though it is.

  14. Before I left the corporate world I noticed a growing trend toward age-based retirement plans whereby the plan you choose is a function of your age (younger == riskier). One can argue that this approach is less stressful for the participants ("I know I'm making the right choice if I know my age") and thus a move away from requiring everyone to be a financial expert. However, I think it gives a false sense of security. It doesn't lower the risk, it merely hides it.

    IF you're going to fund your retirement on speculative assets then you need to understand risk management. Or at least you need to understand that your retirement is based on these. It would be nice if you could, at the same time, understand that it needn't be this way, that there are/were perfectly sustainable approaches based on actual & matched savings.

    Matt: I'm inclined to agree. Maybe 1 std dev but 2 is pretty exceptional.

  15. I'll just add that IQ is probably a terrible way of thinking about financial literacy. Aside from the fact that it is a very squishy concept, being knowledgeable in financial instruments, etc. wouldn't even necessarily correlate well with IQ anyway.

    But while we're on the topic, I'd also widen it a bit to include the policy decisions based on dim knowledge of economics. It's a testament to the complexity of economics (and our own desire to see what we want to see) that even the most expert opinion has difficulty finding consensus. Keynes and Laffer-based rationale are thrown around like playthings when most of us couldn't write an entry-level essay on either.

  16. Keep in mind that financial firms make money in 2 ways, information asymmetries and transactions. So there is always someone trying to keep a person in the dark as much as possible as well as soemone else trying to get them to trade as much as possible.

  17. Call me captain obvious, but doesn't what you teach matter just as much as the act of teaching? I mean what are you teaching? Is real estate a good investment? What sort of formula would you give to students to see if it is a good investment? How would anyone know in 1979 that all residential real estate in the city of Detroit is a bad investment? How would anyone know that investing in New York city in 1979 was a really good investment?

    And so it goes. Maybe you don't give people enough credit. Maybe people make rational decisions that may look bad to you because you have a different outlook on life or a different perception of things. For example, if you buy a nice big TV on credit that you can't afford and it gets repossessed it might look foolish to you. But what if you knew you would never afford it. So you get to have it for a few months for almost nothing and then it goes away. Isn't that maximizing utility? Sure it will ruin your credit, but if you (maybe correctly) calculate that you'll never own a home anyways…

    Just playing devil's advocate but hopefully you get my point.

  18. Benny Lava, I once read something similar to your TV example about innercity teenage moms. It gave a whole list of reasons why it might actually makes sense for teenage girls to have babies.

    I don't think I remember all of them, but some of the reasons were: having a baby as a teen doesn't interfer with going to college if you never were going to go to college, anyway; similarly, if there isn't a big enough pool of marriageble men and you probably aren't going to get married anyway, having a baby isn't going to decrease your next-to-zero chance of getting married; and the moms of the teenager-moms are more likely to help raise the new baby if the mom herself is just a teenager, that is, there is a marked drop-off in grandmother involvement when the mom is in her twenties and seen as old enough to take care of things herself. Not that I think teenaged motherhood is a good thing, just food for thought.

    A gazillion years ago, when I was fresh out of college and a VISTA worker and in a very perverse mood, I decided that since our economic system requires at the very least, some unemployed people — if not some out and out poor people — the poverty-striken were doing all of us middle-class people a favor by filling up the necessary poor slots. For that, I thought, the least we can do is give them food stamps, Medicaid, and other sorts of assistance.

    Even if the family Don Staley saw on TV were more financially astute, in the end, the dad would still be unemployed and the family would still be in financial peril. You think the dad should have picked a different career? Okay, but somebody has to be a construction worker, and that somebody would still be unemployed and as a result, in financial straits.

  19. My grandmother (who memorably once said: "You NEVER spend your capital") got most of her financial ideas from her very conservative church. And the advice was: pay the mortgage, have savings, don't leave a job until you have the next one lined up. She was a smart lady – got a bachelor's in classics from North Dakota State U in 1909 – but she didn't have to be, just had to heed the messages she got in her small groups. My claim here is that there's been a lessening of social strictures, and they substituted for being able to puzzle it out for yourself.

  20. People also make their voting decisions in part using the filter provided by their degree of financial illiteracy.

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