Over the past few years, it’s been difficult to avoid the many discussions, forums, and conferences focussing on the role of financial education in getting people on the path to a better financial future. In fact, so is the belief that it is the key to financial success, that some call for the financial education intervention to start as early as possible, ideally in the national education curriculum. Some even call for a formal qualification to be created and awarded the same status as Maths and English
This is an admirable view point, and clearly anything that can help people create a better financial future should be supported. However, for this article, I’d like to purposefully take a contrarian view, and explore one of the often ignored flaws in the financial education debate; that is the implicit assumption that knowledge leads to good practices.
There are two extensive bodies of research that we should consider in relation to financial education. The first is the general, but plentiful body of research, that proves that simply acquiring knowledge (in any subject, let alone the oft-seen mundane world of finance) does not mean this knowledge will be used effectively. In fact, there is a strong possibility that interventions designed to improve financial knowledge may have little impact on financial outcomes.
The second but more specific body of research was carried out by two Nobel Prize winning Psychologists; David Dunning and Justin Kruger. Their work led to the creation of what is known as the Dunning-Kruger effect. In simple terms, the effect can be summarised by the well-known phrase “a little knowledge is a dangerous thing”.
Dunning and Kruger explain that the problem with humans when learning a new skill (such as acquiring financial knowledge), is that our confidence in the new skill we are learning, increases quicker than we can actually acquire the information needed to make us, at the very least, competent. This means that we reach a point, fairly quickly, where we believe we have the requisite skills to make an informed choice, but the actual knowledge underpinning this has more holes in it than a huge block of Swiss cheese.
In fact, if you take a person who has received a basic level of financial education and ask them to self rate their financial knowledge, there is a good chance that their subjective self-assessment won’t match the objective reality. It’s not that they are being dishonest… it’s just that they haven’t got the ability to recognise that they don’t know what they don’t know, and their brain has tricked them into believing they are more competent than they actually are. It’s Dunning-Kruger in action.
For financial advisers, it is vitally important to understand that even armed with knowledge, a person’s confidence plays a critical role in how they make decisions. Whilst they may appear ‘clued-up’ and knowledgeable, it may simply be an illusion impacted further by the Dunning-Kruger effect.
So, whilst financial education is a great idea, it should not be viewed as “once delivered, problem solved”. More importantly, even if someone has received financial education, it would still be prudent to test and validate their knowledge and capability. Research shows a clear link between under-confidence, over-confidence, and poor financial outcomes, especially in the area of saving and investment. Advisers are in the perfect position to prevent this and ensure that clients are put on the correct path to a better financial future.
Watch comedian John Cleese explain the Dunning-Kruger effect in this very short video (https://www.youtube.com/watch?v=wvVPdyYeaQU).