Talk – What research says about financial literacy and investment behavior

Michael, we conduct an annual financial literacy survey. What can you tell us about it? How would you assess financial literacy in Switzerland?

It’s rather modest. In our financial literacy survey, on average about 54 percent of the questions – that is, only 5.4 out of 10 questions – were answered correctly. This shows that there is still significant room for improvement across all segments of the population.

Why is financial literacy so important in the first place?

The link between education and wealth is very well documented. Cole et al., for example, wrote about «Smart Money» and shed light on precisely this connection. Higher financial literacy leads people to participate more in the capital markets and build more wealth over the long term.

Our study also shows that education and financial literacy are correlated, and that education is correlated with wealth and income. We see a statistical link there.

It’s not always clear what is cause and what is effect. Can you comment on that?

The study revealed that people with higher education answered 65 percent of the questions correctly, whereas those with lower education answered only 37.5 percent. That’s a huge difference. Education is the driver that ensures a person with higher financial literacy is well-informed and ultimately makes better investment decisions.

Should financial education be promoted among young people?

Yes, there are also some really interesting studies on this. A study by Elsa Fornero et al. titled «Four Bright Coins Shining at Me» examined the financial behavior of children and adolescents. Specifically, it focused on the allowance of children aged eight to twelve. This had a positive impact on their later life and financial decisions in adulthood. In short: Giving your children an allowance increases their financial self-confidence and financial literacy in the long term.

At the same time, we see major international differences in investment behavior. In the U.S., far more people invest in stocks than in Switzerland or Germany. Why is that?

I believe Switzerland is rather conservative when it comes to investment behavior. We don’t have a strongly developed stock market culture, but rather a culture of retirement planning and financial security. Americans are different in that regard. In the U.S., the 401(k) provides a strong incentive for workplace retirement savings. Additionally, it must be said that the capital market in the U.S. is naturally much more developed. They are the number one economy in the world.

There’s a lot of discussion right now about a possible AI bubble. What’s your take on that?

Valuations are currently high, especially when you look at the cyclically adjusted price-to-earnings ratio, or the so-called Shiller P/E. Historically speaking, however, true «bubbles» are rare.

Of course, we still have the financial crisis or the dot-com bubble in the back of our minds. But when we talk about it, it’s often not a bubble because awareness of it exists. You may still remember the dot-com bubble. Back then, people truly believed a new era had begun with the internet. A new section suddenly appeared in the newspaper: «The New Market.» Companies were listed on the stock exchange that generated no profits and virtually no revenue. When I think today of companies like Apple, Microsoft, Amazon, Google, or Meta, which benefit from heavy investment in AI, these are companies with large margins and substantial profits.

What role does psychology play in investing? You recently published an article titled «Psychology of Investing – How Automation Reduces Bias,» which discusses how automation reduces our bias. Can you tell us more about that?

I’d like to start with intuition. As children, we heard from our parents or friends: «Just trust your gut.» But that has no place in the capital markets. The capital markets operate on probabilities, not emotions. But we humans simply love stories. Our brains and our intuition prefer narratives and ignore probabilities. Tversky and Kahneman studied this as early as the 1980s. A very simple example:

Linda is 31 years old, single, open-minded, and very intelligent. She studied philosophy, was deeply concerned about discrimination and social justice as a student, and participated in anti-nuclear demonstrations.

Which is more likely?

• (A) Linda is a bank employee.
• (B) Linda is a bank employee and a feminist.

Most people choose (B) – even though it is mathematically impossible for it to be more likely than (A) alone. This is the conjunction fallacy.

If I may touch on another topic or study, it is the one by Thomas Dohmen et al. from 2009. It’s a wonderful paper in which over a thousand people were interviewed. They were asked: «How likely is it that the coin will land on heads when tossed?» They wrote down the previous coin tosses and said: «Tails, tails, tails, heads, tails, heads, heads, heads.» What do you think? What is the probability that it will land on heads now? The correct answer is 50 percent, since coin flips are independent of one another. 60 percent of those surveyed knew that what happened before doesn’t matter when flipping a coin. But there you go: We’re only partially rational. We look for patterns, and when we find one, we believe it must continue that way.

And how can you protect yourself from this?

Automation helps enormously: Those who invest regularly and stick to clearly defined rules avoid these psychological traps.

So, a rule-based approach rather than gut feeling?

Exactly. Instead of constantly searching for the perfect entry point, you should invest consistently and for the long term, for example through broadly diversified ETFs. This automatically takes advantage of the dollar-cost averaging effect. I recommend a very simple «buy-and-hold» strategy, and that’s over decades, not just weeks or months.

But many people struggle with this. Why do we so often overestimate ourselves?

Our intuition thinks, if I may say so, in black-and-white terms. A good story is also a good stock. An example is Elon Musk. A bad story, on the other hand, is a bad stock. But the stock market – or the capital market – is multifaceted. Market movements are influenced by numerous factors. Yet this narrative, which our intuition believes in, gives us an illusion of control. We think we can assess the situation quite well simply because Elon Musk is doing this or that. In doing so, we don’t even look at what the margins and return on equity look like, or how well the companies are managing our money. Are revenue and profits growing? Those are actually the numbers you should rely on.

What specific advice would you give to investors?

I believe that education – and financial education in particular – is like a compass that guides you through life. It’s about staying the course and investing in broad-based index funds over the long term.

Michael, thank you very much for the fascinating conversation. It was a pleasure.