You can lead a horse to water, but you can’t make it drink. It’s much the same with personal finance.
Research is emerging that suggests becoming financially successful involves far more than just financial literacy (AKA “learning”).
The reality is that no matter how much you “teach” someone about money, it doesn’t always make them change their behaviour and become “financially capable”. That applies to both rich and poor. Just the consequences are more serious if you’re poor.
Billions of dollars down the drain
Elaine Kempson emeritus professor, University of Bristol told the Financial Capability Summit in Auckland that billions of dollars had been spent around the world on financial literacy programmes, which have had little impact.
Here in New Zealand, for example, government spending has often been targeted at budget advice centres, which help people out of short term financial problems, but often doesn’t change their behaviour in the long term.
If it was just a matter of learning for example that alcohol was bad for us or that vegetables were good we’d all give up alcohol and turn to a vegetarian diet immediately, says Diane Maxwell, New Zealand’s Retirement Commissioner.
An alcoholic knows the alcohol is killing them. But that knowledge often isn’t enough to change behaviour. It takes something more.
Why we need a shove.
A paradigm shift in thinking is happening. Worldwide the goal for governments is moving from the need for financial literacy (which is about what you know) to financial capability (what you can do).
Simply teaching literacy hasn’t worked. “People need a jolly good shove,” says Maxwell, when it comes to doing something concrete about saving for the future.
Our brains are hardwired to sabotage
One of the biggest problems with financial literacy programmes, says Kempson, is their failure to understand the behaviours that stop people curbing their spending. We have in-built biases unconnected with knowledge and skills.
Research by behavioural economists suggests that our brains are hardwired to sabotage our financial futures – or at least make illogical decisions. For example we:
- Separate our money into mental accounts, based on illogical criteria. You may not be willing to spend $100 from your wallet on an unnecessary gizmo, but might “spoil” yourself with the same gizmo if the money came from Fly Buys or a tax refund. The reality is that the money is part of our overall budget no matter where it comes from.
- Set anchors. If for example a salesperson tells us the RRP of an item is $100, but it’s on sale at $50 we think we’ve got a bargain. The reality is that the company probably never expected to sell that item at $100 and the anchor was used to fool us.
- Fall for the “gambler’s fallacy”. This failing in our brains makes us buy investments when they are high and sell low instead of the other way round. We believe, for example, that the more the property market goes up, the more that is going to continue rising so we buy. Yet eventually there will be a correction and some people will be forced to sell low.
- Let our losses run thanks to “prospect theory”. This means that we will sit on losses hoping they will turn around whilst we will sell at a profit. Losses hurt far more than gains give pleasure.
Ultimately says Kempson there are many different components in the Pandora’s Box of financial capability. Getting it right, however, will have serious positive implications for individuals and society as a whole.