Financial Education: the Key to Rebuilding Trust in the Financial Sector

Financial Education: the Key to Rebuilding Trust in the Financial Sector

The financial sector has been plagued by issues of trust and transparency for years. We interviewed Ludovic Phalippou, a professor in Financial Economics at the Said Business School, University of Oxford. He is known for his extensive research in Private Equity and portfolio allocation. In the Netherlands, Pahallippou is one of the lecturers in the program ‘Certified Pensioenexecutive Vermogensbeheer’ of the Erasmus University Rotterdam. Phalippou emphasizes the crucial role of financial education in regaining society’s trust.

According to Phalippou, the lack of financial education among the general public and even among financial professionals is a big problem. Although finance plays a vital role in people’s lives, a mass of individuals lacks even a basic understanding of it. The professor: “This knowledge gap allows the few who do understand finance to exploit the ignorance of others for personal gain. This situation allows private equity firms for example to charge excessive fees without being held accountable.”

Uninformed decisions

Research conducted in the US into asset location shows that uninformed financial decisions lead to unfavorable outcomes. Phalippou: “People tend to invest in a uniform manner across all assets, regardless of their individual characteristics. For instance, if provided with a selection of 10 investment options, individuals typically distribute their investments equally among all options, so allocating 10% to each. Similarly, when presented with 20 options, the investments are typically divided evenly at 5% for each option.” According to the economist, financial professionals can take advantage of this situation by adding options with a high-risk profile to the menu. “If, for instance, eight bond funds and two equity funds are presented, individuals are more likely to heavily invest in bonds.”

The Reform of the Pension System

Because it is known that because of a lack of education financial decisions often lead to a bad outcome, it is, according to Phalippou, surprising that the Dutch pension system currently is in transition from a Defined Benefit (DB) to a Defined Contribution (DC) system. “There are a lot of problems with Defined Benefit systems, but at least, people know what they are doing. In a Defined Contribution system, you put the decisions in the hands of the people themselves and that’s dramatic. People usually make tons of mistakes.”

Divestment Policies

Professor Phalippou also criticizes the sustainable divestment policies that some pension funds recently embraced. “It is finance 101. Selling shares in oil and gas companies only represents a transfer of ownership from one party to another. But still, few people get this. If everybody knows these ‘sustainable’ policies will never change anything but are used for greenwashing purposes instead, we would talk about the right things that can make a real impact. Without greenwashing the conversation would be in a better place.”

Restoring Trust

To address the lack of financial education, it is crucial to prioritize financial education in the financial sector, according to the professor. “It all starts with educating finance professionals. If professionals are better educated, that is the purpose of programs like this one, they will be able to communicate more precisely and more accurately to a broader audience. Additionally, pension funds and other financial organizations must enhance their communication efforts, ensuring transparency and honesty in their operations.” Moreover, initiatives that focus on educating the general public about financial concepts and empowering them to make informed decisions are essential.

In conclusion, Ludovic Phalippou’s insights shed light on the main causes of the trust deficit in the financial sector. The lack of financial education, both among the general public and within the industry itself, is the most critical issue. By prioritizing education, promoting transparency, and communicating clearly, the financial sector can take significant steps toward rebuilding trust and ensuring a more accountable and sustainable future.

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