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Why Financial Literacy Fails, March 2013

Source: Time Magazine, March 11, 2013  by J.D. Roth

I’m often asked what I’d do to improve financial literacy in the United States. The premise seems to be that if we teach young people about compound interest and two-cycle billing, this information will lead them to make better financial choices. I’m not convinced.

When I was in high school, every senior was required to take a class in personal finance. We learned how to write checks, how to prepare a budget, and the history of the Federal Reserve. After learning some basic financial literacy, you might think my classmates and I were better prepared to make and save money. You’d be wrong. Now, 25 years later, we’re no better with money than those who were never given this sort of instruction.

Personal finance is simple. Fundamentally, you only need to know one thing: To build wealth, you must spend less than you earn. Why, then, is it so hard for everyone to get ahead?

For some people, it’s systemic. There’s no doubt that some people are trapped in a cycle of poverty, and they truly need outside help to overcome the obstacles they face. But for most of us, the issue is internal: The problem is us. In other words, I am the reason that I can’t get ahead. And you are the reason that you can’t get ahead. It’s not a lack of financial literacy that holds us back, but a chain of bad behavior.

One of the key tenets of my financial philosophy is that money is more about mind than it is about math. That is, our financial success isn’t determined by how smart we are with numbers, but how well we’re able to control our emotions — our wants and desires.

There’s actually a branch of economics called behavioral finance devoted exclusively to this phenomenon, exploring the interplay between economic theory and psychological reality. And there’s a new wave of folks who are exploring the gamification of personal finance; they’re trying to turn money management into a game. More and more, experts are seeing that our economic decisions aren’t based on logic, but on emotion and desire.

For years, I struggled with money. I knew the math, but I still couldn’t seem to defeat debt. It wasn’t until I started applying psychology to the situation that I was able to make changes. For instance, I used the debt snowball to pay down my debt in an illogical yet psychologically satisfying way. It worked. And I’ve learned that by having financial goals — such as travel — I’m much more inclined to save than if I have no goals at all.

Our country’s crazed consumerism has little to do with a lack of financial literacy. Instead, two fundamental problems need to be addressed.

  • First, we constantly soak in a bath of the mass media. Radio and television and the internet are all around us. As a result, we’re exposed to a barrage of programming in which we’re given subtle messages about what people do (or should) consume. We cannot help but be influenced by the power of marketing.
  • Secondly, we don’t think about our spending. We spend on impulse. Or we spend — usually subconsciously — to keep up with our friends, our family, and our neighbors. We spend to make ourselves feel better when we’re down and blue. We spend to show off. We spend on things we think we want instead of the things we actually use and do. We spend because spending is a habit.

Instead of teaching Americans about credit cards and rates of return, we need to be teaching them about behavioral finance. We need to be showing them how to break free from the ubiquitous marketing messages. We need to be showing them how to set (and achieve) personal goals, especially financial goals. Building a better budget isn’t going to change your attitude toward saving and spending; but changing your attitude toward saving and spending could very well lead you to building a better budget.

Ultimately, if we want Americans to be smarter with their money, we need to encourage them to consume less media — to avoid advertising — and we need to teach them to master the emotional side of personal finance. We need to show them how to change their behavior. We need to appeal to their self-interest. We need to help them find intrinsic motivation to save. That is, each of us needs to dig deep inside to find what it is that’s important to us, what it is that brings us joy, and we need to prioritize that instead of all the other garbage.

I’m not suggesting that we abandon financial literacy completely. But I think a constant push for more financial education is a waste of time if it’s only going to focus on mechanics, to stick to facts and figures. To truly be successful, financial education has to address the behavioral side of money because that is absolutely the biggest piece of the puzzle.

J.D. Roth is the founder of Get Rich Slowly and the author of Your Money the Missing Manual. He also writes about More Than Money at jdroth.com.