I completed this literature review on 2018-04-23 for IDS 7500: Seminar in Educational Research (self-directed study) at University of Central Florida. I will need to expound upon it in my dissertation, which will be focused on financial education.
A Thematic Literature Review on Financial Capability and the Effectiveness of Financial Education in America After the 2008 Financial Crisis
University of Central Florida
The purpose of this literature review is to investigate Americans’ financial knowledge and capability since the 2008 financial crisis (also known as the Great Recession), by synthesizing empirical research and position papers into a thematic narrative, with a focus on the refereed publications of leading researchers in the financial education space, such as Lusardi, Mandell, Mitchell, Mottola, and Willis. Articles are included based on authorship and their relevance toward this objective, with additional articles gleaned from leading researchers’ citations. Because of the breadth of the relevant literature, the focus herein is on explaining and adequately substantiating phenomena, rather than systematic coverage.
Firstly, we should discuss the meanings of financial knowledge, financial literacy, and financial capability. These terms are inconsistently defined in the literature, but, generally, they are in order of scope. Financial knowledge relates to content knowledge and is often used as a proxy for financial capability (e.g., Lusardi, Mitchell, & Curto, 2010). Financial literacy additionally includes the ability to articulate one’s knowledge and apply it to real-life decisions (Vitt et al., 2000), while financial capability more prominently emphasizes improvement of one’s actual financial behaviors. A key distinction is that having financial knowledge does not actually mean one’s financial decisions will improve, and being taught about financial concepts does not mean that information will necessarily be retained. In the literature, financial knowledge and financial literacy are conflated or treated synonymously, while financial capability is often treated synonymous to financial literacy (Remund, 2010), but consistently refers to a construct more holistic than financial knowledge.
Before the Crisis
Based on fifteen years of Survey of Consumer Finances data, Hanna, Yuh, and Chatterjee (2012) found that consumer debt increased, with 27% of households having more than 40% of their income going toward debt payments in 2007 as compared with 18% in 1992. Although the time leading up to the Great Recession was prosperous, it was also marked by financial institutions’ heavy over-extension of credit which resulted in unsafe debt proportions among American households, and particularly among more highly educated households. These debts, combined with a stock market plunge and widespread job loss, compounded the negative effects for many American households, which persist even a decade later. The crisis also brought about a renewed focus on financial education.
Financial Education Movement
A movement in support of financial education emerged in response to the Great Recession. The Jump$tart Coalition for Personal Financial Literacy, a Washington, D.C. think-tank funded by the U.S. government and corporations like Charles Schwab and Bank of America, gained increasing clout. The organization’s National Standards in K–12 Personal Finance Education, now in its 4th edition (2015), increasingly became adopted by states and school districts throughout the US. While the movement gained momentum, several commentators complained about financial education on a theoretical basis—most notably, Willis (2008, 2009) who likens the movement to teaching citizens to represent themselves pro se in court or to perform their own medical procedures. More recently, Pinto (2013) argued that the movement is misguided in both its suggested implications and underlying assumptions. Later, we will see that unfortunately, there is also empirical support for this position.
Perceived Financial Capability
The National Financial Capability Study (NFCS) is a nationwide triennial survey of over 25,000 Americans that measures their financial position, attitudes, and content knowledge (for more information, see Mottola & Kieffer, 2017). It includes several questions asking respondents to rate their mathematical and financial abilities on seven-point Likert scales—we might refer to these questions as a proxy for self-perceived financial capability. An analysis of responses to these items in the 2009 NFCS survey shows a correlation between perceptions and actual financial knowledge (de Bassa Scheresberg, 2013), but also shows that Americans grossly overestimate their financial prowess. Such overconfidence can have detrimental consequences.
Measures and Proxies of Actual Financial Capability
Here, we will look at recent research on Americans’ financial capability, or proxies thereof (i.e., numeracy, financial knowledge, and financial behavior).
