Literacy is being able to read and write; maths literacy is being able to count and master simple operations; but what is financial literacy? This phrase appeared in the late 1990s and it means knowing enough about finance to take the most appropriate decisions with money.
How do we know if we are “financially literate”?
Financially literacy is not easy to measure. Many governments or international organisations like the OECD have started these last five years to measure the financial literacy… or rather illiteracy to get a better picture of the problem. They do surveys on how much people save for their future, if they can calculate compound interest, if they can explain how a credit card works, how much debt they have, what kind of investors they are, what insurance is all about, etc… What makes it difficult to measure is that pure knowledge (calculating interest for example) is only a small part of financial literacy. Applying knowledge to everyday life requires skills and motivation.
The different levels of financial literacy:
- Level 1: Knowledge: Financial literacy basic bricks (its “alphabet”) are financial concepts or techniques like interest, or understanding what a stock is, or how to read a bill or a salary slip, or checking a bank statement, or tracking expenses.
- Level 2: Skills: the second level is to be able to use this knowledge: for example, how to compare two loan offers, how to decide between two deals, how to write a budget and use it to save. This second level often involves maths, and may put off those of us who hate numbers and calculations.
- Level 3: Behaviour: The third level consists of integrating this knowledge in our behaviour: changing behaviour is difficult and takes time. Studies – especially on investment – have shown how irrational human beings behave! One key aim of financial literacy is that people should understand the risks they take: by overspending with their credit cards, or by not saving enough now for emergencies or retirement, or by constantly buying and selling stocks and trying to time the market… and losing money on stocks and fees.
Are we less “financial literate” than our parents?
Why are governments getting worried now? Has financial illiteracy worsened? Or is it a new problem? Yes… and yes! Financial illiteracy seems to have worsened as younger generations have lower scores in the surveys than their parents, which may also show that parents may not “educate” their kids financially and rely on life experience and school to do it. But only a few countries, like Australia and New Zealand, include financially literacy in their school curriculum. For other countries, even though governments place great emphasis on financial literacy, programmes are still experimental, mostly developed by non-governmental actors (NGOs, banks, other providers) and extra-curriculum. And changing curriculum takes a lot of time, negotiation and consensus!
Challenges are bigger
Many factors contribute to worsening financial literacy scores. First, the required level of understanding finance is getting higher. A few generations ago, most people had only one current account and possibly one savings account, at the same bank and no credit card (let alone ten!). They only borrowed money to buy a house; interests were fixed. Understanding financial services was much easier. Pushing a bank’s door was less intimidating. Bank services, insurance products and investments are now far more complex. Finance people use difficult jargon and people are afraid to ask questions. Actually some journalists or experts use the phrase “financial education” to only refer to understanding financial services and system. This shows that this is a big part of the problem (but we believe not the only one). On the other hand, as most banks design financial literacy programmes, the difference between objective knowledge and marketing has blurred. Banks make no secret of using financial literacy programmes as a marketing tool. In developing countries, as microcredit institutions have become major financial services providers, financial literacy programmes are often packaged with microloans and aim to keep the default rate as low as possible. Our view, as independent financial literacy provider, is that understanding financial products is only one part of being financially literate and that an effective programme to help people take better decisions with their money need to include communication, managing emotion and peer pressure, ethics and self-control.
Shift from public to individual responsibility
Another big change which makes financial literacy even more crucial now than for our grandparents is that governments will not be able to pay for our retirement while life expectancy is getting longer and longer. Until now, many retirement systems are still public money: the governments pay for it through taxes. But as more and more people retire and live longer, retirement financing has become a threatening issue. So governments expect people to take care of their retirement by themselves… by saving.
Savings or spending, this is the question!
At the same time, savings rates, especially in the US, have gone down in a few generations, partly because there are so many cool things to buy now! And things which were “wishes” have gradually shifted to the needs category! The exponentially growing choices of purchases make deciding even harder and the option of not spending often gets left out. But marketing and advertising are not the only pressure to consume more and more: most government economic policies aiming to boost employment and GNP growth rely on consumption.
The debt burden
Over-consumption is not the only challenge to savings. The job market is also less secure: working in the same company for a whole life is an exception now. Lastly, the most worrying challenge is debt: many people all over the world finance their consumption, pay for their emergencies or other expenses with debts. Credit cards debt, loan pay debts, shark lenders, overdrafts, etc… debts are putting ever spiralling pressure on our future incomes as all these debts bear interest. To make things worse, over the last decades, the cost of university and education has risen sharply and many students both in the developed world (especially in the US and England) and developing world start their professional lives with a huge debt burden.
At government level too, debt is a major way to finance public expenses and a burden that this and future generations will have to carry. Debts instruments are major financial components of the financial markets and contribute to ever growing disconnection between the real economy and the financial systems. Financial illiteracy at individual level has far deeper impact on today’s world: by ignoring how finance and economics work, world citizens fail to actively contribute to public decisions and let “experts” and financial specialists take decision and in fact, deprive them of their full exercise of democracy.
Benefits of learning finance:
Managing money and getting knowledge about money will help you and your target groups:
- To have enough money for living
- To be able to achieve goals
- To keep money for emergencies and not let emergencies makes us more vulnerable
- To prioritise our expenses according to what we really value
- To plan and see farther than the end of the day
- To anticipate future expenses
- To be able to help others
- To be more mindful of the “financial print” we leave behind
- To grow as actively aware economic citizens and not just consumers and borrowers.