It may not be what you know, or even who you know, but who you are that shapes your financial future.
That is the implication of a new study of financial decision making that shows little correlation between financial knowledge and financial health.
The study of over 3,000 people in six different countries finds that a propensity to make wise financial choices is deeply rooted in personality — specifically shaped by a person’s perspective on time.
The study conducted by Stanford University psychology professor Philip Zimbardo would appear to go against other studies that have boosted the case for financial literacy.
For example, a recent National Bureau of Economic Research working paper concludes that “Overall, financial knowledge does appear to help people invest more profitably; this may provide a rationale for efforts to enhance financial knowledge in the population at large.” That paper also cited previous studies showing that more knowledgeable people accumulate more wealth.
But Zimbardo — an emeritus professor who has written more than 50 books and is best known for the controversial 1971 Stanford Prison Experiment that highlighted the ease with which people assumed roles as victim or victimizer — found that financial knowledge does not strongly predict financial health.
“In other words,” a summary of the study states, “given a high level of acumen, it is not possible to predict people’s financial behavior.”
The study, sponsored by MagnifyMoney, a personal finance site offering side-by-side consumer-oriented comparisons of banking products, measured financial acumen through a test, but also separately assessed people’s perceptions of their financial knowledge.
There, too, high self-ratings for financial acumen did not correlate with good financial decision making; in fact, people who rated themselves as having financial acumen were more likely to be poor financial decision makers.
The one area found to be predictive of good financial decisions was one’s perspective on time, as viewed through a matrix of past-oriented, present-oriented and future-oriented personality types.
Dwelling in the past, as it were, is highly correlated with financial health; those who live in the present are poor financial decision makers; and those who live in the future are not generally financially “healthy” but often succeed at avoiding being financially “sick.”
Symptoms of financial sickness include a propensity to borrow money from payday lenders; file for bankruptcy or experience foreclosure; carry a credit card balance; or ignorance of the interest rate one pays on borrowings.
The reason past-oriented people are financially healthier is that they “base their decisions and actions on memories rather than current experience,” the summary states. People with negative past experiences, and a past orientation, take less risk and thereby avoid financial ruin. On the downside, such people may be more likely to keep their wealth in cash and avoid prudent investment risk, the summary states.
Those living in the present, however, are more apt to be “hedonists” who “take what they want, when they want it without any thought of future consequences. Candy displays at checkout counters and other checkout “upgrades” are effective on this group.
“They are willing to gamble their life savings, spend money they don’t have and ignore the consequences of poor financial decisions,” the summary states.
Apart from hedonists, another segment of present-oriented are those who feel “stuck in the present” — essentially powerless to influence their futures. Such people “are more likely to gamble or buy lottery tickets” and “are likely to stick with their existing bank or credit card,” ceding control to financial institutions out of a lack of belief that better options exist.
Future-oriented personalities would seem to be models of financial propriety, sacrificing current enjoyment for future gain. However, such people may be apt to over-insure against risk or make bad investments based on bad information or advice.
MagnifyMoney co-founder Brian Karimzad said financial advisors who understand the time orientations can better help their clients navigate financial decision-making.
“For example, someone who is a hedonist should have limited exposure to open credit lines and trading accounts,” Karimzad told ThinkAdvisor. “Someone who is not future oriented should be in an automatic payroll deduction plan for retirement.”
An interesting generational divide observed in the study, which drew half its survey participants from among baby boomers and half from millennials, is that the younger cohort are financially healthier, with a greater proportion (25.3 percent vs. 16.5 percent for boomers) having the healthiest “past-negative” orientation.
“They entered the working world during a financial crisis and face high levels of youth unemployment. As a result, they tend to be more risk-averse,” the summary states, adding “not buying a car (you can’t afford) or a house (for which you do not have enough for a down payment) is sensible.”
That generational dynamics have implications for financial services, Karimzad says.
“Millennials are bifurcated among those who have found good incomes which give them the freedom to make choices and those who are underemployed.
“Those who can make choices are reshaping things as a result of their scarred past. Not wanting to commit to financial risk, preparing for worst case outcomes, and a focus on products that offer an experience and good present memory, rather than material appearances are all trends we're dealing with today. These miliennials will take a risk when they have control, such as via entrepreneurial activities or self-employment. But they are wary of risk out of their direct control like traditional investments.
“They will be less in debt overall and avoid the worst financial traps better than the prior generation. But they may miss out on growth opportunities… Investment advisors must give them a sense of control and security to help them feel comfortable with safe growth.
“But among those that don't have a good paying job, these choices aren't available," he says. "People who will give them an unbiased view of which products to switch to and get them out of traps are more important than ever.”