Numeracy, broadly, is the ability to understand and manipulate numbers, including basic mental arithmetic. These skills are closely associated with financial capability, yet sadly are consistently lacking among Americans, especially among those who are already financially at-risk such as senior citizens, women, and those with less educational attainment (Lusardi, 2012). A striking investigation is Lusardi and Mitchell’s (2007) analysis of 2004 survey data of Americans aged 51–56, which focused on three basic questions assessing numeracy. One asked how a $2 million lottery prize would be divided among five people, which was answered correctly ($400,000) by only 56% of respondents. More shockingly, a basic question on compound interest on a savings account over two years was correctly answered by only 18% of respondents, with most incorrect responses failing to consider the compounding effect. This shows that even older, wealthier Americans, close to retirement, have issues with basic mathematics, let alone complex financial decisions. Overall, quantitative literacy, an umbrella construct encompassing numeracy, has been shown to be significantly related to financial behaviors (Nye & Hillyard, 2013).
Financial knowledge is often assessed by several questions first proffered by Lusardi and Mitchell (2011), which are actually quite simple, yet frequently answered incorrectly. The 2015 NFCS survey included these six content-knowledge questions:
- Suppose you had $100 in a savings account and the interest rate was 2% per year. After 5 years, how much do you think you would have in the account if you left the money to grow?
- Imagine that the interest rate on your savings account was 1% per year and inflation was 2% per year. After 1 year, how much would you be able to buy with the money in this account?
- If interest rates rise, what will typically happen to bond prices?
- Suppose you owe $1,000 on a loan and the interest rate you are charged is 20% per year compounded annually. If you didn’t pay anything off, at this interest rate, how many years would it take for the amount you owe to double?
- A 15-year mortgage typically requires higher monthly payments than a 30-year mortgage, but the total interest paid over the life of the loan will be less.
- Buying a single company’s stock usually provides a safer return than a stock mutual fund.
Although the answer choices are all multiple choice or true/false, in the 2015 NFCS survey, only 28% answered Question 3 correctly, 33% answered Question 4 correctly, and 46% answered Question 6 correctly (Thripp, 2017). It appears that respondents cannot mentally compute compound interest, even when correct choices are as simple as “less than five years” with respect to Question 4, requiring no computation. For Millennials, financial knowledge is even worse than older groups (Mottola, 2014), and for all Americans, the micro and macro (e.g., Lusardi & Mitchell, 2014) effects are profoundly troubling.
Lusardi (2011) puts forth a literature review alongside an analysis of 2009 NFCS data. In part, her review notes the importance of financial literacy toward outcomes such as accumulating wealth, planning for retirement, taking on reasonable mortgages, and investing in equities via low-cost index funds. Then, an analysis of survey data reveals that about half of Americans report difficulties paying month-to-month bills, 51% have less than a three-month rainy day fund or no emergency savings at all, and a quarter have used high-cost borrowing such as payday loans. These are just a few of the many findings showing that Americans are living paycheck-to-paycheck with no safety net for unexpected events like job loss, a car breaking down, or unexpected illness (see also West & Mottola, 2016).
Gender differences. Mottola (2013) also used 2009 NFCS data to look at the gender gap with respect to credit card usage, finding that women tend to pay more interest and late fees, but suggesting that when controlling for demographics and perceived mathematical ability, the gender gap disappears. This shows that the gender gap in financial knowledge is multidimensional, relating to the gender pay gap and other inequities. It was seen in Chen and Volpe’s (2002) study that female college students have less motivation and confidence for learning about finance. These feelings of disempowerment may be related to mathematical stereotypes and may contribute to maladaptive financial behaviors such as aversion to saving (Garbinsky, Klesse, & Aaker, 2014).
Effectiveness of and Recommendations for Financial Education
When financial education works, it is often given “just-in-time,” such as requiring student loan applicants to complete relevant learning modules as a prerequisite for receiving their loan (Fernandes, Lynch, & Netemeyer, 2014). In addition, curriculum may be more easily remembered if based on benchmarks (“rules of thumb”) rather than complex decision-making criteria (Drexler, Fischer, & Schoar, 2014). This may result in improved financial decision-making subsequent to the course. At first glance, these suggestions may sound like common sense. However, in actuality most financial courses present complicated information in a lengthy format (e.g., a semester or school year), far in advance of when the insights are needed. Fernandes et al. (2014) conducted a sweeping meta-analysis of 201 financial education studies, which showed only 0.1% variance in financial behavior accounted for by financial education. In fact, the effects were weaker for those with low-income—who have the most to gain from increased financial capability, and any effects that were present generally dissipated within 20 months regardless of the length of the instructional intervention.
