How Our Brains Betray Us

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Photograph by Lori Andrews/Getty Images

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Photograph by Lori Andrews/Getty Images

In the wake of the financial crisis, parents, educators and even students have argued for more financial literacy courses in schools. Problem is, many studies show that financial education doesn't make a difference because people don’t change their behavior – even if they know better. David Laibson, an economics professor at Harvard University, says understanding this anomaly could help us take charge of our financial lives.

Most Americans know they should save for retirement and pay off their debts. Yet they often don’t do those things. Why?

Our brains are responsible for good intentions not being translated into action. There’s a little tug-of-war going on in our minds. One region of the brain tells us that the right thing to do is to execute. Another brain region says to go for instant gratification. The presence of the dopamine reward system make us biased to do things we can do now. To make things that are not pleasant happen, we have to learn how to exert self-control.

When my wife had a baby, we knew we had to set up a will if we weren’t there to take care of this guy. Imagine if we went out for dinner, got into an accident and died. Who would look after him? For six years we kept saying we would [set up a will], and finally we did.

Economist David Laibson. Photograph by Jodi Hilton/The New York Times via Redux Close

Economist David Laibson. Photograph by Jodi Hilton/The New York Times via Redux

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Economist David Laibson. Photograph by Jodi Hilton/The New York Times via Redux

It’s not that we didn’t understand the importance of doing a will. We didn’t do it because we were postponing the pain of hard work. It’s like saying, ‘I’ll eat this piece of chocolate cake today and next week I’ll go on a diet.’ That mentality is at the core of a lot of financial problems today.

Does this mean that even the most financially savvy of us will make mistakes?

It’s amazing how many economists I’ve asked if they have calculated what their savings should be when they retire. They say they are going by gut. Instead, they should be asking what their savings rate should be so they can smooth out the quality of their lives over a lifespan and not run out of money. They also don’t want to over-save and then miss out on other opportunities in their lives.

Think about the financial crisis and the Wall Street bankers, the masters of the universe. They fell for the same mistakes everyone else did. You can understand the lower-income homeowner who took out a mortgage he couldn’t afford. It’s hard to believe bankers at Bear Stearns didn’t understand compound interest. Even Alan Greenspan kept saying housing prices couldn’t go down on a national level. It was his mantra. Maybe he needed a better high school education, but I am guessing that wasn’t the problem. It was that he got carried along with the ideology of so many people who, because of their financial education, believed the markets could do no harm and be socially efficient.

Given these limitations, is it a waste of time and resources to teach financial literacy in school?

The notion that one course can turn people into sophisticated financial decision-makers is unrealistic. It would also be bizarre if we believed the right amount of financial training in high school is zero, which is the way it is for most high school students. I do believe, though, that there are diminishing returns to investment. The first bite of ice cream is more delicious than the 20th. The first semester of financial education is worth more than the 12th semester.

If we tend to put off planning our financial futures, it seems that financial literacy classes would be as useless as trigonometry classes – you forget it when the course is over.

Not quite. Unlike trigonometry, financial literacy is a skill set that almost everyone is going to use, so it can be useful to spend a certain amount of time learning basic principles for those instances when we can exert self-control and work on tasks viewed as painful. The problem is that if you aren’t going to use it for a decade, then you won’t remember it when you need it.

What does this tell us about the best way to teach financial education?

What this means is that you should get the financial education you need when you need it. If you enroll in a 401(k) plan today, you should take the 45-minute educational seminar on it during the enrollment process. The time to learn about credit cards, borrowing and compound interest is when students are 18 and starting adult life.

The human memory is so fallible. If I tell you something and expect you to remember it five years from now, that’s a big ask. So I would focus on teaching skills that translate immediately to practical application.

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