Does education in the financial field improve financial planning or, more specifically, does it lead to greater savings? This is the most widely examined question concerning the effectiveness of economic education on actual behaviour. Most likely, this is because the desired effect (savings) is relatively easy to measure. Moreover, the question is quite a burning issue in the United States, which is not exactly a nation of savers.

In fact, studies undertaken by the economist and financial literacy expert Annamaria Lusardi show that those who concern themselves with financial planning and, therefore, behave in a more ‘educated’ way will have considerably more savings by the age of 50 or so. One possible reason for this is that, quite simply, those who plan are also those who earn more. Yet research suggests that the average savings of ‘planners’ exceed the savings of ‘non-planners’ by 20%, even if the effects of income, education, age, etc. are neutralised. Other studies show a positive correlation between financial knowledge and planning and savings.[1]

There are plausible reasons for this. Financial knowledge helps per se as it heightens a person’s awareness of the subject. Furthermore, those who are less knowledgeable in economic matters tend to underestimate the effect of interest rates. In one of Lusardi’s surveys, participants (around the age of 50) were asked the following question:

“You have USD 200 in your savings account. The annual interest rate is 10%. How much money will be in your account in two years?”

 

Only 18% of the answers were correct. Yet the answer is so simple: 10% of 200 = 20. So: 200 + 2x20 = 240. Or have I missed something?[2]

So far, so good. But the question remains – does it really make sense to save more? Certainly not at every age or in every situation. Those who expect that they will spend more later on in life than they’ll earn should save beforehand, at a stage when things are going well for them. But at some point in time, it is also okay to spend one’s earnings, or else it will ‘only’ be the heirs who benefit – and even they will benefit only if they choose not to keep saving. What does make sense, therefore, is deliberate, long-term financial planning.

Moreover, in the current economic situation, there is no doubt that the US, in particular, would be better off if its population (and government) had saved more in the past. And this leads us to the financial crisis. But more on that later.

On behalf of the iconomix team

Michael Manz

[1] For a survey of these studies, cf. Lusardi, Annamaria (2008), Household Saving Behavior: The Role of Financial Literacy, Information, and Financial Education Programs, NBER Working Paper 13824.

[2] This was the most common answer. Many participants failed to take compound interest into account, however. For the correct answer, one also has to add 10% of 20.