In 2014, I led a six-nation study on financial literacy with MagnifyMoney. The purpose of the study was to understand:
- Is traditional financial literacy training sufficient to help people live financially healthy lives?
- What role does a person’s time perspective play in how that individual makes financial decisions?
- How does an individual’s national identity impact his or her approach to time and money?
We conducted the study in the United States, United Kingdom, Germany, Sicily, Hong Kong and Brazil. Every participant was given:
- A traditional financial literacy exam
- A “financial health” exam, which determined whether an individual was living a financially healthy life. Someone who is financially healthy would have retirement savings, an emergency fund and a good credit score. Someone who is financially sick would be in debt, have a bad credit score and possibly could have suffered bankruptcy or other defaults.
- The Zimbardo Time Perspective Inventory, to determine an individual’s approach to time.
The results were groundbreaking. We found millennials are less financially literate than their boomer counterparts, but are actually more financially healthy. 33% of the American population tested as financially healthy, with the United Kingdom coming in with 54% and Brazil only 14%. Most importantly, we uncovered that an A+ math student doesn’t correlate to being financially healthy. What does matter, is the direct link of a person’s approach to time with financial behaviors.
The Failure of Traditional Financial Literacy and The Importance of Time Perspective
Traditionally, financial literacy training focuses on mathematical aptitude. A traditional financial literacy exam would ask people to understand inflation-adjusted returns and to calculate the impact that an interest rate change would have on the price of a bond. The implicit assumption underpinning traditional financial literacy education is that by understanding math, you can live a financially healthy life.
However, our study conclusively demonstrated that simply “understanding the math” was not sufficient to live a financially healthy life. A high financial literacy score did not translate into a high level of financial health. That does not mean that we encourage people to stop learning math. Quite the contrary. Instead, the data demonstrated that financial acumen is necessary but not sufficient to live a financially healthy life.
It’s a person’s time perspective that can really predict how financially health they are.
An individual’s approach to time has a big impact on financial health. People who took our quiz and scored a very high “past negative” score (meaning they have negative associations with past events in their lives) tended to be financially healthy.
Aversion to risk can be bad for your social life (keeping people from enjoying life and falling in love) but great for your finances. Because you are afraid of what might happen, you are more likely to save. Because you don’t trust people, you won’t buy into their next big speculative investment.
People who start saving early and invest consistently, without emotion, in a diversified investment portfolio do extremely well over time and are the most prepared for retirement. It seems that being past negative actually does have a benefit: when the next Ponzi scheme comes along, a past negative individual will reject it. Imagine your wise grandmother who lived through the Depression. She might not be able to calculate compounding interest, but she knows how to save and isn’t a fool. Your grandmother probably has more money sitting in her bank account than her flashy neighbors.
We found the strongest statistical relationship between “present hedonists” and financial sickness. And while intuitively this finding is not surprising, we now have data from six nations validating our intuition. Present hedonists want to enjoy the moment without thinking about the consequences. Imagine the investment banker making millions every year. He understands the complexities of derivatives, but he is unable to say no to a first class air fare and the VIP room at a club. Although he makes millions, he spends it all (and then some) as part of one big adrenaline rush. Present hedonism helps him work 80 hours a week on a big financial deal, completely focused on the outcome. But it also helps him lose all of his money on champagne and the other addictions found in close proximity to champagne.
And when we compared the different geographic limitations, we saw time perspective at work. The most “financially sick” country was Brazil, which is culturally a much more present hedonist than other surveyed nations.
While we might not worry too much about the intoxicated investment banker, we should worry about present hedonists and their impulsive indulgences. A single mother living on minimum wage knows that she needs to save. But she buys those concert tickets because they make her feel better. The hard-working husband knows that he needs to save for his children’s education. But during a trip to Vegas, the temptation of the tables proves to be too much for him. Present hedonists often make very bad financial (and life) decisions. They might feel fleeting regret, but it doesn’t last. They will search out their next present hedonist treat and repeat the pattern.
