Financial Literacy Courses – A Bad Idea?

In an interview on CBC The 180,  Daniel Munro, Associate Director, Public Policy at The Conference Board of Canada, and an ethics lecturer at the University of Ottawa, asks the question: Do mandated high school financial literacy courses do more harm than good? I urge you to listen to the podcast of the entire episode, and read the piece he wrote for Macleans on the same topic, but essentially he bases his argument on three points.

1. As usually structured, such courses give an incorrect view that making good financial choices is all that is important (neglecting circumstances). 
2. The evidence suggests that the positive impact of mandatory financial literacy courses is short lived.
3. There may be misplaced over-confidence from taking a single financial literacy course, actually contributing to bad financial choices made later in life.

In March I argued that we need more financial literacy, and I stand by that assertion. I am glad to see that in various parts of Canada there are new initiatives to support enhanced financial literacy.

However, I think that Daniel Munro's interview is a wake up call to make sure that we have the right sort of financial literacy education. Also, we must do the research to make sure that financial literacy courses are actually contributing to improved long term outcomes.  Let us look at the three points from the Daniel Munro interview.

(1)  He argues that courses, at least as currently formulated in the grade 10 course about to become mandatory in Ontario, place too much emphasis on just one element of financial decisions, making good choices.  While clearly good choices matter, he argues that this emphasis in the absence of a consideration of circumstances, is at best incomplete.  Circumstances of many types, including family circumstances and obligations, costs of living in your region, educational opportunities, natural abilities, and much more, all contribute to the right financial decision in a situation. In his Macleans piece Daniel Munro states the case clearly and powerfully as follows:

"...fairness and responsibility argue that while people ought to be responsible for what results from their choices, they should not be responsible for what results from circumstances that are beyond their control..."

(2)   With respect to the long term impact of mandated financial literacy courses, he points out in the Macleans piece that research evidence supports the idea that financial literacy course impact is limited.  He mentions a meta analysis of 168 research papers covering more than 200 studies on effectiveness of financial literacy courses.   While I have not read that analysis in detail, I am familiar with this report by Shawn Cole, Anna Paulson, and Gauri Kartini Shastry that looked at the effectiveness of mandated financial literacy courses in the US, where in some states there is a history of sufficient length to study such effects. The report is a white paper of the Harvard Business School, and is entitled High School Curriculum and Financial Outcomes: The Impact of Mandated Personal Finance and Mathematics Courses. I quote from part of the abstract of the paper that gives a clear indication of the results:

"Financial literacy and cognitive capabilities are convincingly linked to the quality of financial decision-making. Yet, there is little evidence that education intended to improve financial decision-making is successful...this paper answers the question 'Can good financial behavior be taught in high school?' It can, though not via traditional personal finance courses, which we find have no effect on financial outcomes."

Interestingly, the paper goes on to show that more mathematics education can lead to enhanced long term improvements in financial decision making and investment participation.

(3)   We all know that over-confidence can be dangerous, and this certainly applies to financial decision making.  Daniel Munro cites a 2014 study by Marc Kramer that found that

"...confidence in ones‘ own (financial) literacy is negatively associated with asking for help, while actual expertise does not relate to advice-seeking"

While I firmly believe that finance and investment education is a positive, his remarks remind us that part of that education must be a clear understanding of the limitations of understanding, and the value of seeking advice.  As mentioned in my previous post,  I prefer a spiral approach to financial education, starting in elementary school and extending throughout life.

I believe that mathematics education has a longer impact than financial literacy courses due to two factors.  Mathematics education tends to be taught in a very active learning mode: most mathematics educators realize that you learn math by doing math (including discovering some relationships on your own), not by having it explained to you.  There is an important lesson here for financial literacy teachers.

The second reason is that mathematics education emphasizes concepts and techniques with broad application, and through those applications it keeps getting used regularly. I think that a similar approach is necessary for successful financial literacy courses, and "one of" financial literacy efforts will be doomed to failure.

I have been working for some time on a future post that will present my ideas for a different kind of university based financial education course.  That will stress active learning, quantitative reasoning, and the link between financial decisions and positive public policy. Sign up to follow this blog and you will receive each new post directly to your email, complete with all hyperlinks (and no advertisements!).

I would love to hear your opinions, either through the comment section or through an exchange on Twitter.

 The writer is not a financial planner or investment advisor, and reading this column should not be interpreted as obtaining individual financial planning or investment advice.  While an effort has been made to be accurate, any statements of fact should be independently checked if important to the reader.

Added note: I have added material to the original posting based on his Macleans article, and the linked studies therein, that I did not know about at the time of the original posting.

Do XAW, VXC Represent Global Stock Market ?

Do you know what proportion of the global stock assets are represented by US markets? those in Canada? Europe? China? A surprising number of investors have either vague or out of date answers. This post will provide some data on the global equity space, along with reflections on how that might inform your investing choices.

While most investors exercise some degree of home country bias,  for a variety of good reasons, it makes sense to invest globally. In this posting I propose a simple idea: why not invest in different markets according to the size of those markets?

Some Data

The size of economies is somewhat different from the size of equity markets in those countries, and it is a good question whether we should use stock market or economy size. I will work with stock market valuations in this post.

There are about 60 stock markets globally, and their valuations are shown in a really nice data visualization here. You can get the raw data with the most recent statistics here from the World Federation of Exchanges.

Kim Iskyan wrote an article for Asia Wealth Investing Daily in November, 2016 that provides statistics (taken from Bloomberg) on the sizes and growths of different national stock markets, with a look at the top ten. You can read his report here courtesy of Stansberry Churchouse Research.

