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Financial Literacy: A Guide for Your Whole Family

Schematic of Financial Literacy EvaluationIntroduction

As a follow-on to our previous article – “Financial Literacy for Your Kids and Teenagers“, the goal of this article is to provide you with a comprehensive guide, for your whole family, to “Financial Literacy” – what it means, its importance relevant to everyday life and how you rate as being “financially literate”. Additionally, we have also given you some links to resources that could help you and/or other family members improve your understanding of financial matters.

What Do We Mean by Financial Literacy?

Financial literacy is the ability to understand and effectively use various financial skills, including personal financial management, budgeting, and investing. When you are financially literate, you have the foundation of a relationship with money.

Why Financial Literacy Matters

Financial literacy matters at many levels. From day-to-day expenses to long-term budget forecasting, financial literacy is crucial for managing these factors. It’s important to plan and save enough to provide adequate income in retirement, while avoiding high levels of debt that might result in bankruptcy, loan defaults, and foreclosures.

FINANCIAL CAPABILITY

What is Financial Capability?

Financial capability refers not only to the knowledge needed to make sound financial decisions. It also refers to a combination of financial knowledge, skills, attitudes, and confidence that leads to positive financial behaviours and money management decisions that fit the circumstances of one’s life.

Are Australians financially literate?

Within Australia 63% of men and 48% of women demonstrate an understanding of at least three basic financial literacy concepts. If understanding three basic financial literacy concepts can be considered financially literate, then these statistics suggests that around 8.5 million (or 45%) adults in Australia are financially illiterate(Credit: Professor Alison Preston UWA Business School March 2020)

Let’s explore each of the above a little further…..

What Do We Mean by Financial Literacy?

What are the Principles of Financial Literacy?

There are five broad principles of financial literacy. Though other models may list different key components, the overarching goal of financial literacy is to educate individuals on how to earnspendsaveborrow and protect their money.

There are a number of ways of measuring financial literacy. A common approach is to define a person as financially literate if they can correctly answer three questions (commonly known as the Big-3) testing knowledge related to three key financial literacy concepts. These include:

  1. An understanding of interest rates, especially compound interest;
  2. An understanding of inflation; and
  3. An understanding of diversification.

The actual number and complexity of the financial literacy questions included in various surveys differs depending on the focus and length of the survey. A survey conducted by HILDA ( Household, Income and Labour Dynamics in Australia) in 2016 is a large and detailed survey, thought time only permitted the inclusion of five financial literacy questions. The questions followed international best practice and were as follows:

Q1: Interest Rate: “Suppose you put $100 into a no-fee savings account with a guaranteed interest rate of 2% per year. You don’t make any further payments into this account and you don’t withdraw any money. How much would be in the account at the end of the first year, once the interest payment is made?”

Q2: Inflation: “Imagine now that the interest rate on your savings account was 1% per year and inflation was 2% per year. After one year, would you be able to buy more than today, exactly the same as today, or less than today with the money in this account?”

Q3: Diversification: “Buying shares in a single company usually provides a safer return than buying shares in a number of different companies.” [True or False]

Q4: Risk: “An investment with a high return is likely to be high risk.” [True or False]

Q5: Money Illusion: “Suppose that by the year 2020 your income has doubled, but the prices of all of the things you buy have also doubled. In 2020, will you be able to buy more than today, exactly the same as today, or less than today with your income?” Respondents also had the option of a “don’t know” response or a “refuse to answer” response.

The results obtained are reflected in the statistics quoted in the first section of this article regarding the literacy/illiteracy of Australians.

Key Points

Being financially illiterate can lead to several pitfalls, such as being more likely to accumulate unsustainable debt burdens, either through poor spending decisions or a lack of long-term preparation. This, in turn, can lead to poor credit, bankruptcy, housing foreclosure and other negative consequences.

Image of quote by Albert Einstein on the magic of compound interestAlthough many skills might fall under the umbrella of financial literacy, popular examples include household budgeting, learning how to manage and pay off debts, and evaluating the trade-offs between different credit and investment products. These skills often require at least a working knowledge of key financial concepts, such as compound interest and the time value of money.

Other products, such as mortgages, student loans (HECS), health insurance, and Self-Managed Superannuation Funds (SMSFs) accounts, have also grown in importance. This has made it even more imperative for individuals to understand how to use them responsibly.

Image of Risk Tolerance chartFinancial literacy can cover short-term financial strategy as well as long-term financial strategy, and which strategy you take will depend on several factors, such as your age, time horizon, and risk tolerance. Financial literacy encompasses knowing how investment decisions made today will impact your tax liabilities in the future.

