John Hoffmire: The inexorable logic of financial literacy
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The future of humanity is irrevocably tied to empowered individuals capable of discharging their obligations and responsibilities. Literacy was a key enabler in our collective civilizational advance. In a similar vein, the evolving context is placing big financial burdens on individuals, demanding an enhanced level of financial ability.
Should we continue to trudge in a cloak of fatalism where financial well-being is tethered to the benevolent designs of vigilant legislation or do we let the markets make provision for this good? Concerns about poor financial decision-making and weak consumer protection have elicited feverish regulatory and legislative responses. The overriding intent is to empower consumers about personal financial management and the role of economic literacy as an antidote to limited individual financial capabilities.
The global financial crisis, rapidly changing economic climate, bewildering array of financial products, increased life expectancy and greater focus on personal investment management have brought a heightened attention to financial capabilities and fitness. The complexity of the financial terrain calls for a more effective response than is provided by a simple combination of “a parent-like government” and service providers, often companies that also sell investment products.
The market forces will only help consumers overcome their fallibilities while the incentives to such interventions align with their interests. There is some evidence suggesting that markets help individuals surmount the affliction of limited financial capabilities. But a financial services company with a product to sell seldom helps naïve consumers in all the ways they need. Opaque and complicated fee structures are pandemic in the market and their very existence is a testament to all too common customer frailty and fallibility.
Though far from conclusive, academic studies shed some light on the positive correlation of financial literacy with planning for retirement, savings and wealth accumulation. Financial literacy has also been found to lead to greater financial inclusion, participation in capital markets, better diversification and choosing a low-fee investment portfolio.
On the other hand, low financial literacy is associated with insidious outcomes such as debt accumulation, high-cost borrowing and poor mortgage choices among others. While a cautious response should make us guard against an unabashed acceptance of the redemptive powers of financial literacy, waiting interminably for big government and big companies to solve this problem will not work.
Globally there are nearly 2.3 billion working-age adults who are financially excluded, and financial inclusion can help break the vicious circle where people incur inordinate costs on account of lack of access to mainstream financial products and knowledge. Financial development matters for the distribution of incomes and poverty. With increasing sophistication of financial markets, the enhanced capacity to embrace investment opportunities may help reduce inequality.
Economic literacy has been found to mediate the empirical association between financial development and reduced inequality, suggesting that financial development in the absence of economic competences may do little to reduce inequality.
However, in the final analysis, financial efficacy and competences are driven by the judicious mix of content, delivery, knowledge retention and instigation to transform intent into action. “Teachable moments” just prior to making key financial decisions are especially pertinent. Joe Saari, who co-founded Precision Information LLC, a leading provider of interactive financial education products, echoes this sentiment about context when he says that “the best place to administer wealth education is where people make money, namely the workplace.”
Financial education in the workplace complements a wide array of other imperatives such as learning about these matters in the home, religious institutions and at school. Financial inclusion, financial literacy, companies that are willing to help, and consumer protection by government and nonprofits are recognized as four pillars of a financial education strategy. Together they might yet help to realize the ideal of developing a financially literate populace.
John Hoffmire is director of the Impact Bond Fund at Saïd Business School at Oxford University and directs the School of Business and Poverty at the Wisconsin School of Business at UW-Madison. He runs Progress Through Business, a nonprofit group promoting economic development. Pankaj Upadhyay, Hoffmire’s colleague at Progress Through Business, did the research for this article.
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