Financial literacy won´t cure shortcomings in DC investments


For many the solution to (defined contribution pensions) s increasing the financial literacy of the population. Better decisions and choices, and with that superior outcomes for retail investors is held as the prospective result. George Osborne’s advice or guidance is a prime and current example here. There is a strange coalition of promoters for this idea. Some are self-evidently self-interested, such as the suppliers of educational services; some less so. At first sight, we might expect the financial services sector to resist a more educated customer base, but the reality is that this is integral to the process of financialisation of our lives, and that is very much in the interest of the financial services sector. Financial education programmes, and state sponsored arrangements in particular, serve to present this activity as habitual and customary. It holds the prospect for the financial service sector of selling ever more “sophisticated” products, for which read complex and opaque contracts. The mechanism to worry over here is an increase in the confidence of retail investors without a commensurate increase in their analytic ability. We should also note make light of the role of mimicry among peer groups. 

Disclosure and transparency are important in another way, since they can serve as a form of blame and liability shifting mechanism for the fund manager; that small, fine and unintelligible print can absolve the fund manager of all but criminal behaviour. 

The effectiveness of financial education is extremely suspect: in part, because the recipients are not predisposed to it. The question is more than ability; it is willingness. The take-up of the default option in DC pensions is prime evidence for this. 

The real challenge for financial education arises with its apparently extreme ineffectiveness. It appears that the effort and money spent on financial education delivers far less value than similar amounts expended in other comparable areas. In what will probably remain for a very long time the definitive study , Fernandes et al. find that: “…interventions to improve financial literacy explain only 0.1% of the variance in financial behaviors studied, with weaker effects in low-income samples. Like other education, financial education decays over time; even large interventions with many hours of instruction have negligible effects on behavior 20 months or more from the time of intervention.” That may help to inform the debate currently under way on the timing of advice and guidance, but the overall message is cause for concern. The study is well worth reading for its concluding discussion of “… the characteristics of behaviors that might affect the policy maker’s mix of financial education, choice architecture, and regulation as tools to help consumer financial behavior.”

The paper referenced is: Fernandes, Lynch and Netemeyer, “ Financial Literacy, Financial Education and Downstream Financial Behaviors”, Jan 2014 This is a meta-study of 201 previously published studies.

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