I recently searched online for an answer to the question: “How many consumers understand compound interest?” The answers varied but overall provided a consistent view: Somewhere between one half to two-thirds of all adult consumers in the U.S. lack a basic understanding of what compound interest is.
While I was prepared for a big number, I was nonetheless shocked at the finding. Consider the implications. Compound interest is one of the most basic and fundamental concepts in personal finance. The failure to understand compound interest means a consumer cannot truly understand the full benefits or risks involved in virtually any savings or lending product.
When you combine this lack of basic financial understanding with the complexity and lack of transparency inherent in many contemporary financial products, it is no wonder that consumers consistently and repeatedly make bad financial decisions.
In conducting my online search, I fortuitously came across a study prepared by the World Bank/International Finance Corporation titled: “Global Financial Development Report 2014: Financial Inclusion”. While this study focuses on the concept of financial inclusion and is global in reach, it contains a treasure trove of useful information regarding financial education and the need for it.
Here is one key finding from the study: “Evidence on consumer credit card and mortgage markets suggests that both consumer lack of information and irrationality lead to substantial errors in financing choices that are accelerated by the design of products by financial providers who want to exploit shortcomings in understanding among consumers.”
The World Bank research team found that only about half of surveyed consumers demonstrate basic understanding of concepts such as compound interest and risk diversification. Inflation seemed to be one of the few financial concepts that are well understood. Their overall conclusion: “Basic financial knowledge is weak.”
So what can be done to address this crisis in financial education? Many credit unions have become attuned to the crisis, and have taken steps to implement financial literacy (aka financial wellness) programs. These programs are well intentioned and some have achieved notable gains, but in many cases these efforts often miss the mark.
While current financial literacy programs vary in structure and content, I feel many share common shortcomings, including:
Lack of scalability: Many financial education programs are labor intensive and costly to implement. As a result, they are offered only periodically, and may in fact be reduced during periods of financial stress.
Not data driven: The real measure of success of a financial literacy program is whether the program results in lasting behavior changes over an extended period of time. I’ve seen very few programs conducted and monitored longitudinally over multi-year periods.
Lack of lasting behavior modification: Financial education needs to avoid the “binge diet syndrome” – i.e. drop 50 pounds now, only to put it back on later. As noted, success means driving lasting behavioral changes.
The World Bank/IFC report cited above contains, in my opinion, excellent findings and recommendations that can guide a credit union in designing and implementing a truly effective financial literacy initiative. Here are some of the key findings:
General education is the foundation: “Solid education, including numeracy, has a clear relationship with financial inclusion.”
The delivery mode matters: Consumers of all ages have increasingly short attention spans. Adult consumers in particular tend to be stubborn when it comes to changing behavior patterns. The mode of delivery for financial literacy must anticipate and respond to these challenges.
Comprehensive interventions are critical: “One-off interventions focusing only on one area of financial constraint have little impact.” Successful programs must be comprehensive in nature and utilize a variety of complementary interventions across a number of areas of financial need.
- Teachable moments have value: There are times when consumers may be especially motivated to gain and use financial knowledge and skills and put them to use. It is precisely at these times when a credit union should make the right tools available.
- Targeting the young is key: As noted above, changing established behavior patterns in adults is very difficult. Teaching financial literacy to young people should be a cornerstone of any successful initiative.
- Reinforce messages through social networks: Note the finding says “social networks”, not social media. Of course, social media might play a role in addressing a social network, but the power of reinforcement from friends and community members can provide the support needed to make a behavioral change permanent.
The World Bank report also noted that new technologies hold promise for expanding financial inclusion. One of the most encouraging aspects of the FinTech revolution has been the emergence of a number of technology-based companies focusing on implementing truly scalable solutions for financial literacy.
One example is a Silicon Valley-based company I’ve advised called GuideSpark (www.guidespark.com). GuideSpark has developed a software platform that enables the creation, curation and delivery of multi-media financial wellness modules targeted to the needs of a specific user. The GuideSpark platform is designed to provide for broad dissemination of financial education in a manner that is both highly customizable to the needs of the individual consumer and at the same time is highly scalable and cost effective.
Whether it be with GuideSpark or one of the other FinTechs developing new technology-based solutions for financial education, I believe the time has come for the credit union system to take advantage of the tech tools available in the market to deliver sustainable, data-driven financial education that will be capable of achieving true behavior modification.
The World Bank report sums it up best: “It is possible to enhance financial capabilities – financial knowledge, skills, attitudes, and behaviors – through well-designed, targeted interventions.”
Let us know if we can be of assistance in helping your institution to implement an effective, state-of-the-art financial literacy solution.
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