Behavioral Economics, Key to Financial Education

Author: 
Andrea Reyes, ProSavings Program Coordinator

Psychological aspects are not only key to the design of a savings product, but they also play a fundamental role in financial education. This notion aligns with the concepts found in Xavier Martin’s Note 3: Keys to Success with Commitment Savings.

I have always said that financial education is a broad concept that can consist of a comprehensive program on different financial topics, or could also be delivered through a series of short lectures provided by financial institutions to its clients. Therefore, it is important to define a clear objective when looking to design and implement a financial education program or strategy: Do we seek to promote financial inclusion or do we seek to promote making better financial decisions? Such were the points presented by Maria Jose Roa, Researcher at the Latin American Center for Monetary Studies – CEMLA, during the financial education seminar organized by Fasecolda (Federación de Aseguradores Colombianos) this past February 12.

Any of the two objectives mentioned above is valid, but there needs to be clarity in terms of which objective will be pursued in order to deliver the appropriate information and tools to achieve it.

During her presentation Maria Jose argued that, when it comes to making financial decisions, it is assumed that individuals consider all the information available to them and use it in an intelligent way. However, behavioral economics has demonstrated that there is an important level of complexity when it comes to making decisions on savings or investments; one that leads us to use shortcuts such as the following:

  • We try to look for information that reinforces our beliefs; therefore, instead of using all the information available to us, we choose that which makes us feel more comfortable – also known as cognitive dissonance.
  • We believe that the more knowledge we have, the better decisions we make – creating a level of confidence that turns into an illusion of knowledge, without really grasping the information that is required to make a certain decision.
  • We exhibit an excess of confidence that leads us to reject available information.
  • We tend to follow what others do – leading to group conformity.
  • We tend to respond best to specific and synthesized information than to statistics.
  • We tend to trust more in graphic information than in what is more visually attractive.

We can thus conclude that psychological aspects are a fundamental element in the financial decision-making process. Therefore, financial institutions must incorporate this ingredient into the design of financial products as well as into the financial education content, materials and methodologies in order to achieve the desired impact.

Comments

Submitted by Veronica Michel on
Certainly, we need to study more the way people, and in particular low income households, make choices on savings (although we may see that there is no substantial difference in the way these groups behave). Economists have tried to identify which are the kind of behaviours that make it harder for people to achieve savings goals (given that they know the benefits of doing so). Broadly, three behavioural barriers are well identified (experimental evidence): procrastination, inertia and forgetfulness or inattention. The first one keeps people from engaging in saving money today, because there is always the possibility to start 'tomorrow'. Clearly, saving money requires lots of discipline to avoid temptation and it is unpleasant. It has been shown that people who struggle more in committing to do any kind of activity that in some way drags them away from comfort (such as going to the gym, or being on a healthy diet) have time-preferences such that they want to give up on the activity today, but they are sure they will be able to undertake it in the future. Therefore a savings product could be designed in such a way that makes the act of saving 'painless' today and 'painful' in the future. For instance, one could offer a savings plan in which the savings rate (or the proportion of income to be saved) increases only after the person has reached a certain level of income. To overcome inertia the savings scheme needs to switch the costs between saving and not saving, so to make the latter more costly. Instead of offering a scheme in which the client has the opportunity to increase the savings rate after some time or amount has been reached, the institution could make this the default option and a client that does not want this option would need to go to the manager, submit a request form to change the scheme and maybe other steps on a tedious procedure that discourage the client to switch. Finally, to deal with forgetfulness the institution only needs to send reminders to the clients. It works better to be specific and state the personal saving goals of each client. I think the work you do is fantastic and has a great impact to the extent that you grasp the rigorous evidence to learn what works and what does not and design the financial products in an effective way. Congratulations! This topic is of great interest for me and I would like to examine it for the Mexican case.
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Submitted by Andrea on
Thanks so much Veronica for those interesting insights. All of your points are relevant for the work we are doing with savings for low-income people. We would be happy to continue discussing with you about this topic via our blog or e-mail at pro-savings@iadb.org. Look forward to hearing from you again
Submitted by Xavier Martin on
I completely agree with Veronica. Saving is difficult for everybody, not just for the low-income population. In that sense many of the mechanisms that make it hard to save that have been identified by behavorial economists are also valid for low-income populations. Veronica mentions procrastination, inertia and forgetfulness. We now have much more evidence of how a commitment savings product can be designed by incorporating some of this knowledge to facilitate savings. It this line of thought, an interesting paper was published last month by ideas42, based on the case of CARD Bank in the Philippines. It shows how applying behavioral design principles at important stages of opening a savings account could have a significant impact on savings rates.http://ideas42.org/content/Applying-BE-to-Improve-Microsavings-Outcomes.pdf
Submitted by Jack William on
Veronica mentions procrastination, inertia and forgetfulness. We now have much more evidence of how a commitment savings product can be designed by incorporating some of this knowledge to facilitate savings.<a href="http://www.nutriclean.org/your-health-your-choices-sitemap/">Health Tips</a>

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