May 14, 2008 — A No-Brainer?

The link between financial education and money management isn't clear, but new research may change that
By Doug Campbell

The theory of financial literacy is straightforward enough: If people understand the increasingly complicated financial products available to them, they will make better choices. By extension, it seems reasonable to assume that financial education programs can help people achieve financial literacy.

Establishing that link has not been so easy in practice, however. As Matthew Martin, an economist with the Federal Reserve Bank of Richmond, put it in a 2007 paper: "Many [studies] find a relationship, but they take it as given that there is a causal chain from knowledge to behavior. A key issue here is the difference between correlation and causation."

Many studies confirm the effectiveness of certain programs for some people under specific conditions. Counseling home buyers before they take out mortgage loans has been documented to be helpful in reducing delinquency rates, for example. But little overarching evidence exists on the benefits of financial education in general. And there is little research that avoids some of the classic measurement problems apparent in many studies on the effectiveness of financial education programs.

It is not so much that researchers doubt whether financial education works — that is, some information actually sticks or leads to positive changes in financial behaviors. It is the link between education and literacy and improved financial outcomes that is unclear, making it difficult to say which programs are really the most effective. Researchers tend to believe, as noted in a recent Federal Reserve Bank of Cleveland paper, that financial education does work, but that some programs aren't effective and for those that may be effective, evaluation techniques do not fully capture the benefits.

The two biggest problems are: 1) a lack of control groups, and
2) a dearth of longitudinal data (which follow people over time to track their learning and behavior). Additionally, there are questions about how to best measure growth in financial literacy among individuals. Do you simply look at their debt and savings after the fact? Their ability to live within their means? Their general level of satisfaction about their financial situations?

A study now under way at the Federal Reserve Board of Governors aims to overcome the largest problems with financial education research. The Board researchers are following the financial behaviors of two sets of young people, one of which has experienced a two-day financial education program, and another that didn't. Both groups share basically the same demographic makeup, live in the same place, work for the same employer, and perform substantively similar jobs. They are all young soldiers at Ft. Bliss, an Army base in El Paso, Texas.

"I don't want to overstate the potential results of this study," says Jeanne Hogarth, program manager in the Consumer Education and Research Section of the Board's Division of Consumer and Community Affairs. "But I'm cautiously optimistic that we will be able to discern some of the impacts of financial education programs that have eluded other researchers."

About 2,600 soldiers are in the test group. They are members of Army Air Defender units. The control group, whose members don't go through the financial education program, are also soldiers at the base. Both groups reported similar behaviors on a survey taken at the start of the study, providing a baseline from which to observe the diverging behaviors.

The two-day financial education program for the soldiers is provided by San Diego City College, with support from Army Emergency Relief. Soldiers are told about how to analyze the components of their pay statements, from the tax deductions to the saving plan options. They are schooled on the importance of budgets, how to evaluate different car purchase deals, and the fundamentals of credit cards.

The surveys began in 2006. The first results from follow-up questionnaires were compiled earlier this year, and the data are expected to be turned into a report within the coming months. The questionnaires focused not on knowledge retention but on behavior changes — how much credit card debt have they accumulated (or not)? Do they have emergency funds or retirement savings of any sort? Have they recently bounced checks? By having a control group, the Fed researchers can better tell whether it's the financial education or general life experience that is leading to different financial outcomes.

"We need to be careful in what we're able to say based on this [targeted] study. We won't be able to say generally whether financial education works or not," Hogarth says "But we may be able to say that, for young people transitioning into independence, in that age segment, under these sets of circumstances, that this two-day class had these kinds of impacts on their financial management."

Other studies in progress within the Federal Reserve System include a homeownership counseling study led by the Philadelphia Fed and a workplace financial education study led by the Kansas City Fed.

Doug Campbell is an economics writer in the Richmond Fed's Research Department.

"A Literature Review on the Effectiveness of Financial Education." Matthew Martin. Federal Reserve Bank of Richmond Working Paper 07-3, June 15, 2007.

"Do Financial Education Programs Work?" Ian Hathaway and Sameer Khatiwada. Federal Reserve Bank of Cleveland Working Paper 08-03, April 2008