Swedroe: The Dangerous Educational Gap

September 26, 2016

A large body of research on the behavior of individual investors has demonstrated that low levels of financial knowledge, in addition to biases in the selection and processing of information, drive suboptimal financial choices.

Among the findings from the literature are:

  • Men tend to be more financially literate than women, independent of country of residence, marital status, educational level, age, income and their possible role as decision-makers.
  • Women tend to be less confident than men, though they are more aware of their own limits. This is a positive finding, because overconfidence, which may lead to excessive risk taking, excessive trading and lack of diversification, is negatively related to performance. The result is that women outperform men. Note that it has been found that higher levels of education may lead to higher levels of overconfidence. (Any financial advisor who has worked with doctors would confirm this!)
  • Degree of financial knowledge tends to be positively correlated with education and wealth.
  • Individuals with a high degree of financial literacy tend to exhibit a higher risk tolerance and a higher degree of patience, as well as greater willingness to spend time acquiring financial knowledge.
  • Financial experience, as measured through the ownership of financial instruments and the holding period length of risky assets, is positively associated with financial knowledge.
  • Regret aversion (coupled with low literacy) may deter the demand for professional help if individuals anticipate the possibility that advisors will highlight mistakes in their previous decisions.

Monica Gentile, Nadia Linciano and Paola Soccorso contribute to the literature on investor education and behavior with their March 2016 working paper, “Financial Advice Seeking, Financial Knowledge and Overconfidence: Evidence from the Italian Market.”

The authors write: “The effectiveness of both investor education and financial advice may be challenged by individuals’ behaviours and reactions. Unbiased financial advice can substitute for financial competence only if unsophisticated investors seek the support of professional advisors. Furthermore, advice may not reach overconfident investors deciding on their own on the basis of self-assessed rather than actual capability. Conventional financial education initiatives may exacerbate overconfidence and/or other biases distorting further investors’ decision-making process.”

Drawing on data from more than 1,000 Italian households, the authors analyzed the relationship between investors’ propensity to seek professional investment advice, financial knowledge and self-confidence, as well as the determinants of financial knowledge and self-confidence.

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