Video: How financial confidence helps individuals and couples manage their debts

Transcript

Scott Rick: OK. So I'll have some similar and divergent points from Keri. I really enjoyed that. Yeah, so this is a project with Jenny Olson at Indiana, and I'm really happy to be here to discuss it. We're looking at how the role of financial confidence helps individuals and couples manage their debts, confidence being a somewhat overlapping and distinct trait from financial literacy, and we can think about that as we move along here.

But let's consider a very similar scenario to what Keri was discussing. Imagine you're juggling two debts. One has a hundred-dollar balance and a ten percent APR, and the other has a thousand-dollar balance and a 15 percent APR. And you're suddenly kind of gifted a hundred dollars that you choose to use to repay your debts, and you're deciding, well, how should I repay it between the two of these. So arguably, the math and the kind of objective financial advice is clear. So if you look at an organization like FICO, for example, they're clear. They say you should put the money towards your highest interest cards first, assuming you can't just pay it off in one fell swoop. If you have to prioritize, prioritize based on interest rates.

But what we find that a lot of people do is they take the hundred dollars and they're very happy to just kind of close out the small debt and leave the higher-interest debt untouched. And there are lots of reasons why they might do that. Before going into those, I should mention that this pattern, which we call debt account aversion, people who display it in laboratory tasks in their real life have significantly lower credit scores and significantly more kind of negative items on their credit reports than people who don't display this mistake in the lab tests. So if you're making the mistake in the lab, it is potentially telling us about how you're managing your real debts. It's a bad signal for how you're managing your real debts.

That said, it's very common – common because there's so many causes to it. And some are arguably quite reasonable. So you might, for example, want to reduce paperwork and reduce your risk of forgetting to pay a bill. So you might just be managing your own attention, and – and that is arguably quite rational. Maybe you've gotten some advice. Certainly different financial advisors and financial gurus have their own approaches that they've proposed. If you've been in a US airport lately, you've probably seen this guy's face on a book, Dave Ramsey. He argues for the debt snowball method, explicitly arguing that you should take the motivational path, that paying off the small debts will give you the boost you need to tackle the big ones.

There's also this notion that it's kind of– we choose the easy goals to do first and the – the larger goals can wait. So a lot of us have plans to start our diet tomorrow. The problem is that when tomorrow comes, tomorrow becomes today, and the whole cycle starts over again. But there's a lot of evidence suggesting that kind of larger goals, we kind of procrastinate in our pursuit of those.

And if you think about that in the context of debt, there's this idea that if a debt is kind of – kind of daunting or intimidating, we just kind of ignore it. Credit.com, for example, notes that when faced with a daunting credit card balance, some might be tempted just to make the minimum payments or ignore the debt altogether. It's too distressing to think about, so I won't even bother devoting a lot of effort to thinking about it. We think that financial confidence might be a remedy here, a construct that Fernandez and co-authors defined a feeling capable and assured with respect to how you navigate the marketplace. And some prior work has suggested that maybe it plays a role in reducing your hesitation and encourages people to act boldly. And so that might be good. That might get you to tackle that daunting, intimidating credit card balance.

So we tried that in an experiment here with individuals, where we had them – we tried to boost – we randomly assigned them to receive a boost to their confidence or not. So we started out by asking everyone just how many financial products do you engage with, how many decisions do you make, and you know, you – tell us about yourself, and then the computer randomly assigned them to receive different messages. Some people got a boost. They said – some people were told things like, oh, based on your answers to those questions, we have no doubt that you'll do great on the next set of questions. We're going to ask you how you would manage different debts. And people like you really succeed in this kind of task. Remember you've got this, you can do it. Other people were just told click next and good luck. Like, they got no boost.

And then everyone got this task where there – you have six debts, they vary in their size and interest rates. Here you can see that interest rate is positively correlated with debt size. We give you a repayment budget of $5000 and say how would you allocate it. Again, the math and the financial – the objective financial advice might be hey, focus on debt six. It's your biggest interest card. But it's also pretty daunting. And what we find is that people who receive the confidence boost devote significantly more dollars to repaying that otherwise intimidating debt. They seem to be motivated to kind of go after that. Like, they feel that they can do it. I'm going to chip away. I'm going to start climbing this really high mountain.

Of course a lot of big debts in our life are not individual; they're kind of jointly held between, say, romantic partners. And so we thought, well, how might the confidence play out in these joint decisions. In a lot of collaborative tasks, confidence wins. I might not know, for example, how financially literate my partner is. I might not even know how financially literate I am. But I can tell if they're confident. And so in a lot of these joint tasks, confidence wins in terms of who has a greater voice. And based on the past results that I just showed you, that might be a good thing. We want the higher confidence person because they do better on this kind of task. So maybe it's good when romantic partners work together.

So we tried that in a few experiments – I'll tell you about one here – where we brought in established couples to the lab and we randomly assigned them to complete a debt management game to – much like the one you just saw, either together or we split them up, they did it on their own. And we played that same game that I just told you, but now, instead of one shot, we played it for 25 rounds. Each round is a year. So you make your decision and then, oh, well, here's the interest that accumulated on all of those. Here's some more money. And you did that round after round, and we paid you based on how little debt you had at the end of the experiment. So you're motivated to reduce your total amount of debt across cards.

And then we measured each participant's financial confidence. It's a five-item scale from the Fernandez et al. paper I mentioned. Has items like I'm confident in my ability to recognize a good financial investment. We measured it right after the experiment. We also measured it ten months later because we wanted to make sure it wasn't obviously influenced by the experiment. It didn't seem to matter.

So here's what we found. These first – you know, the white bars here, this is just looking at individuals. And so this is exactly consistent with the study I just showed you. So individuals with financial confidence below the midpoint – in other words, individuals with low financial confidence – end up with significantly more debt than individuals with high financial confidence. So again, more debt is bad. You leave the lab with less real money. So the people with high confidence are doing significantly better. That makes total sense.

The interest—the especially interesting thing here is the couples results. The couples, on average, look like individuals with high financial confidence. So couples differ in their financial confidence, and they seem to be letting the person with high confidence take the lead. They're – they're letting that person kind of navigate the process, and they're benefiting from doing so. They're mitigating the damage of the person with low confidence. They're able to acknowledge and follow the lead of the person with higher confidence. So we see that confidence helps within individuals, and within couples as well. So it's something that potentially could be boosted for individuals in the moment. We see that couples benefit by following the lead of the partner with higher confidence, so good news there about couples working together.

And in terms of education, we certainly wouldn't suggest that you just want to maximize confidence. Like, there are times when you can be super confident with no literacy, and – and that could be not good. So in terms of education, we would certainly suggest you want to cultivate both literacy and confidence. We see in our – our research, for example, there's a lot of people with high literacy and – and low confidence, not a lot with the opposite combination. So we really want to enhance both, and – and we think that could help people juggle their debts. So thank you very much, and will hand it over.

(Applause)

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