This also includes knowing which investment vehicles are best to use when saving, whether for a financial goal like buying a home or for retirement. This is not to add the novelties in finance such as digital money, buy now/pay later (BNPL such as After-Pay, Zip and the like), P2P lending, and other new financial products that can be convenient and cost-effective but require potential consumers to be educated to assess them adequately to their advantage.

Why Financial Literacy Matters

Financial literacy matters at many levels. From a social welfare perspective, it obviously matters greatly whether or not people are able to manage their financial affairs wisely and live within their means. 

For individuals and families, the benefits of financial literacy, in other words – “being good with money” – are well understood. The financially discerning parent recognises the wisdom of sound financial planning from an early age and, by doing so, improve their children’s chances of them achieving their financial goals.

Regarding for your own goals as an adult, these might commonly include the purchase of a family home – usually by combining savings and a sensible amount of mortgage debt, putting enough money to one side for the education of children and, importantly – making suitable provision for old age. The financially educated are also quick to appreciate the importance of making additional personal contributions to their superannuation – at least if they want to live comfortably in retirement.

The costs of being financially illiterate, that is, “being bad with money” – are equally apparent. Those who go through life making poor financial decisions will inevitably end up with a far lower standard of living than was otherwise achievable. As it happens, the opportunities for making poor financial decisions come thick and fast through life. Many of these – particularly for the young – are associated with easy access to credit and the ‘buy now, pay later’ marketing of many retailers. For some people, this fuels poor spending habits – indiscriminate and compulsive spending behaviour – which leads on, in turn, to spiralling debt problems. And as we all know, it’s no easy matter to get out from underneath a heavy debt burden.

And of course, there are those individuals and families who budget carefully and spend wisely but still fall into costly financial traps. It is often astonishing to learn just how easily otherwise sensible people can be parted from their hard-earned money. This usually occurs in one of two main ways. Some people fall prey to straight-out financial ‘scams’ or frauds – offers that ‘seem too good to be true’ and are. Others – especially in a low-inflation, low-interest rate environment, are tempted to go off in search of investments offering far higher returns without completely understanding that these higher returns are likely to go hand-in-hand with much more risk. We have all too many examples in Australia of personal investors, often retired couples, losing their life savings by investing in property-related ventures where the returns were high but so was the underlying risk, which was, admittedly, often quite well camouflaged.

The Benefits of Financial Literacy

Holistically, the benefit of financial literacy is to empower individuals to make smarter decisions. More specifically, financial literacy is important for a variety of reasons:

  • Financial literacy can prevent devastating mistakes: Variable rate loans may have different interest rates each month, while traditional superannuation account contributions can’t be withdrawn until retirement. Seemingly innocent financial decisions may have long-term implications that cost individuals money or impact life plans. Financial literacy helps individuals avoid making mistakes with their personal finances.
  • Financial literacy prepares people for emergencies:Financial literacy topics such as saving or emergency preparedness get individuals ready for the uncertain. Though losing a job or having a major unexpected expense are always financially impactful, an individual can cushion the blow by implementing their financial literacy in advance by being ready for emergencies.
  • Financial literacy can help individuals reach their goals: By better understanding how to budget and save money, individuals can create plans that set expectations, hold them accountable to their finances and set a course for achieving seemingly unachievable goals. Though someone may not be able to afford a dream today, they can always make a plan to better increase their odds of making it happen.
  • Financial literacy invokes confidence:Imagine making a life-changing decision without all the information you need to make the best decision. By being armed with the appropriate knowledge about finances, individuals can approach major life choices with greater confidence realising that they are less likely to be surprised or negatively impacted by unforeseen outcomes.

Financial Capability

To reiterate the reference to “Financial Capability” in the first section of this article –

What is Financial Capability?

Financial capability refers not only to the knowledge needed to make sound financial decisions. It also refers to a combination of financial knowledge, skills, attitudes, and confidence that leads to positive financial behaviours and money management decisions that fit the circumstances of one’s life. Therefore, it can be said that:

  • Financial knowledge is an individual’s awareness and understanding of money and financial concepts, products and services, and their own financial situation.
    • Examples of financial knowledge include understanding financial concepts such as inflation, interest and risk, as well as knowing where to get advice and support.
  • Financial skills are hard and soft skills that give an individual the ability to use relevant knowledge to manage financial risks and opportunities. Financial skills are supported by general skills such as literacy, numeracy, problem‑solving, communication and critical thinking.
    • Relevant skills include an individual’s ability to compare financial products and avoid financial pitfalls such as scams.
  • Financial attitudes refer to an individual’s mindset and opinions about finances.
    • Examples include an individual’s motivation to engage with their finances, financial impulsivity and their levels of stress associated with making financial decisions.
  • Financial confidence is the belief an individual has in their own abilities to access and use financial products and services, make financial decisions and accomplish financial goals.
    • For instance, being comfortable talking about money and being comfortable managing their own finances.
  • Positive financial behaviours refers to actions that an individual takes to improve their financial outcomes, and can be broadly divided into those involving managing money day‑to‑day and those related to planning for the future.
    • Some positive financial behaviours include managing debt and credit use, making savings goals and tracking spending.

