Education, Human Capital, and Financial Decision

University of MarylandJinhee Kim

SFEPDOctober 26, 2015

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Education and Financial Decisions• Education is controlled as socioeconomic “status.”

• However, the causal role of education in other outcomes such as health has been established in demography or social epidemiology independent of status attainment (Baker, Leon, Greenaway, Collins, & Movit, 2011).

• “Education has an enduring, consistent, and growing effect” (Mirowsky & Ross, 2003).

• Causal effect of education on financial decision?– Correlation by unobservable characteristics

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Education and Financial Decision-Making

Education Income Financial Decision

•Increase steady employment•Increase wage rates•Decrease poverty

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Education, Asset Ownership, and Wealth

• Education is positively associated with asset ownership and wealth.

• Education is associated with investment asset ownership among low to moderate income households (Gutter, et al., 2012).

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Financial Literacy by Education Group

Source: Lusardi & Mitchell: The Economic Importance of Financial Literacy Journal of Economic Literature, Vol. LII (March 2014)

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The Causal Effects of Education on Financial Decision

• Education increases financial market participation and reduces the probability that an individual declares bankruptcy, experiences a foreclosure or is delinquent (Cole, Paulson, & Shastry, 2014). Individuals with higher education are more likely to participate in the stock market, accumulate, any return-yielding assets, and stay current with their credit cards.

• The causal effect of education on stock market participation and risky asset holdings was estimated using the Swedish data. An extra year of education increases stock market participation by about 2% for men but there is no evidence of any positive effect for women (Black, Devereux, Lundborg, & Majlesi, 2015) .

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Educational Attainment

Cognitive Factors

Psychological Factors

Family Background

Other External Conditions

Educational Attainment

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Intergenerational Transmission of Education

• Educational attainment is an intergenerational transmission of family background as well as individual’s ability (Huang, 2013).

• Family income, assets, and education influence children’s academic achievement and academic aspiration and educational attainment (Elliott, Kim, Jung, Zhan, 2010) .

• Family structure plays role in intergenerational transmission of education (Martin, 2011).

• Racial/ethnic minority and low resources households (Robert Wood Johnson Foundation, 2013).

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Intergenerational Education Mobility

Authors: Richard V. Reeves and Joanna Venator | October 27, 2014 The Inheritance of Education 9

Education and Financial Decision• Is education same as cognitive ability?

• Does education simply reflect underlying psychological traits such as an orientation toward the future, traits which might lead them to do well across multiple important life domains such as impatience?

• Or does the effect of education result from actual cognitive gains associated with schooling? (Herd, 2010)

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Education, Human Capital, and Financial Decisions

Education

Human Capital

Financial Decisions

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Human Capital Pathways

EducationEducation

Psychological FactorsFuture Orientation, Impatience/ Self-regulation,

Self-efficacy

Psychological FactorsFuture Orientation, Impatience/ Self-regulation,

Self-efficacy

Neurological and Cognitive FactorsHigh-order cognition, Numeracy, Literacy

Neurological and Cognitive FactorsHigh-order cognition, Numeracy, Literacy

Social CapitalConnections and contacts, Peer effects, trust

Social CapitalConnections and contacts, Peer effects, trust

HealthMorality, Morbidity, Health disparities

HealthMorality, Morbidity, Health disparities

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Education, Neurological and Cognitive Skills, and Financial Decision

Education Neurological and Cognitive Skills

•High-order cognition•Numeracy•Literacy•Risk Assessment•Decision Making Skills

Financial Decision

“Activity-dependent development” or “neural plasticity”

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Neurological and Cognitive Impacts• Education is regarded as a proxy of cognitive reserve (Stern, 2002; staff, Murray,

Deary, & Whally, 2004). • Higher cognitive skills “thinking skills, reasoning, critical thought, and problem

solving”• “Executive Functions” refers to the higher-level cognitive skills you use to control

and coordinate your other cognitive abilities and behaviors. • Neurological development of high-order cognitive skills occurs through late

adolescence and is highly responsive to environmental stimulation (Baker, Leon, Greenaway, Collins, & Movit, 2011). “Neural plasticity”

• High-order cognition is associated with risk assessment and decision making skills (Bruine de Bruin et al., 2007).

• Executive function such as inhibition, working memory, and cognitive flexibility is linked to financial decisions (Drever et al., 2015).

• Schooling can have long-lasting effects on neurological functioning (Quartz & Sjenowski, 1997). Education enhances high-order cognition (Baker et al., 2011) and executive functions (Debora et al., 2013; Wecker et al., 2005).

