Does Financial Education Make You a Better Investor?

The effects of education are often small and the knowledge gained is quickly forgotten - but it is still important

Morningstar 10 April, 2018 | 1:20PM

Financial education

Countless studies have been conducted to measure the impact of financial education on investor behaviour. Some of these report increased saving and debt reduction, while others find that education has no effect on investor habits at all. The findings are often discouraging for those working in financial services: the effects of education are often small and the knowledge gained is quickly forgotten.

But financial knowledge still matters. Without it, people would be at the mercy of unscrupulous salespeople and predatory products. Without financial literacy, financial experts could not add value, and if knowledge truly had no impact on behaviour, experts would make the same bad decisions as novices.

The standard measures of financial literacy are based on simple multiple-choice questions about fundamental financial concepts. They read very much like a school maths quiz and test a person’s understanding of interest rates, inflation, and risk. While these are important concepts for investors, they have little to no bearing on day-to-day financial habits or spending.

Knowing the right thing and doing the right thing are two different things entirely. We can know that saving is important, but if we are easily tempted by what we can buy today, we may not have the willpower to follow through. This explanation says, simply, that knowledge itself isn’t enough. We need to look at other influences that might be stronger than knowledge when determining financial behaviour.

If factors other than knowledge are overpowering people’s ability to apply that knowledge, then financial advisers should focus on these other influences.

For example, an investor who has a lot of knowledge but is also highly impulsive, or thinks in the very short term, may still exhibit bad financial habits because knowledge on its own is not enough.

The concept of coaching is different from financial-literacy teaching, though some elements overlap. Teaching is about knowledge transfer, while coaching is about action and skills in the here and now.

The analogy of a fitness trainer may be apt here. Trainers offer just enough information for the task at hand and use the events of the moment to train the person being coached into developing positive habits over time.

How Memory Decays

Some examples of positive coaching involve the timing of advice. Memory retention research shows a clear pattern of knowledge decay over time. The rate of memory decay is exponential, meaning that it drops off extremely quickly.

Because knowledge retention follows this exponential decay curve, it is best to offer important information just before it needs to be applied. In many ways, good advisers apply this rule intuitively. For example, if a client has just received a windfall, that would be a good time to consider a lump sump mortgage payment, using up all the year’s tax allowances or putting that money into a pension fund.

Other studies from the world of psychology and memory training show that we are more likely to remember things that are vivid and emotionally charged. And information is better remembered when it is generated from our own minds. Investors feel more focused on their plans if they feel in charge of their own financial futures and feel invested on an emotional and intellectual level.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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