Financial knowledge plays an important role in enabling individuals to engage in good financial behavior. However, like other forms of knowledge, financial knowledge is subject to decay if we don’t apply and reinforce that knowledge regularly. While this may seem fairly obvious, the reality is that the many decisions we make – including the decision to retain (or delegate) responsibility for making financial decisions – may influence our development and retention of financial knowledge.
In this post, Derek Tharp – lead researcher at Kitces.com, and an assistant professor of finance at the University of Southern Maine – delves into the recent research on how financial knowledge may increase or decrease over time based on how a couple allocates responsibility for making financial decisions.
A recent study from Adrian Ward and John Lynch provides some interesting insights into how the divvying up of financial decisions among couples may influence financial decision making. Contrary to what many may expect, the authors found that the initial assignment of financial responsibility was not influenced by levels of financial knowledge at the beginning of the relationship. While this may seem counterintuitive, from an economic perspective, it is the individual with the comparative advantage (rather than the absolute advantage) that we would expect to take on a larger share of financial responsibility in an efficient outcome. For example, despite a CFO’s potential absolute advantage over a stay-at-home spouse’s financial knowledge, it may be the case that it is better for the household financially if the CFO focuses on their work rather than managing household finances. Because all households have limited time and resources, the reality is that some trade-offs in all areas of life are ultimately inevitable.
Long-term, the assignment of financial responsibility appears to influence financial knowledge, with spouses who take on 100% of the responsibility becoming most knowledgeable, whereas those who take on no financial responsibility (i.e., delegate those responsibilities to their partner) actually experience a reduction in their financial knowledge over time. Furthermore, while those who share responsibility do appear to each see modest knowledge gains with time, those gains are much smaller than the gains experienced by households with one member specializing in financial responsibility.
Overall, this finding has important implications, as it suggests that there is both risk and opportunity associated with sharing or delegating financial responsibility. On the one hand, those who delegate may benefit from the higher levels of knowledge gained by the specializing spouse. On the other hand, should the specializing spouse experience disability or premature death, a spouse with less financial knowledge than they may have had if they were involved in making financial decisions could be thrust into a role as a financial decision-maker without being prepared. Moreover, it’s possible that financial knowledge of those who delegate responsibilities to a financial advisor could similarly experience a decrease in financial knowledge over time. While this is not explored in Ward and Lynch’s study, it is nonetheless important for financial planners to help clients understand both the risks and rewards associated with divvying up responsibility between members of a household… and between a household and their financial advisor!