October 18, 2011
People Make Mistakes When Paying Cards
Myth: I should pay off the debt with the highest interest rate first to get out of debt quickly.
Truth: You should pay off the smallest debt first to create the greatest momentum in your debt snowball.
Behavioral economist Dan Ariely might agree with Dave Ramsey’s second statement: Ariely and fellow researchers for the first time have established that people do, indeed, pay off their small card balances first, because it gives them a feeling of accomplishment.
“We have a desire to close things, to feel we’re making progress,” Ariely said in a recent interview. As each card is knocked off the list, “it’s something you can count.” The strategy also dovetails with people’s natural inclination to break down overwhelming tasks into sub-goals to make the task feel more manageable.
But the mathematical truth remains that holders of multiple cards get out of debt faster and cheaper if they first pay down the cards with the highest interest rates. In other words, it’s not in a card holder’s financial best interest to pay off the small balances first, even if it does make them feel better.
The researchers’ first experiment confirmed this behavioral tendency by testing 162 undergraduates…Learn More
September 13, 2011
How to Save: Imagine You’re Older
Economists’ explanation for why people don’t save for retirement is that they “discount” the future, placing a higher value on today’s pleasures. Educators argue that people don’t have the information they need to save.
Psychologists have a new theory: people can’t relate to their older, retired selves.
To test this theory, Hal Ersner-Hershfield and collaborators at Stanford University devised a way to help their research subjects – college students – identify with those nebulous figures out in the future, their older selves. When they did, the subjects were more likely to save money.
The national media have already covered this research. But it’s worth sharing as The Journal of Marketing Research plans to feature it in a special November issue on financial decision-making. The experiment demonstrates the contribution by psychologists to our understanding of how we handle money. …Learn More
September 8, 2011
The Power of Compound Interest
Every entrant to the workforce should be subjected to the same questions posed to California undergraduates in a new experiment about how well people understand compound interest.
Better to show the math than to explain it. Franny and Zooey just started working. Franny immediately begins depositing $100 per month – $1,200 every year – into her new retirement account, which pays 10 percent interest annually. Zooey doesn’t start saving for 20 years, but he puts in $300 every month — $3,600 annually — and also earns 10 percent interest.
In 40 years, Franny retires with $584,222 in her account – more than double Zooey’s $226,809.
Asked to calculate these future savings on their own, 90 percent of the undergraduates had vastly underestimated the totals in the experiment by Craig McKenzie at University of California, San Diego and Michael Liersch at New York University. Yet, this mathematical calculation is central to the financial well-being of most Americans. In 2009, more than half of all households were at risk of not having sufficient assets to retire, according to Boston College’s Center for Retirement Research, which hosts this blog. …Learn More
September 6, 2011
Journal to Spotlight Financial Behavior
The Journal of Marketing Research (JMR) will devote a special issue to interdisciplinary research on the hot topic of financial decision–making and behavior.
The issue is a smorgasbord of 15 articles on behavioral, marketing, economic, and psychological research on various financial activities, from borrowing money to establishing trust in financial transactions.
The November issue’s guest editor-in-chief, John G. Lynch, a psychologist who “wandered into marketing and consumer decision-making,” said the interdisciplinary approach advances everyone’s understanding of complex financial decisions.
“A given field understands a part of the answer. But we’re missing the larger whole,” he said. The special issue “would bring people together to read each other’s work and have an effect of causing more cross-fertilization.”
Squared Away plans to cover some JMR articles in a series of blog posts in coming weeks. Here’s a preview: …Learn More
August 11, 2011
How Emotions Drive Investing
With the Standard & Poor’s 500 stock index down 13 percent in three weeks, new research confirms what many people believe to be true: emotions drive investment decisions that can lead to costly mistakes.
In a forthcoming paper in the Journal of Market Research, three business professors were able to show for the first time that an investor’s prior experience with buying and selling a company’s stock – not cold, hard analysis – is what determines whether he or she would repurchase that same stock at a later date. When the entire market plunges hundreds of points, as it has this week, the tendency to be led by one’s emotions is only magnified.
Money-losing stocks are “associated with disappointment and regret,” the researchers wrote. “Simple reinforcement learning deters them from repeating the behavior that previously caused pain.”
Their paper, “Once Burned, Twice Shy,” adds to a growing literature that attempts to clarify the psychology of financial behavior. It’s a twist on one classic study that determined that people feel the pain of financial losses – or “regret” – far more acutely than they feel the joy of gains. Other studies have firmly established that investors more often sell winning stocks than losing stocks. … Learn More
June 28, 2011
Hubris Hampers Education Efforts
Most people think they’re above average when it comes to financial knowledge. And it’s not easy to educate people who think they know more than they actually do.
But hubris – or something like it – is what financial educators are up against, indicates research by professors Annamaria Lusardi at the George Washington School of Business and Olivia Mitchell at the University of Pennsylvania’s Wharton School. Their paper used data from 1,200 respondents to a survey they conducted for the Investor Education Foundation or FINRA, the self-regulatory agency for the securities industry. It may be the most comprehensive study on Americans’ financial literacy.
Seventy percent of the survey’s respondents believe they know more about basic financial concepts than most other people. But they scored poorly on the survey’s three rudimentary financial literacy questions. One-third to one-half of them answered the questions incorrectly or indicated they didn’t know the answers.
The results “paint a troubling picture of the current state of financial knowledge in the United States,” the authors said.
Further, this low level of knowledge, when combined with overconfidence about that knowledge, does not bode well for attempts to educate people about money and their personal finances.
Before I provide more detail about Lusardi and Mitchell’s findings, take the quiz yourself. Here are the questions1:
May 11, 2011
High School Influences Life Knowledge
It’s been well-established that most people have low levels of financial literacy and struggle to manage and plan their personal finances. Now two Wisconsin researchers have taken the conversation to the next level by trying to explain why.
According to their study, featured in a webinar posted online today, the financial literacy of people entering retirement is significantly determined by high school IQ level or by whether the individual took high-level math classes in school.
University of Wisconsin professors Pamela Herd and Karen Holden arrived at this finding by analyzing 6,000 individuals from a unique longitudinal data set of people who graduated from Wisconsin high schools in 1957 – and were in their mid-60s at the time of the study. …Learn More