Teaching Financial Planning through 'Five Steps'

Featured in print Bulletin on Aging & Health

Americans are increasingly responsible for planning for their own retirement security, as private pensions shift to a defined contribution (401(k)-style) model that requires individuals to decide whether, how much, and how to save and invest for retirement. While financial knowledge has been convincingly linked to improved financial behavior, basic understanding of economics and finance remains low among the general population and across all age, income, and education groups.

What is the best way to teach basic economics and finance concepts? Some past research suggests that intensive interactive programs can have sizeable effects on participation in retirement savings plans, but these programs can be costly in terms of money and time and may not scale easily to an audience that is larger or different than the one for which they were designed. More limited interventions such as distributing printed materials or hosting a one-time benefits fair generally have smaller effects.

In Five Steps to Planning Success: Experimental Evidence from U.S. Households (20203), researchers Aileen Heinberg, Angela Hung, Arie Kapteyn, Annamaria Lusardi, Anya Samek, and Joanne Yoong take up the question of how to provide effective yet highly-scalable financial education for the general population. The authors design a financial education program called Five Steps that draws on insights from psychology to more effectively deliver information about five core concepts underlying financial planning for retirement. The program's format is suitable for easy, low-cost replication and mass dissemination.

The first concept addressed by the program is compound interest. People tend to underestimate how compound interest grows, a phenomenon referred to as future value bias. If individuals can be shown how quickly interest accumulates over time, they may realize the importance of starting to save early and the dangers of borrowing at high interest rates. The second concept is inflation. Many people suffer from money illusion, meaning that they think in terms of nominal rather than real monetary values. Correcting money illusion can help people to understand the real rate of return earned on investments and to appreciate that a fixed nominal stream of payments has falling purchasing power over time.

The third concept is risk diversification. Research has found that individuals often view their company stock as a safer in-vestment than a diversified stock fund and follow "naïve diversification" strategies such as dividing contributions equally among all available funds, which may needlessly expose them to higher return risk. The fourth concept is the tax treatment of retirement savings vehicles such as 401(k)s and IRAs. Investing in such vehicles conveys significant tax benefits, but because people possess limited knowledge and attention and often do not deliberatively consider all features of complex decisions, they may overlook these benefits. The final concept is employer matches of defined contribution savings plans. Matches greatly increase the rate of return to retirement plan contributions, but many employees do not take full advantage of these matches, behavior that research suggests is not fully rational.

In creating the Five Steps program, these five concepts were embedded in simple short stories. The stories had a number of features designed to increase their impact, based on principles of psychology and marketing. First, the stories were dialogues between two people, with a few key take-away points and minimal jargon. The stories followed a narrative in which characters accomplished desired tasks and achieved their goals after overcoming obstacles. As the program was targeted towards young adults, when the narratives were turned into videos, the actors employed were in their 20s and 30s and were filmed in everyday settings. All of these choices were made in order to heighten the viewer's comprehension of program content and the viewer's belief that he or she could learn from the program and successfully perform the modeled behaviors.

The program was provided using two alternative delivery methods, written narratives and videos. Past research suggests that video content may have greater impact by providing an observational learning experience and creating the opportunity for cognitive engagement.

The program was tested through a field experiment using the RAND American Life Panel (ALP). The ALP is a sample of respondents who are regularly interviewed over the internet and are representative of the US population. At the time of the experiment, the ALP comprised about 3000 respondents (currently, about 6000). Survey respondents were randomly assigned to receive either written narratives or videos, though all respondents saw both the video and the narrative for one of the five topics. Respondents were administered a baseline survey to assess their financial knowledge several months before being exposed to the program, then were re-surveyed immediately after exposure as well as about six months later.

The results indicate a number of positive effects of the treatment on financial knowledge. Interestingly, effects are larger when baseline knowledge is modest, as with the tax treatment of retirement savings plans, and smaller when knowledge is higher, as with compound interest and inflation. While the video treatments have somewhat more positive effects than the narrative treatments, this is not uniformly true. Respondents also do not appear to learn more when they see both the video and written narrative versus when they receive only one of these treatments. In general, the effects of the program are somewhat stronger for women, younger respondents, and for those with higher incomes.

In the follow-up survey, positive effects of the treatment remained but were much smaller, on the order of one-third to one-fifth the size of the original effect.

Overall, the authors find that their Five Steps program has sizeable short-run effects on objective measures of respondent knowledge. The authors note that the ultimate goal of the study is to examine effects on behavior, with outcomes to be collected in a follow-up survey. They conclude, "in general, the program presented is an example of how field experiments can contribute to better understanding of the effectiveness of financial literacy interventions."

This research was performed pursuant to a grant from the U.S. Social Security Administration funded as part of the Financial Literacy Research Consortium.