Many economists and policymakers agree that financial-literacy education — credit counseling, homeownership classes and retirement seminars — is a good thing, and evaluations designed to determine the efficacy of financial-literacy programs show that participants tend to make better financial decisions overall, carry less debt and save at a higher rate than nonparticipants.
Improving financial decision making is particularly crucial for low-income individuals because making uninformed decisions while living on limited means can have critical consequences, such as the loss of housing or reduced access to medical care. But everyone can benefit from improved financial decision making, and rising levels of consumer debt, low rates of personal savings and other financial pressures made more urgent by the recent economic downturn have underscored the need for people at all income levels to better attend to their financial stability.
Professor Stephan Meier wanted to understand why, if financial literacy is such a good thing, more people — especially those who stand to gain the most — don’t seek it out more often? He hypothesized that people view financial literacy much as they view other forms of education: as an investment in the future that incurs costs (like time or money) in the present but returns most benefits (like income or choice of meaningful work) in the future. If so, patient, future-oriented people should have a greater tendency to participate in financial literacy programs, while impatient people should be less likely to do so.
Meier, along with Charles Sprenger of the University of California, San Diego, worked with a Voluntary Income Tax Assistance (VITA) program in Boston to learn if peoples’ time preferences, as measured by patience and impatience, influenced their decisions about whether to participate a financial literacy education.
A free tax-preparation program offered to low-income residents by cities and community groups all over the United States, VITA had previously conducted surveys in which a large percentage of its clients indicated that they had debt problems and wanted help managing their finances. To provide some debt management assistance to their clients, VITA developed a 15-minute financial counseling program, which it offers at its tax-assistance sites. Participants receive a copy of their credit report and are counseled by a volunteer, who reviews the report, the probable factors contributing to their score, the importance of a credit score and what steps can be taken to increase their score.
The tax-assistance service can be popular, with wait times of up to two hours. All VITA clients are given the option of receiving the free financial-counseling session while they wait, without losing their place in line.To measure the time preference of those who participated in the financial counseling sessions as well as those who did not, Meier and Sprenger gave all of VITA’s clients the choice of participating in a raffle.
Raffle participants first filled out a survey that asked them to make a series of choices. Each of the 22 choices involved deciding between receiving a smaller payment of money (decreasing from $49 to $14) a day or two in the future or a larger payment (always $50) at various points in the more “distant” future (one, six or seven months). For example, for the today versus one-month choices, the seven questions ranged from “If you draw raffle number 1, would you like to receive $49 today or $50 in one month?” to “If you draw raffle number 7, would you like to receive $22 today or $50 in one month?”
Upon completing the survey, the participants drew a numbered raffle ticket. Those with winning numbers were mailed a money order in whatever dollar amount corresponded with their survey questions, one day or one, six or seven months from the date of the raffle, consistent with their survey response.
By looking at the point at which a person switched from taking the smaller amount in the present to taking the bigger amount in the future, the researchers were able to determine how much each person discounts his or her dollar in a month, or how much value he or she places on receiving a larger reward in the future compared with the receiving a smaller one in the present.
The results confirmed Meier and Sprenger’s hypothesis that those who were more likely to wait for a larger amount of money in the future were far more likely to sign up for the financial counseling. “There is a substantial correlation,” Meier says. “In order not to wait one month, people who don’t participate in the financial-counseling program are willing to accept dollar amounts 8 percent smaller than those who participate.” (Slightly more than half of the raffle participants opted to participate in financial counseling sessions.)
These results suggest that people who stand to gain the most from financial literacy — those who are less patient and less like likely to postpone immediate gratification for future gains — are the least likely to seek it out.
Significantly, the results also suggest that most evaluations of the impact of financial literacy may not reveal the whole story about the efficacy of such programs. “We know very little about whether financial literacy actually works,” Meier says. “That’s because most of the studies done so far don’t account for the fact that people who self-select into these programs are more patient and future-oriented that those who don’t. So, you can’t rule out the possibility that those more future-oriented participants might be better off than nonparticipants, even if they had never participated in a program.”
Because of this self-selection bias, the positive outcomes the policymakers have attributed to financial literacy education may be overestimated: existing evaluations overlook the possibility that people who seek out financial-literacy education already place a higher value on the future. Randomized trials (as in medicine) would go far to produce more understanding, but providing counseling on a random basis is challenging.
“It’s very hard to rely only on voluntary financial education,” Meier says, “because so many people don’t opt in.” But he cautions against embracing mandatory financial-literacy programs, like those required for filing bankruptcy. “Like voluntary programs, we don’t know enough about mandatory programs,” he says. “If individuals’ time preferences play such a big role in the decision to become financially literate, policymakers must critically examine the costs and benefits to consumers of financial programs to make them attractive to those who need them most.”
Stephan Meier is assistant professor of management at Columbia Business School.