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Education, Psychosocial Factors, and Financial Decision

Education Psychosocial Factors

Self-efficacyTime-horizonSelf-control/impatience

PowerPerceived barriers

Financial Decision

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Psychological Factors, Education, and Financial decisions

• Psychological non-cognitive attributes may be genetic endowment that mediates the relationship between education and financial decision. However, through schooling psychological factors change across the life course (Herd, 2010).

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Education and Self-Efficacy• The extent or strength of one's belief in one's own ability to complete tasks and

reach goals (Bandura, 1997) . Self-efficacy affects cognitive, affective, and motivational processes. Self-efficacy can affect how people think, feel, and act (Bandura, 1997).

• Self-efficacy affects accomplishment directly and indirectly through its influence on the belief that one can achieve one’s goals.

• The effects of self-efficacy on academic achievement and performance have been well established. Self-efficacy also has been linked to goal setting and performance (Zimmerman et al., 1992).

• Higher education was associated with higher self-efficacy and high cognitive skills (Zahodne et al., 2015).

• Self-efficacy can be a protective factor. High levels of self-efficacy may buffer the negative effects of low education on executive functioning (Zahodne et al., 2015). Individuals with low education but high self-efficacy performed similarly to individuals with high education.

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Financial Self-efficacy• Social Cognitive Perspective emphasizes domain specific self-

efficacy in relation to specific performance such as economic self-efficacy or education self-efficacy.

• Financial self-efficacy is a sense of one’s ability to perform responsible financial behaviors contribute to the performance of those behaviors (Serido et al., 2013).

• Financial efficacy can be used to influence individuals’ financial behaviors (Serido et al.,2013) such as savings (Lown et al., 2015), credit management (Wang et al., 2011), and retirement investing (2007)

• Financial self-efficacy can be additional financial capability that

motivate financial behaviors.

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Enhancing Self-Efficacy• Self-efficacy beliefs are developed by four sources: mastery

experience, vicarious experience, verbal persuasion, and physiological state (Alderman, 1999; Bandura; 1986).

• Strategies to improve students’ self-efficacy towards learning include modeling, sharing of self-efficacy stories, constructive feedback, goal setting, rewards, and estimating student self-efficacy by using a scale (Alderman, 1999; Schulze & Schulze, 2003 ).

• A recent research suggests activities, exercises and financial video games help students acknowledge and enhance self-efficacy (Maynard et al., 2012).

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Other Psychosocial Factors• In addition to objective knowledge, subjective knowledge in consumer financial

decisions can be important consumer’s investing behavior (Hadar et al., 2013). The effort of financial education may actually undermine consumer’s level of subjective knowledge. If too much information is presented in a highly technical format, consumers may be deterred from those investment options and take no actions or choose inferior alternatives.

• Personal trait such as impatience can affect educational attainment as well as financial decisions (Cadena & Keys, 2015). Impatient people more frequently invest in dynamically inconsistent ways, such as dropping out of college with one year or less remaining. They estimated the cumulative investment differences may cost 13% less in earning for the impatient. Self-regulation and soft skills are important in education and other time-dependent investment decisions (Cadena & Keys, 2015).

• Perceived barriers is associated with savings among low to moderate income (Mauldin et al., 2013).

• Feeling powerful also increases saving (Garbinsky et al., 2014).

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Health and Education• Education impacts longevity, disease, health disparities.

• For health disparity, improving socioeconomic conditions such as education is one of the strategic areas that HHS, CDC, and other federal agencies identified (Beckeles & Truman, 2013).

• National Prevention Strategy targets education as to boost health and decrease health disparity (Robert Wood Johnson Foundation, 2013). For example, effective evidence-based interventions to prevent and reduce the dropouts of middle and high school student can decrease health disparity.

• Wealth disparity?

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Averaged Freshman Graduation Rate (AFGR) for public high school students, by race/ethnicity: School

year 2011–12

U.S. Department of Education, National Center for Education Statistics

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Status dropout rates of 16- through 24-year-olds, by race/ethnicity and sex: 2012 National

Center for Education Statistics

U.S. Department of Education, National Center for Education Statistics23

Race and Educational Attainment

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Who Has Student Loan Debt?

Caroline Ratcliffe and Signe-Mary McKernan, The Urban InstituteBased on the 2012 National Financial Capability Study Forever in Your Debt Who Has Student Loan Debt, and Who’s Worried?

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Implications for Financial Educators

• Education may have effects on financial decision other than wage earnings.

• Possible pathways include human capital:– Cognitive, psychosocial, social capital, and health

• Financial educators may consider both cognitive and psychosocial factors in influencing individuals’ financial decisions as they may buffer adverse effects of low education on financial decisions.

• Strategies to enhance cognitive and psychosocial factors can be utilized in financial education.

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