Although not refereed and sponsored by a corporation, Menard (2018) presents a cogent narrative about the history of American financial education and its ineffectiveness toward inciting behavioral change, citing leading researchers on financial education, psychology, and behavioral economics, while leveraging her past work on behavioral healthcare interventions (e.g., smoking cessation). Overall, despite doubling as a sales pitch for Questis, Menard (2018) points to financial coaching, just-in-time teaching, and behavioral interventions as alternatives to financial education courses that lack impact (e.g., Fernandes et al., 2014).
Hastings, Madrian, and Skimmyhorn (2013), in a narrative literature review exploring measurement of financial knowledge and the effectiveness of educational interventions. They note that while financial literacy is correlated with many beneficial financial behaviors, “the evidence is more limited and not as encouraging as one might expect” (p. 359) when it comes to financial education’s causal impact on financial outcomes. In fact, if we turn to Mandell’s prolific research (Mandell, 2006, 2009, 2012; Mandell & Klein, 2009), we see that high school students’ participation in lengthy financial courses failed to improve financial knowledge, let alone financial outcomes. Despite being a lifelong researcher and proponent of financial education, Mandell (2012) concedes that K–12 and college financial courses simply do not work, at least as presently conceived. This lends surprising credence to Willis’s long-held contention (2008, 2009, 2017) that financial education is useless and detrimental, standing in stark contrast to Lusardi’s (2011, 2017) conviction of its necessity. In fairness, a balanced conclusion is that financial education can be useful, but must be easily digestible and of immediate relevance (Drexler et al., 2014; Fernandes et al., 2014). Sadly, this is not a characteristic of the Jump$tart Coalition (2015) standards on which many financial courses are based.
Chen, H., & Volpe, R. P. (2002). Gender differences in personal financial literacy among college students. Financial Services Review, 11, 289–307.
de Bassa Scheresberg, C. (2013). Financial literacy and financial behavior among young adults: Evidence and implications. Numeracy, 6(2), 1–21. https://doi.org/10.5038/1936-4618.104.22.168
Drexler, A., Fischer, G., & Schoar, A. (2014). Keeping it simple: Financial literacy and rules of thumb. American Economic Journal: Applied Economics, 6(2), 1–31. https://doi.org/10.1257/app.6.2.1
Fernandes, D., Lynch, J. G., Jr., & Netemeyer, R. G. (2014). Financial literacy, financial education, and downstream financial behaviors. Management Science, 60, 1861–1883. http://doi.org/10.1287/mnsc.2013.1849
Garbinsky, E. N., Klesse, A.-K., & Aaker, J. (2014). Money in the bank: Feeling powerful increases savings. Journal of Consumer Research, 41, 610–623. https://doi.org/10.1086/676965
Hanna, S. D., Yuh, Y., & Chatterjee, S. (2012). The increasing financial obligations burden of US households: Who is affected? International Journal of Consumer Studies, 36, 588–594. http://doi.org/10.1111/j.1470-6431.2012.01125.x
Hastings, J. S., Madrian, B. C., & Skimmyhorn, W. L. (2013). Financial literacy, financial education, and economic outcomes. Annual Review of Economics, 5, 347–373. https://doi.org/10.1146/annurev-economics-082312-125807
Jump$tart Coalition for Personal Financial Literacy. (2015). National standards in K–12 personal finance education, (4th ed.). Retrieved February 6, 2017, from http://www.jumpstart.org/assets/files/2015_NationalStandardsBook.pdf
Lusardi, A. (2011, June). Americans’ financial capability (Working Paper No. 17103). Washington, DC: National Bureau of Economic Research. Retrieved from http://www.nber.org/papers/w17103
Lusardi, A. (2012, February). Numeracy, financial literacy, and financial decision-making (Working Paper No. 17821). Washington, DC: National Bureau of Economic Research. Retrieved from http://www.nber.org/papers/w17821
Lusardi, A. (2017, March 9). Remarks by Annamaria Lusardi, Academic Director of the Global Financial Literacy Excellence Center at the George Washington University School of Business. Meeting of the Security and Exchange Commission Investor Advisory Committee. Retrieved from https://www.sec.gov/spotlight/investor-advisory-committee-2012/lusardi-remarks-iac-030917.pdf
Lusardi, A., & Mitchell, O. S. (2007). Financial literacy and retirement preparedness: Evidence and implications for financial education. Business Economics, 10(1), 35–44.
