The Big Idea: Rethinking FinEd in the Age of FinTech
Throughout the year, we’ll be offering a deeper look at some of the biggest trends we see shaping fintech now and in the coming decade. This week, we’re taking a look at financial education in the U.S., and considering whether fintech is a cause of or solution to a lack of financial literacy. As always, if you have any ideas for us, or there’s anything you’d like to know more about, drop us a note at email@example.com.
One of the most important aspects of the fintech revolution has been the democratization of consumer financial products and services traditionally accessible only by certain consumers. This democratization has produced enormous benefits from the perspective of financial inclusion and opportunity, but it has also created more opportunities for exposure to complexity and risk. This week, we’re looking at what risks might be posed by financial illiteracy and fintech tools and asking ourselves, “What’s the Big Idea with financial education in the age of fintech?”
Wait, fintech has a downside??
Improvements in financial inclusion stemming from the increase in tech-driven delivery mechanisms for financial services have been well documented: between 2011-18 alone, more than 1.2 billion people globally gained access to financial accounts, “a crucial step in escaping poverty.” Even in developed countries, technology has helped to lower the bar in accessing consumer financial services: Robinhood has allowed anyone with $1 to become an options trader, SoFi presented an easier and cheaper alternative to banks for students seeking loans, Lemonade serves up insurance policies in a handful of clicks, and Better lets you refinance your mortgage without ever setting foot in a bank. On the whole, these disruptions – and the access they’ve provided – have done a lot of good; they have improved markets and helped millions of people improve their financial outcomes.
Buuuuuut… the story’s not that simple. With a wealth of financial tools literally at their fingertips, more people are exposing themselves to a broader range of financial risks, often without being properly prepared. While some fintech tools are relatively straightforward evolutions of traditional services (think ApplePay vs. credit cards, or mobile banking vs. in-branch banking), others may seem much different or traditionally would have required a certain amount of training before use (think stock trading, crypto exchanges, or automated wealth management).
Why should I care?
It’s that second bucket of tools (let’s call them “Complex Tools”) that we’re concerned about here, because they’re the ones that have a history of causing trouble for individuals and the broader economy. One cause of the 1929 Great Crash was rampant stock speculation by small investors who believed the market would never decline. Likewise, one cause of the 2008 mortgage crisis was homeowners agreeing to onerous loan terms, often because they didn’t understand the tricks and traps in the agreements. The point is this: most people don’t need lessons on how to write checks or transfer money to friends; but stock trading, mortgage lending, and financial planning are far less intuitive activities that often require certifications (e.g., Series 7, CFA exams) at the professional level.
Complex Tools require some degree of financial literacy; the alternative is consumers engaging in activities that affect the economy without really understanding what they’re doing. Think of it this way: even if you’ve never ridden a bike, it’s likely you’d figure it out without harming yourself or others. The same logic does not apply to flying a plane. Similarly, while the average person can probably figure out how to write a check without too much difficulty, it’s much harder to learn how to safely engage in leveraged stock trading.
Moreover, the problem gets larger as the size of the population grows. If you don’t know how to drive but you’re the only one on the road, the risk of damage is relatively limited. But if you’re trying to get out of L.A. before Thanksgiving and you can’t distinguish the brake from the accelerator, there’s probably going to be trouble.
However, even as access to Complex Tools has increased, knowledge about how to use those tools – and even about the underlying financial concepts – has actually decreased. For example, a 2018 FINRA survey found that only 34% of Americans could correctly answer a set of basic questions about interest rates, inflation, bond prices, financial risk, and mortgage rates, down from 42% in 2009. Financial literacy has long been a challenge in the United States that affects all ages and socioeconomic levels, and the increasing prevalence and accessibility of Complex Tools is making that lack of financial education increasingly risky.
Indeed, those risks are starting to produce real-world consequences. In mid-June, we shared the tragic story of 20-year-old Alex Kearns, who took his own life after thinking he had dug himself into a $730,000 hole through his trading activities on Robinhood. The facts that Alex actually had $16k in his account and admitted in his suicide note that he had “no clue” what he was doing only serve to emphasize the necessity of a baseline financial knowledge prior to engaging in certain activities. Similarly, some loans from fintech firms may come with inflated interest rates (e.g., 458% APR?!); some purportedly fee-free offerings may come with hidden charges; and, of course, stories abound of people losing their savings by riding one cryptocurrency roller-coaster or another. Every case is different but they all point to the same two facts: consumer financial products can come with dangerous consequences, and those consequences are amplified by both complexity and insufficient knowledge.
Finally, it’s important to address this problem because of the momentum Complex Tools are gaining. According to a New York Times analysis, in the first three months of 2020, “Robinhood users traded nine times as many shares as E-Trade customers, and 40 times as many shares as Charles Schwab customers.” The democratization of Complex Tools has opened new roads to millions of consumers, but the cars are getting faster and there are not enough resources teaching people how to drive.
What to look out for?
Fintech hasn’t created the problem of financial illiteracy, but the number of fintech products and the volume of users both demonstrate the extent of the risk presented by financial illiteracy and exacerbate its potential impacts. We here at Team TFU are naturally optimistic, and we’re hopeful that the explosion of innovative delivery mechanisms for financial services is creating a companion movement and sense of urgency for improved financial education. We’ve already seen this to some extent in services like Finimize and the erstwhile LearnVest, not to mention the welcome news that 21 states now require high school students to take a course in personal finance, but there remains a dearth of engaging educational resources that both prepare users to engage with Complex Tools and test their readiness to do so.
We expect this to change, whether because of popular pushback on the gamification of financial success, regulatory pushback on firms that offer Complex Tools, or simply the business decisions of the firms themselves. Regardless, in a country where over 40% of adults don't have enough cash to cover a $400 emergency, where nearly 50% lack a retirement savings account, and where the median retirement savings is only $5,000, one thing is for certain: we literally can’t afford to take uneducated risks with our cash. As a society, we need financial literacy programs commensurate to the tools at our disposal, and we hope to see more fintech firms doing their part to get us there.