Educating consumers on how to make better financial decisions may seem simple: Provide the information, and better decisions will follow. But Jeanne Hogarth, a former high school teacher turned national expert on consumer finance education, knows better. Developing financial education programs that make a difference in people’s lives is challenging work. It’s not always clear why some of these programs improve outcomes and others don’t.
Even so, Hogarth, manager of the Consumer Education and Research Section of the Federal Reserve Board’s Consumer and Community Affairs Division, puts great stock in the virtues of financial literacy. Her research strongly suggests that knowledge has a positive effect on financial behavior. Yet she wants to see results from more studies. “Nowadays there is more of a push to have evidence-driven, empirically based programs,” she says. “That gives the research community an opportunity to do a lot more of the experimental studies that allow us to tease out what’s effective.”
Hogarth, a native of Northeast Ohio, recently visited the Federal Reserve Bank of Cleveland and shared some of her perspectives.
Money Management Is Partly Psychology
In thinking about how people manage their money, economists tend to imagine a population of rational beings who base all of their decisions on expectations for the future. Hogarth disagrees. Midway through her career, she says, she had an “aha” moment that made her rethink the traditional approach to consumer finance research.
“One of the most interesting things I’ve learned is that a lot of financial education isn’t about economics—and that might be heresy!” Hogarth says. “It’s really about psychology; it’s about how people think and feel.”
Behavioral economists have explored how psychology affects whether people participate in 401(k) plans. The optimal choice for a worker’s financial well-being is always the same: to participate. But studies have shown that when companies make “opting in” automatic—meaning that workers must actively decline 401(k) participation—more people participate. That’s the sort of result that traditional economists might not have predicted.
This realization has encouraged Hogarth to think about how to help people deal with the psychological issues they confront when they make home loans and retirement and investment decisions. “Your risk tolerance is not a financial thing; it’s a psychological thing. And yet it has a huge impact on what happens. Because if you’re not tolerant of risk, you’re not going to get a very high rate of return,” she says.
Financial Education Seems to Work
Hogarth’s faith in financial education has grown over the years, thanks to some of her own research. In 2003, Hogarth and two of her colleagues at the Board of Governors, Casey Bell and Dan Gorin, began studying the effectiveness of a two-day financial education program for military personnel at Fort Bliss in El Paso, Texas. Staff from the San Diego City College taught the course, which covered budgeting, credit, consumer awareness, car buying, insurance, and retirement savings.
For the study, the soldiers were split into two groups—those who took the financial education course and those who did not. Both groups had to come from the same population and had to be tracked over many years; these are hard-to-satisfy requirements in natural experiments. To determine the effect of financial education, the researchers monitored13 positive behaviors (such as comparison shopping and starting an emergency fund) and 15 negative behaviors (such as paying bills late). They found that soldiers who participated in the financial education group showed more positive behaviors and fewer negative behaviors than those who did not.
Hogarth has been generally pleased with the study and its findings. “Financial education did seem to have an effect on specific financial management behaviors,” she wrote in a paper presented at the 2009 Federal Reserve System Community Affairs Research Conference.
“The bottom line is that we want good financial outcomes for consumers,” Hogarth says. “We want them to have financialsecurity. We want them to feel comfortable about managing their money.”
The Earlier the Better
Not only should consumers have access to financial education programs, but the earlier the better. In a 2006 paper, for example, Hogarth cited a study (Bernheim, Garrett, and Maki) that showed that consumers who graduated from high schools in states with mandated financial education averaged higher savings rates and higher net worth.1
The benefits also persisted over time. The research on soldiers stationed at Fort Bliss showed that those who had bank accounts when they were growing up became better money managers as adults, as did those whose parents talked with them about family finances early in life.
Financial Literacy Doesn’t Always Mean Financial Capability
But being knowledgeable about financial management does not guarantee that people will put that knowledge to good use. Hogarth pointed out that educators have spent a lot of time and effort trying to distinguish between financial literacy and financial capability without reaching a consensus.
Hogarth has her own take on the difference: “I think that literacy connotes a certain level of knowledge,” she says. “Capability takes it one step beyond knowledge to actions. I might know intellectually how to play baseball, but if I’ve never gotten onto a field and tried to swing a bat at a ball, I wouldn’t necessarily be capable. But when I actually get out there and start practicing, my capability kicks in. That’s how I differentiate literacy from capability.”
“The bottom line is that we want good financial outcomes for consumers,” Hogarth says. “We want them to have financial security. We want them to feel comfortable about managing their money.”
Focus Future Research on Behaviors and Outcomes
Hogarth has seen research nail down a connection between consumers’ knowledge and behavior—if you know more, you do better. But another question looms large for Hogarth and others who study consumer behavior. Sometimes people exhibit all the “correct” financial behaviors, but their outcomes are underwhelming.
Hogarth illustrates the point with an example: “Let’s say I max out my 401(k) every year. With the recent decline in stock market values, I’ve actually lost money. I’m doing all the right things, but my outcome isn’t so great.
“Sometimes the outcome isn’t caused by the things you do or don’t do,” she explains. “It’s because of external factors such as unemployment or a decline in housing values. The struggle for researchers is connecting behaviors to outcomes while also controlling for external factors. I don’t know that we’ve figured out how to do that.”
Hogarth acknowledges that it is difficult to track financial outcomes five to 40 years in the future. She points to the Social Security Administration, which has set up three centers for financial security research. The Financial Literacy Research Consortium, as the centers are collectively called, will create innovative materials and programs for Americans at various phases of their lives. For example, mid-career professionals and near-retirees will be helped to understand the role of Social Security benefits and to plan for retirement.
“I think the centers will really help financial educators provide evidence-based research to policymakers,” Hogarth says. “There are many, many projects that have been funded through the three centers that will bring some fresh insights on the links between financial knowledge, financial capability, and financial outcomes.”