Since our study in 2014, we have been looking at financial products that bring out the worst in present hedonists. And we have focused on one product in particular: credit cards.
Credit Cards: The Perfect Present Hedonist Trap
Present hedonists are driven by two key driving forces:
- They want it now. There is a strong desire for instant gratification.
- They do not want to think about the consequences. And if you force a present hedonist to think about the consequences of their actions, they might move on to the “next easiest adventure.”
Credit cards have been designed to take full advantage of a present hedonist.
I will explain the trap in a moment. But first, it is important to understand that this is not an indictment of credit cards for everyone. A financially healthy past negative individual can make excellent use of a credit card. He or she can find a credit card to be a convenient way of paying. Credit cards can be a convenient way to make transactions all over the world. A responsible individual could earn rewards or airline miles, which can result in free trips. And so long as the individual does not spend more than he or she can afford, most credit cards are virtually free. If you pay the credit card balance in full and on time every month, you will never pay any interest expense. So, for a financially responsible individual, a credit card can be both a convenience and a way to earn rewards. In fact, credit card companies lose money on responsible people. But they more than make up for it with present hedonists who overspend.
And for a present hedonist, a credit card is like a loaded gun.
Why is a credit card so dangerous for present hedonists? Because it’s a carefully designed product to trap those willing to live beyond their means:
A credit limit that is much higher than your monthly gross income.
When you apply for a credit card, you will be assigned a credit limit. Most credit card companies will assign a credit limit that is significantly greater than your monthly gross income. If you make $3,000 a month, you might get a $6,000 or even $10,000 credit limit.
The credit card company charges a minimum due that is usually 1% of the principal balance (and includes any interest that accrues). For example, if you have a $10,000 balance on your credit card, your minimum monthly payment would only be only $225. The credit card company will be happy if you only pay $225 a month (the minimum due) because $125 of the payment would go towards interest. And for someone making $3,000 a month, a $225 payment could be affordable.
But that big credit limit is a huge temptation for a present hedonist. In the heat of the moment, a present hedonist has at least $10,000 available that could make today more fun. Do you see shoes that you would like to buy? Do you see a new iPhone you would like to buy? Your big credit limit makes it easy.
There is no “pain of paying.”
Present hedonists want to enjoy the moment without any thought of the consequences. At the moment of the transaction, any barriers to that payment removes fun, slows down time and makes the consequences more visible. With credit cards, a payment is instant and easy. A simple swipe of the plastic and the purchase is complete.
A credit card makes it possible to spend very large quantities of money with very few barriers or moments to create thought. Retailers are willing accomplices. At Amazon, you can make a purchase with just one click. Retailers and credit card companies have created a world where present hedonists can indulge quickly and easily, with no thought of the consequences.
Automate Payments and Eliminate Statements
Credit card companies offer the ability to automate your monthly payment. You can easily set up a recurring monthly payment that only covers the minimum payment due. You can also sign up for electronic statements, which removes the monthly physical reminder of the decisions you made and the cost of those decisions.
Tactile therapy has proven an effective way of helping present hedonists. A monthly, physical statement would force a present hedonist to stop and think about his or her financial statement. But once those are turned off, all can be forgotten.
What to Do
Because of the importance of time perspective, individuals must self-diagnose. Financial literacy training should include a mandatory self-assessment using the Zimbardo Time Perspective Inventory.
Present hedonists need to know and understand who they are. They should consider cutting up their credit cards. Perhaps cash is the best way to ensure financial health. If the money in the wallet is gone, there is nothing to lose.
Credit card companies should consider creating tools to help people reduce their credit limits and limit their spending. For example, maybe a credit card would allow people to turn off the ability to make transactions after 10 PM, making it impossible for the hedonist to spend wildly in dangerous situations.
But one thing is certain: teaching a present hedonist how to calculate compounding interest and then handing him or her a credit card is not the way to ensure a financially healthy life.