Can (Financial) Ignorance Be Bliss?

Abstract

Financial illiteracy is widespread and leads to bad financial decisions. Individuals cannot answer basic questions about inflation, compounding, and diversification. This article argues that financial literacy programs should be complemented with a new class of financial instruments that embed goal-specific compounding and inflation protection. These income-only real bonds, with a forward start date, would pay investors for the period required for the respective goal. Further, there is ample potential supply from natural issuers. This innovation trivializes the investment problem to just simple multiplication or division, thereby addressing the challenge of financial illiteracy with financial innovation across a range of saving/investment goals.

Disclosure: The author reports no conflicts of interest.

Editor’s Note

This article was externally reviewed using our double-blind peer-review process. When the article was accepted for publication, the author thanked the reviewers in his acknowledgments. David Chambers and Raul Leote de Carvalho were the reviewers for this article.

Submitted 18 March 2018

Accepted 5 October 2018 by Stephen J. Brown

Acknowledgments

Thanks to Robert C. Merton for his collaboration on SeLFIES, for his continued guidance, and for many ideas that helped in developing this article. Thanks to Kazuhiko Ohashi and Sunghwan Shin for their collaboration on the RAPM and BFFS and Adam Kobor for pricing BFFS/SeLFIES. Also, thanks to Mehmet Gerz for pointing me to Richard Thaler’s work on this topic and Shaila Fernandes, Rui Ferreira, Amlan Roy, Robert Savickas, and Margaret Towle for helpful comments/collaboration. Thanks also to the editorial staff, David Chambers, and Raul Leote de Carvalho for helpful comments that greatly improved this article.

Notes

¹ I have taken poetic license in the use of “monetary illiteracy” and “cursed”; my take is not the original meaning to which Pound (1970) alluded.

² Gunzberg, Li, and Ashton (2018, 2) noted, “Costs associated with college tuition and fees, as measured by the U.S. Bureau of Labor Statistics, have far outpaced general U.S. inflation as measured by CPI (5.9% versus 2.6%, annualized from January 1987 to June 2018).”

³ www.brainyquote.com/quotes/quotes/c/confucius140548.html?src=t_goals.

⁴ See Muralidhar (2016b).

⁵ www.commonfund.org/commonfund-institute/higher-education-price-index-hepi.

⁶ Otherwise, colleges would bear the risk between their tuition inflation and the HEPI.

⁷ Many universities and colleges have issued tax-exempt and taxable bonds. Furthermore, when the student attends his or her college, the college can use cash flows received from the student to repay the bondholders, thereby totally hedging the college’s position.