 

An improvement in each one of these elements improves an individual’s financial capability. They also build upon each other: knowledge enables skills, skills enable better attitudes and confidence, and they all may lead to the ultimate goal of behavioural change. There is a feedback loop in the development of these attributes – the development of each positively reinforces the others.

How Financially Literate Are Teenagers?

Financial Literacy Rates for Teenagers and Adults ChartThe above chart shows the extent of financial illiteracy amongst teenagers (aged 15-17) in Australia (comparisons are also made with adults). There are no statistically significant differences in the financial literacy rates of teenage males and females across Australia’s States and Territories.

In 2016 only 28% of teenage males and 15% of teenage females were able to correctly answer all of the Big-3 financial literacy questions. This is significantly less than the mean share for adults (the non-patterned bars). There is also a large gender gap. The low level of financial literacy amongst young people is particularly concerning given the range of financial decisions that young people are increasingly required to make, including decisions about investing in education, saving, credit cards etc. It’s quite clear from the above that the observed gender gap in financial literacy in adulthood stems from gender gaps in financial literacy that have emerged during the teen and pre-teen years.

Interventions to increase the financial literacy of young people could, therefore, be expected to raise the financial literacy of people in adulthood. Understanding the determinants of financial literacy amongst young people is, therefore, an important research priority. Studies that have and are investigating this, suggest that there is an important household transmission effect, particularly between mothers and daughters.

Fortunately, some Government Authorities are starting to step up to alleviate this situation. For instance – the NSW Treasurer’s Financial Literacy Challenge, launched in 2022 for students from Kindergarten to Year 10, will be expanded to include Years 11 and 12 students under a new partnership with Chartered Accountants Australia and New Zealand. Content for Kindergarten to Year 10 students will also be updated to ensure students understand, and are able to make the most of, financial initiatives such as the new Kids Future Fund account.

Another example is the initiative of Tasmania’s ATSC (Office of Tasmanian Assessments, Standards & Certification), in support of the Australian Government’s National Financial Literacy Strategy through its agency the Australian Securities and Investments Commission (ASIC).

As an overview of the Course being conducted by them, the following Compulsory Components are addressed within the Course Curriculum:

  • Financially, what do I want from life?
  • How do I set financial goals?
  • How do I reach those goals?
    • Short term, medium term and long term goals
  • How do I make wise financial choices?
    • How do I set up a bank account?
    • How do I use a debit card and a credit card?
  • How do I draw up a personal budget?
    • Income, fixed and variable expenses, savings
    • Budget adjustments
  • What sort of risks might I meet?
    • Role of insurance
    • Job loss, income variations
  • What if I need to know more?
    • Who or where from?
    • What is the ‘objectivity’ of this advice?
  • What if I cannot afford something I need?
    • The benefits and pitfalls of borrowing money
  • Do I stay at school or go to work?
    • What is HECS?
    • What is the GST?
    • What is the role of the ATO in my life?
    • What is superannuation?
    • How do I build a financially secure future?

Elective Component

At least ONE activity must be chosen from the following list. Learners use provided and collected information about the activity, work out the cost of the activity and if they can afford it, make a suggestion as to an appropriate course of action based on that information and state why they made that suggestion.

  • Buy the first car
  • Select a mobile phone plan
  • Plan a holiday
  • Buy or rent a property.

HOWEVER, although some governments and various teaching institutions are delving into the financial literacy regime, it is our view that it’s the parents who must ultimately take responsibility for the judicious financial education of their children.

How FBA Can Help You With Your Family's Financial Literacy

At Family Business Advisory (FBA), our purpose is to help family businesses succeed on a sustainable basis. As such, we provide you with access to specialist family, business and technical services with a goal being to generate opportunities for families in business.

Our Co-Founder, Phil Manhire, is well-versed and well-experienced in teaching children of all ages from 6-18 years of age, both here in Australia and overseas. This of course is well-backed-up by the investment and wealth management expertise of our other highly-experienced Co-Founder, Tony Skinner. 

In order to complement our own particular specialised skills, over the past several decades, we have also developed a network of trusted, professional advisers in such areas as:

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Moreover, we work at all times to give you peace of mind and proactive support to help navigate any changes in the market brought about by legislative changes, geopolitical events and general market conditions – all to maximise your personal wealth and security.

These services are provided by FBA, in association with the Wealth IQ Group.

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