The way you manage credit has a great deal to do with your financial smarts, but also has much to do with how financially smart you think you are, a new study finds.
Two economists from the University of Nebraska-Lincoln, Sam Allgood and William Walstad, surveyed more than 27,500 people to measure Americans’ financial knowledge in two ways — how much they actually know and also how much they believe they know — and studied how that affected their ability to manage their credit cards.
At the top, of course, were the people who had high knowledge of finance and knew it. But the researchers hadn’t expected to find that a person’s confidence in their financial knowledge mattered as much, or more, in some cases as a factor in how they handled their cards.
For example, the study found, Americans who are actually smart about finance and know it are 15.5 percent more likely to pay their credit card bills in full compared with people with the same level of financial knowledge, but who perceive themselves as not having solid financial knowledge.
Overconfidence not necessarily a bad thing
“Part of the motivation in looking at this was to see whether high perception of knowledge, when you actually did not have that knowledge, resulted in more mistakes – kind of an overconfidence. That’s not what we find,” Allgood says. “We find even those who don’t have high financial knowledge but have high confidence are still making better decisions.”
Survey respondents fell into four groups: Forty-one percent had both low actual and perceived financial knowledge. Twenty-five percent had low actual financial knowledge but thought their knowledge was high; 16 percent had high actual knowledge but perceived their knowledge as low and 18 percent had high actual knowledge and perceived themselves the same way.
The study measured five behaviors: paying credit card bills in full; carrying a card balance; paying just the minimum amount due; paying late fees and going over the card’s limit. In all cases, respondents who believed their financial knowledge was high had better credit card behavior than those who saw their knowledge as low — even if their actual knowledge was low.
The researchers didn’t explore why people perceived their knowledge differently. “The data set was collected by FINRA—the Financial Industry Regulatory Authority — so we didn’t get to craft the survey to help us get at that specific question,” Allgood says. He says the next step is to see why there’s a difference in how people perceive their financial knowledge and whether further study would show that it varies across racial, ethnic and gender lines. “My expectation is that it will,” he says.
Behaviors may extend beyond credit cards
Credit cards were chosen for focus because credit card abuse has been such a hot topic, particularly on college campuses, Allgood says. But Allgood and Walstad are currently researching other areas where confidence levels might be affected.
“We have looked at other areas – investment behavior, savings, holding stocks, decisions involving mortgages. One of the interesting things in the survey is people were asked whether they have sought counseling in a variety of ways – whether it’s about tax planning, general personal financial counseling and what we’re finding is that perception is also related to that—people who have a higher perceived knowledge are more likely to seek assistance from a professional.”
Allgood likened it to students asking questions in class – if you have more confidence, you may be more likely to ask more questions.
That information could be useful in the way personal finance is taught, he says. “We don’t want in any way to downplay the role of actual knowledge,” Allgood says. But if changes were made in teaching, people might gain more confidence, he says.
One possibility is in leading people through the process of making decisions in their own lives, rather than learning how decisions are made in theory. Talking to people about making decisions such as how to change the withholding on their paychecks and who can help them with that at their workplace might help build confidence more than giving them a list of things to check.
“It could be part of the curriculum for personal finance where people could do a case study on themselves where they take a personal financial decision that they’re grappling with and you could help the person work through that,” Allgood says.
Mike Sullivan, education director for Take Charge America in Phoenix, said this study emphasizes that it’s not what you know, “it’s more the capabilities you have that determine how successful you are. It’s almost more of an attitude.”
He says teaching confidence is an important part of financial literacy and “that calls for simulations and activities where students make decisions about money and they see the ramifications of those decisions. After they do that a few times, they’ll get confident about making those decisions … We should teach attitudes and we should teach it via experiences.”
Allgood says the need for more financial education is highlighted by the financial collapse of 2008. Amid the finger-pointing at large institutions and government, people also realized that a part of what was going on was that individuals were the ones taking on mortgages and getting the adjustable rate mortgages, he says.
“Whether that was because they were given bad advice or didn’t know better, the bottom line was that it appeared people did not have the financial knowledge to make good decisions or ask good questions,” Allgood says. “It put a spotlight on how much more complicated finances are today. Forty years ago, it was difficult to get any credit—there just weren’t that many options . What we saw leading up to 2008 was that credit became very available for people. Without knowledge about the good and bad, people made a lot of bad decisions.”