Not surprisingly the US stock market is the largest by a significant factor, at 36.3% of the total.   China was second, at 10.1%, followed by Japan at 7.9%, Hong Kong at 6.3% and UK at 4.6%. Canada, followed by France, Germany,  India and Switzerland complete the top ten.

 If we accept the premise of investing globally in proportion to equity assets, about 36% of your equity investments should be in the US, 10% in China (with another 6.5% in Hong Kong),  8% in Japan, about 3% in Canada.

The World It Is A Changing

The article cited earlier points out that a fairly dramatic change in the relative capitalizations of different markets is taking place.  For example, from October 2003 to 2016, the US stock market while increasing in an absolute sense, dropped as a fraction of global stock assets  from 45.2% to 36.3%. The big increases were all in Asia, with China going from 1.5% in 2003 to 10.1% in 2016, Hong Kong from 3.0% to 6.3%,  and India from 0.8% to 2.6%. Stock markets in Europe and Japan all fell as a global percentage. Interestingly the Canadian market, with a slight rise from 2.6% to 2.9%, was the only top 10 'developed' market to show an increase.

 Do XAW and VXC Represent World?

So how would you build an ETF portfolio consisting only of TSX listed ETFs that faithfully represented the entire global equity market. While specialized ETFs representing almost any market now exist, and you could build an ETF portfolio to almost exactly represent the world's equity markets, the MER would be high for so the many specialized products.

Most use ETF products like XAW from iShares or VXC from Vanguard Canada to represent most of the world.  These track different indices, with XAW tracking the MSCI while VXC tracks the FTSE global index.

Both XAW and VXC have excess weight on the US equity market, with XAW at about 54% and VXC at almost 56%, whereas the actual size of the equity markets suggest that only about 36% should be in US equities. Both under represent  emerging markets, with a total emerging market share of 11.5% in XAW and 7.8% in VXC currently. Note that VXC does not include any Canadian equity at all, so you should include at least 3% of your investments in a broad Canadian ETF such as VCN or XIC.

A simple way to make your global equity ETFs more representative of the entire world is to include about 20% of your holdings in XEC or VEE emerging market ETF (even though there are emerging holdings already in the XAW and VXC).  This would reduce the US holdings to about 44%, neareer to the 36.1% of the global equity assets, and similarly for other developed markets.

Another option would be to make up your global holdings using VEF (developed markets except the US, but including Canada), VUN (or some other widely represented US holdings) and XEC (or VEE) for the emerging markets component.  In this way you can adjust your US, other developed and emerging market holdings to the exact amounts you desire. If  Scotia iTRADE is your discount broker, VEF and XEC are both commission free to buy and sell, making this option even more attractive.  If you want to include China as a separate component, ZCH could be used, although remember you do have China represented in XEC or VEE. Also, the number of individual stocks within ZCH is limited.  If you want to add some Canadian home market bias (see below), XIC or VCN (or many others) could be added.

But I Want to Minimize Risk!

While it is natural to look backwards, as the excellent book The 3 Simple Rules if Investing reminds us: only look forward. It is true that volatility has in the past been greater in emerging markets. However, with high developed market equity valuations, unusually low interest rates, and political uncertainty in several developed economies, it can legitimately be asked whether the more governmentally controlled 'emerging'  economies such as China may offer lower future volatility.

Just as passive investors are urged to own all (or really a major part) of a domestic market,  it could be argued that the same principle would argue to hold most of the world equity assets proportionately in a global equity portfolio. 

Why Home Bias?

I'm sure they have been written, but I can't recall reading an investment commentary on the virtue, or lack thereof, of home bias.  This is a topic for a future column, but I considered reasons that you would want to show some home bias in your investments.

• Your income needs are related to the inflation rate in your home economy, so significant Canadian holdings make sense.
• As we argued in a post about holding individual stocks, it makes sense to invest in what you best understand, and that for most is the Canadian market.
• While government intervention is only one of many factors, it does influence the rewards and risks of different types of investments. You will understand the political climate of your own country best.

Only you can decide what amount of home bias you want to have in your investments.  It probably makes sense to have less home bias in your accumulation phase than in retirement when you are withdrawing regularly from your funds.

Concluding Thoughts

Of course there are good reasons to not weight investments only according to the relative size of that countries equity assets.  For example, risk will vary in different countries. Also, average valuations, as expressed by P/E or other measures, may be significantly different in different regions.  Also, we know the North American stock market much better, and that familiarity might help us make better choices.

You should expect more than a rule of thumb about what fraction to be held in Canada, US and internationally based on the situation of ten years ago.  Make sure that your financial advisor discusses international holdings, and in particular emerging economies, in a current, evidence based fashion. If you do decide to have extra North American assets, make sure that it is a deliberate choice.

The international ETF space continues to change, so make sure to investigate the holdings of each ETF with current data before you make any decisions. We will be reviewing emerging market ETFs in a future post.

This posting is intended for education only and should not be considered investment advice. The reader is responsible for their own financial decisions.  The writer is not a financial planner or investment advisor, and reading this column should not be interpreted as obtaining individual financial planning or investment advice. For major financial decisions it is always wise to consult skilled professionals. While an effort has been made to be accurate, any statements of fact should be independently checked if important to the reader.

Disclosure:  The author of this column holds the following ETFs mentioned in this article in one or more account I manage: XEC, XIC, VCN, VEF and VXC.  I use Scotia iTRADE discount brokerage services.  No compensation by any company has been offered, requested or received for writing this column.