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Does financial education make you a better investor?

Morningstar  |  12 Apr 2018Text size  Decrease  Increase  |  
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Countless studies have been conducted to measure the impact of financial education on investor behaviour. Some of these report increased saving and debt reduction, while others find that education has no effect on investor habits at all. The findings are often discouraging for those working in financial services: the effects of education are often small and the knowledge gained is quickly forgotten.

But financial knowledge still matters. Without it, people would be at the mercy of unscrupulous salespeople and predatory products. Without financial literacy, financial experts could not add value, and if knowledge truly had no impact on behaviour, experts would make the same bad decisions as novices.

The standard measures of financial literacy are based on simple multiple-choice questions about fundamental financial concepts. They read very much like a school maths quiz and test a person’s understanding of interest rates, inflation, and risk. While these are important concepts for investors, they have little to no bearing on day-to-day financial habits or spending.

Knowing the right thing and doing the right thing are two different things entirely. We can know that saving is important, but if we are easily tempted by what we can buy today, we may not have the willpower to follow through. This explanation says, simply, that knowledge itself isn’t enough. We need to look at other influences that might be stronger than knowledge when determining financial behaviour.

If factors other than knowledge are overpowering people’s ability to apply that knowledge, then financial advisers should focus on these other influences.

For example, an investor who has a lot of knowledge but is also highly impulsive, or thinks in the very short term, may still exhibit bad financial habits because knowledge on its own is not enough.

The concept of coaching is different from financial-literacy teaching, though some elements overlap. Teaching is about knowledge transfer, while coaching is about action and skills in the here and now.

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The analogy of a fitness trainer may be apt here. Trainers offer just enough information for the task at hand and use the events of the moment to train the person being coached into developing positive habits over time.

How Memory Decays

Some examples of positive coaching involve the timing of advice. Memory retention research shows a clear pattern of knowledge decay over time. The rate of memory decay is exponential, meaning that it drops off extremely quickly.

Because knowledge retention follows this exponential decay curve, it is best to offer important information just before it needs to be applied. In many ways, good advisers apply this rule intuitively. For example, if a client has just received a windfall, that would be a good time to consider a lump sump mortgage payment, using up all the year’s tax allowances or putting that money into a pension fund.

Other studies from the world of psychology and memory training show that we are more likely to remember things that are vivid and emotionally charged. And information is better remembered when it is generated from our own minds. Investors feel more focused on their plans if they feel in charge of their own financial futures and feel invested on an emotional and intellectual level.

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© 2018 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782 ("ASXO"). The article is current as at date of publication.

© 2021 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'regulated financial advice' under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information, refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Morningstar’s full research reports are the source of any Morningstar Ratings and are available from Morningstar or your adviser. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782. The article is current as at date of publication.

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