Self-Efficacy: The Missing Component for Financial Success
Popular wisdom suggests that if you want to succeed financially, you need two things: financial knowledge and access to appropriate financial products. This combination is commonly referred to as financial capability. But a groundbreaking paper from the EARN Research Institute points out that these two factors only lead to financial success when paired with a third component: financial self-efficacy.
Financial Knowledge vs. Self-Efficacy
The new research, based on survey data collected over seven years from more than 500 low-income workers, illuminates a crucial gap in how most financial education experts believe people manage their money successfully. The common assumption in the financial education field is that greater knowledge about personal finance leads to fewer financial problems. But according to Dr. William Lapp, the EARN Research Institute’s Chief Investigator and author of this latest study, “even though financial knowledge grew” among participants in EARN’s direct service programs, “it did not directly predict a decrease in financial problems.”
Rather, the pivotal predictor of fewer financial problems was financial self-efficacy, or a person’s actual and perceived ability to combine their financial knowledge with the use of high-quality products. In other words, to achieve financial success, you must operationalize your financial knowledge by using it, building both confidence and ability along the way.
That’s not to suggest that knowledge isn’t important. According to EARN’s research findings, knowledge plays a crucial role in heightening a person’s self-efficacy. “For people who participated in the program,” explains Lapp, “increases in their financial knowledge above and beyond baseline levels further increased their financial self-efficacy, which in turn reduced their financial problems.” A growing body of research reinforces this notion that financial education should be delivered with a way to put that newfound knowledge to use; otherwise, it will not foster the financial capability people need to get ahead economically.
Fostering Self-Efficacy Through Financial Coaching
EARN’s Research Institute will continue to explore which combination of ingredients – products and programs alike – can foster self-efficacy in low-income workers. But we already have a promising lead. EARN’s research suggests that financial coaching, a unique tool that EARN continues to pioneer to help low-wage workers move the needle on financial well-being, noticeably bolsters clients’ self-efficacy.
In EARN’s Wealthcare program, our alumni receive a 12-month, one-on-one engagement with an expert coach for the individualized support they need to develop sound money management habits and maintain their upward financial trajectory.Financial coaching is unique from traditional financial literacy programs in three ways:
First, it is anchored in behavioral change, not in a transfer of information about finances. Planning, literacy, and counseling are all focused on helping someone determine what they need to do to achieve financial goals. We argue that focusing on how people will achieve financial goals is of even greater importance for helping low-income people achieve prosperity.
Second, financial coaching is client-directed. In contrast, when delivering financial literacy, financial planning, and financial counseling, the service provider drives the process. Coaching is rooted in a belief that the client ultimately has the answers for what behavioral changes will be required to succeed in meeting financial goals.
Third, being client-directed makes financial coaching inherently empowering to clients. Traditional models of serving low-income people often involve power imbalances that can decrease the confidence and self-esteem of service recipients. Through client feedback, we have learned that coaching places the decision-making in the hands of clients, who find this immensely empowering. Their confidence increases significantly, and they believe they make better financial decisions as a result.
When combined, these three factors create a coaching program that demonstrably fosters self-efficacy in its clients. “The differences in two aspects of financial self-efficacy between those who were coached and those who were not coached were significant,” writes Lapp, “suggesting that coaching accelerated the process of acquiring higher levels of this pivotal aspect of financial capacity.”
At EARN, we believe that the fundamental approach of letting coaching flow from client decisions – as opposed to a top-down approach – is a major factor in helping our clients build self-efficacy and, ultimately, financial capability.
A New Iteration of Financial Capability?
In light of EARN’s research findings, the definition of financial capability– that financial knowledge plus access to appropriate products equals financial success – needs to be expanded to include self-efficacy. To discuss this and other ramifications of EARN’s research, we invite you to join our upcoming webinar on this topic on Thursday, April 14. For more information and to register, email charlotte@earn.org.
Until next week,
Charlotte Hill
Communications Associate
