What has Education got to do With It?
Does financial literacy inoculate against fraud? Is someone's superior financial understanding more likely to prevent an investment scam or fraud? For some, the question appears odd because they believe that scams self-announce their character as "too good to be true."
But, we now have some empirical data from the NASD - Investment Education Foundation which demonstrates the exact opposite conclusion. Smarter people, especially self-reliant males are prone to investment scams. With luck, this is the beggining of a reasonable fraud protection program, which relies upon the science of influence and not formal economics.
The NASD Investor Fraud Report concludes that:
* Investment fraud victims are more financially literate than non-victims;* Investment fraud criminals use a wide array of different influence tactics--from friendship to fear and intimidation tactics--to defraud the victim;
* Fraud pitches are tailored to match the psychological needs of the victim;
* Investment fraud victims are more likely to listen to sales pitches;
* Investment fraud victims are more likely to rely on their own experience and knowledge when making investment decisions;
* Fraud victims experience more difficulties from negative life events than non-victims;
* Investment fraud victims are more optimistic about the future;
* Investment fraud and lottery victims dramatically under-report fraud. (my emphasis)
The report has an number of other interesting observations, and you should read it in its entirety.
The science behind the survey is provided by Anthony Pratkanis, one of the co-authors of Weapons of Fraud., which I highly recommend reading also.
One useful finding in the report, is about the difference between the victims of investment fraud, which are primarily self reliant men, and lottery fraud, which are widows that are relatively deprived. This important because telemarketing fraud is easier to handle: buy an answering machine and don't call back until you have counted to a thousand. And maybe not even then.
But I want to focus on the report's conclusion that "Investment fraud victims are more financially literate than non-victims." This conclusion is based upon the finding that investment victims answered eight financial questions correctly at a rate of 57.5% versus 41.% by non-victims, which would not be predicted by chance alone.
Lottery victims were significantly less financially astute answering only 31.1% of the answers correctly.
One question both victims and non-victims of investment fraud did poorly on was on the effect of diversification and risk. The relationship between true diversification and risk, measured as variance from the mean, entails that diversification lowers risk. But both groups got it wrong: the lottery victims stunningly so, with around 10% correct answers.
Although the report concludes that more general financial knowledge is necessary, it points out that it is not financial knowledge which prevents frauds. Better financial knowledge may lead to better overall capital allocation amongst real companies, but it is not a cure for the common illusions that enable con criminals to succeed. This limitation on rationality should not surprise people: even when you know how the illusion of magic is done, you cannot prevent your eyes from "seeing" the illusion.
