When financial literacy helps and when it does not

Beginning in the late 1990s and early 2000s, various countries have introduced financial literacy programs. The first to do this were economically developed countries such as the US, Great Britain, and the Netherlands. Today, financial literacy programs are being developed and implemented by more than 60 countries, targeting more than 5 billion people.?

Still, financially literate people can fall for crafty tricks because knowledge can make a person excessively self-confident. Such people often take too risky, sometimes even reckless decisions, such as speculating or borrowing a lot,? research by Japanese economist Tetsuya Kawamura and co-authors shows. They found that financially literate people are more likely than others to invest in bitcoin, trade forex, and turn to futures and margin trading. The share of high-risk instruments in their portfolio is also higher, and they borrow at a high interest rate.

Counter-intuitively, people with high levels of financial literacy also hold more naive attitudes, Kawamura’s research showed. That is, financial literacy causes people to become “daring and reckless towards some financial” decisions, such as buying expensive insurance plans or investing with a capital guarantee and high returns that are a frequent sign of fraud.

Kawamura also noted the benefits of financial literacy: more literate people are “better at retirement planning and are indifferent to gambling.” This confirms conventional ideas about the benefits of financial education for long-term financial planning, the scholars write.

In recent years, there has been an increasing amount of research that confirms the positive impact of financial literacy on financial behavior. A paper by Tim Kaiser from the University of Koblenz-Landau and a group of his co-authors was published in 2020. It presents a new meta-analysis that was said to be more complete than that of Fernandes et al. (2014). Kaiser et al.? examined the results of 76 randomized controlled trials compared to 13. They summarized data from 33 countries and more than 160,000 individuals, and found that “an estimated effect of financial education interventions is more than five times as large as the effect reported in Fernandes et al.,” taking into account differences in programs. In addition, Kaiser and his colleagues did not find clear evidence of a sharp weakening of the impact of financial education over time; rather, it persists for up to two years.

Modern randomized controlled trials show that financial education programs improve financial literacy and, although to a smaller extent, influence financial behavior, Tim Kaiser and Annamaria Lusardi, a professor at Stanford Graduate School of Business, write in a recent review of the literature on financial literacy.

And what about Russia?

Economists from Moscow State University and the Russian Central Bank have come to similar conclusions. In a joint project they assess how financial literacy relates to the financial behavior of Russians. This paper has similar methodology to the one of Japanese scholars, also using data from surveys conducted by the Central Bank and the Ministry of Finance in different years, and using the same variables, for example, speculative investments, an appetite to excess borrowing, financial naivety, etc. However, they also considered additional indicators: optimism and confidence, consideration of certain information when making decisions, saving behavior, pension planning, portfolio diversification, etc. In addition, Russian scholars used survey data conducted in different years – 2020 and 2022.

The authors assessed the impact of financial education on 10 key features of financial behavior. There was a noticeable relationship with six of them, while with the other four the relationship was statistically insignificant.

Despite the similarity with the methodology of the Japanese research, Russian economists have not found a relationship between speculative investments and excessive debt burden on the one hand and financial literacy on the other. That is, as literacy improves, people do not cut high-risk investments or expensive borrowing. "The good news would be a statistically significant negative relationship [between financial literacy on the one hand and speculative investments and excessive debt burden on the other]," the paper says.

Another important finding of the research is that financial education does not affect pension planning either.

However, there are quite a few positive findings. In particular, more financially literate people save more, distribute assets between different ‘baskets’ more, analyze information more often and perceive economic trends more correctly. An unexpected for the researchers finding was that individuals, becoming more financially literate, begin to trust loans less.

Scholars also found that more financially literate Russians were more likely to make naive decisions: they kept money mostly in cash, invested at a dubious high interest rate, and dealt with illegal creditors. This is probably a consequence of the abnormal situation of 2022, when the survey was conducted. It may partly explain the high (more than 50%) share of savings in cash US dollars of this group. But even without taking into account currency transactions, the positive relationship between financial literacy and naivety remains, the economists say.

Another important finding of their research is that improving the financial literacy of the population contributes to the development of the economy. When people manage their money better, save more and distribute these savings among different assets, banks receive more stable resources and demand for investment instruments increases, which, in turn, spurs the growth of the financial market and the economy as a whole.

How to achieve financial literacy

Despite the debate about the impact of financial literacy on financial behavior, even those scholars who doubt the strong relationship between them are not calling for the abolition of financial education. Most researchers believe that improving financial literacy can be beneficial if programs are designed correctly.

Daniel Fernandes, who disputes the relationship between literacy and behavior, noted in a research paper that it is important to have training at the right moment when an individual is faced with a choice whether to open a deposit or invest money in a certain asset. It is difficult to explain to people how to invest their savings correctly if they do not think about it themselves, NES professor Oleg Shibanov argued in an episode of the "Economics out Loud" podcast. It is best to instill financial literacy when an individual is ready to make some financial decision. "For example, he or she says: ‘I want to buy Apple stocks. 20 years ago, I was wrong not to believe in this company. Now is the time to start.’ At this point, they should be given a textbook on investing, which says that buying [with all the available money] one company is a prohibitive risk. And they start thinking about a reasonably diversified portfolio, because you gave them the right advice at the right time," Shibanov explains. Anyway, Russians’ portfolios are quite diversified. According to the Central Bank, in 2022 an average of 10.8 companies were represented in their stock portfolios.

Fernandes also points out the need to focus education on the development of soft skills, such as the ability to plan, self-confidence and willingness to take investment risks. This, in his opinion, may be even more important than profound knowledge of complex financial instruments such as compound interest or bonds.

In a recent review, Kaiser and Lusardi highlight several key elements for developing effective financial literacy programs. Research in Brazil with more than 25,000 students showed that programs at schools have improved students' knowledge for a long time, giving them financial independence. Such programs are not very expensive and they are easy to scale, the authors of the review argue. In addition, the adaptation of educational programs to real-life situations and needs of the target audience, the use of simple and understandable rules, as well as personalized elements such as consultations, significantly increase their effectiveness.

Another important element is the introduction of digital platforms and gamification, which also contribute to deeper involvement of financial literacy students and improve their financial skills. In Colombia, tablets were used for training (not everyone has them in everyday life), which gave positive results, Kaiser and Lusardi note, pointing out that financial literacy programs should be "relevant to the life situation of students, accessible, entertaining and engaging." This is true for any education, especially for children and youth, NES graduates Gayane Simonyan, then head of the Uchi.ru Olympiad department, and Natalia Pereldik, co-founder and director of the ‘Funexpected Math’ startup, argued in an episode of “Economics out Loud” podcast.

It is important that people receive information on a regular basis: not once in every three years, but every month, Shibanov notes. In his opinion, financial literacy programs are good and beneficial precisely for this, and not because the state can force some knowledge through schools. "I hated half the classes at school,” he recalls. “At that time, I was a fan of math, and if they had started telling me about loans, I would simply skip those classes, because it was complete nonsense. What loans?! Give me some problems to solve!”