Rules of Thumb

MAKING FINANCE SIMPLE USING RULES OF THUMB AT THE POVERTY ACTION LAB

http://www.povertyactionlab.org/finance-microfinance

A simplified financial training based on “rules of thumb” improved business practices and outcomes among microentrepreneurs in the Dominican Republic, while standard, fundamentals-based accounting training produced no significant effect.

Individuals and business owners have to make many financial decisions that are critical for their success and well- being. Yet in both developed and developing countries, research has shown that a large fraction of the population is unprepared to make these decisions. A good understanding of simple financial concepts can potentially lead to better business decisions and, ultimately, greater household welfare. The challenge is to determine not only whether training programs can improve financial practices and outcomes, but also how to teach financial literacy more effectively.

A randomized evaluation implemented by ideas42 and conducted by J-PAL affiliates Greg Fischer and Antoinette Schoar, along with Alejandro Drexler, tested the impact of financial training on both firm-level and individual outcomes1. The researchers also investigated how the content and complexity of training influence its effectiveness.

Specifically, the researchers tested two distinct types of financial training offered to existing clients of a microfinance institution in the Dominican Republic: (1) a standard approach, similar to what is currently in use by many large development organizations, which teaches the fundamentals of financial accounting; and (2) a simplified training based on financial rules of thumb.

• The rule-of-thumb training produced significant improvements in financial practices.

Microentrepreneurs in the Dominican Republic who learned the rules of thumb were more likely to report separating business and personal accounts, keeping accounting records, and calculating revenues than those in the comparison group who received no training.

• The rule-of-thumb training had positive impacts on business outcomes. In particular, it led to increases in the level of sales during self-reported bad weeks, suggesting that training helped participants to better manage negative shocks.

• On the other hand, a standard, fundamentals-based accounting training produced no significant impact along these same dimensions. Results from the evaluation and follow-up visits to the clients suggest that the accounting training was harder to understand and to incorporate into the everyday running of a business.

THE FULL ARTICLE CAN BE FOUND IN THE PSYCHOLOGY OF MONEY SECTION OF THIS BLOG