Oliver Mitchell, CEO and founder of Moneycado, argues why classroom financial literacy doesn't work and what should replace it.
Financial literacy is rubbish. The theory is seductive. If people understand the mechanics of money they will make better financial decisions. If someone can confidently explain compound interest, they will naturally begin thinking long-term.
Unfortunately, people don't work like that. In 2013, experts in consumer finance conducted the largest meta-analysis of financial literacy programs to date. They studied 201 programs and 168 prior papers and found that interventions explained only 0.1% of the difference in subjects’ behaviour. This was a far lower result than they had expected.
The researchers offered two explanations. First, any benefit of financial education decays over time. The average gap in the studies between education and measuring their benefit was around 11 months, at which point most of the effect had disappeared. After 20 months, the researchers posited, all benefit was lost.
Second, most of the benefits previously attributed to financial literacy programs could actually be explained by ingrained behavioural differences between the subjects. For example, subjects who demonstrated a tendency to plan, or who were highly numerate, tended to have better financial outcomes irrespective of financial literacy training.
I've seen how ineffective financial literacy can be first hand. When I started Moneycado, I ran workshops on a range of personal finance topics, trying to learn more about how people relate to their money. I found that no matter how I presented the information, the gap between theory and practice was too wide. Students struggled to apply the concepts from the seminars to their own financial lives.
Why is this so?
Personal finance is not a classroom subject, it is a set of habits. This is not a new idea – behavioural finance has been identifying the logical inconsistencies in peoples' financial decision-making for decades – but only now is this philosophy creeping into financial product design. People do not perform objective calculations when they make financial decisions, but rather rely on heuristics, or rules of thumb, which they've developed through observation and repetition.
Further, personal finance is intensely emotive. Financial means is closely tied to personal identity and how we relate to our peers. Though we shouldn't, we use wealth as a proxy for worth. How many of the posts on your Instagram feed quietly boast of expensive meals, lavish holidays and beautiful clothes? In the face of such powerful social motivation, textbook rules for money management will never cut through.
How then, can we give people the tools to make better financial decisions? Happily, there are a few methods outside the bounds of traditional financial literacy which can be wildly effective because they are aligned to the true psychology of personal finance.
First, the information should be presented contextually and at the point which it is needed. This combats the 'time decay' effect mentioned previously and helps users to apply the theory to their own situation. Cleo, a personal finance bot, is an outstanding example. Once users set a budget it provides real-time reminders on progress ("£171 left, or £34.20 per day") and nudges if you're expected to exceed your target. Interactions are light, instant, and mercifully brief.
Second, interventions should be social. People are far more motivated by cues ("60% of your peers round-up their spare change") than commands ("you should round-up your transactions into a savings pot"). StepLadder is using Rotating Savings and Credit Associations (ROSCA) to incentivise saving for a home deposit. Users join small groups which pre-commit to contributing a certain sum each month. Each group member then takes turns to receive the entire group contribution once. ROSCAs are common and highly effective in developing economies, precisely because of the social pressure they imply.
Third, the correct behaviours should be incredibly easy. Consider the difference between the following interventions:
- Would you like to make a transfer to your savings account this week?
- You can afford to save £10 this week. Would you like to transfer £10 to your savings account?
- You're scheduled to make a £10 savings transfer tomorrow. Click here to modify.
The first option is cognitively difficult. A user needs to not only decide whether to save, but how much, and whether they can afford to do so. The second option is better since a recommended amount has been presented, but still requires an active choice by the user. The third option is the best. It presents a default option while still retaining the users' ability to opt-out.
Plum and Chip, two successful savings apps, utilise just this psychology. They automatically calculate a safe amount for users to save and transfer it weekly into a separate account. Once properly set up, regularly saving becomes easier than not saving!
Behavioural economics, the study of how people really think about money, offers a wealth of insight into how to make more effective, more useful financial products. The apps mentioned here are early adopters in this regard; there is plenty of space both to incorporate minor tweaks into existing products and to design entirely new experiences financial experiences. We can safely discard the staid notion of financial literacy and progress toward dynamic, engaging and accessible product design!