Lusardi, A., & Mitchell, O. S. (2011). Financial literacy around the world: An overview. Journal of Pension Economics & Finance, 10, 497–508. https://doi.org/10.1017/S1474747211000448
Lusardi, A., & Mitchell, O. S. (2014). The economic importance of financial literacy: Theory and evidence. Journal of Economic Literature, 52, 5–44. https://doi.org/10.1257/jel.52.1.5
Lusardi, A., Mitchell, O. S., & Curto, V. (2010). Financial literacy among the young. The Journal of Consumer Affairs, 44, 358–380. https://doi.org/10.1111/j.1745-6606.2010.01173.x
Mandell, L. (2006, April). Financial literacy: If it’s so important, why isn’t it improving? (Issue Brief No. 2006-PB-08). https://doi.org/10.2139/ssrn.923557
Mandell, L. (2009, January 4). The impact of financial education in high school and college on financial literacy and subsequent financial decision making. Paper presented at the meeting of the American Economic Association, San Francisco, CA.
Mandell, L. (2012). School-based financial education: Not ready for prime time. CFA Institute Research Foundation, 2012(3), 107–124.
Mandell, L., & Klein, L. S. (2009). The impact of financial literacy education on subsequent financial behavior. Journal of Financial Counseling and Planning, 20(1), 15–24.
Menard, M. B. (2018). So many courses, so little progress: Why financial education doesn’t work—and what does. Questis, Inc. https://doi.org/10.2139/ssrn.3098279
Mottola, G. R. (2013). In our best interest: Women, financial literacy and credit card behavior. Numeracy: Advancing Education in Quantitative Literacy, 6(2), 1–15. https://doi.org/10.5038/1936-4622.214.171.124
Mottola, G. R. (2014, March). The financial capability of young adults—A generational view. Retrieved from http://www.finra.org/file/financial-capability-young-adults%E2%80%94-generational-view
Mottola, G. R., & Kieffer, C. N. (2017). Understanding and using data from the National Financial Capability Study. Family and Consumer Sciences Research Journal, 46, 31–39. https://doi.org/10.1111/fcsr.12227
Pinto, L. E. (2013). When politics trump evidence: Financial literacy education narratives following the global financial crisis. Journal of Education Policy, 28, 95–120. https://doi.org/10.1080/02680939.2012.690163
Remund, D. L. (2010). Financial literacy explicated: The case for a clearer definition in an increasingly complex economy. The Journal of Consumer Affairs, 44, 276–295. http://doi.org/10.1111/j.1745-6606.2010.01169.x
Thripp, R. X. (2007, April 4). Relationships between financial capability and educational attainment: An analysis of survey data from the 2015 National Financial Capability Study. Poster session presented at the University of Central Florida’s 14th Annual Graduate Research Forum, Orlando, FL. Retrieved from http://thripp.com/finedu/
Vitt, L. A., Anderson, C., Kent, J., Lyster, D. M., Siegenthaler, J. K., & Ward, J. (2000). Personal finance and the rush to competence: Financial literacy education in the U.S. Middleburg, VA: Fannie Mae Foundation.
West, S., & Mottola, G. R. (2016). A population on the brink: American renters, emergency savings, and financial fragility. Poverty & Public Policy, 8, 56–71. https://doi.org/10.1002/pop4.130
Willis, L. E. (2008). Against financial-literacy education. Iowa Law Review, 94, 197–285.
Willis, L. E. (2009). Evidence and ideology in assessing the effectiveness of financial literacy education. San Diego Law Review, 46, 415–458.
Willis, L. E. (2017). The Consumer Financial Protection Bureau and the quest for consumer comprehension. The Russell Sage Foundation Journal of the Social Sciences, 3(1), 74–93. https://doi.org/10.7758/RSF.2017.3.1.04