Financially literate people can make informed financial choices regarding saving, investing, borrowing, and more. Without an understanding of basic financial concepts, people are not well equipped to make decisions related to financial management. This is the view expressed by Leora Klapper, Annamaria Lusardi, and Peter van Oudheusden in their report on Financial Literacy Around the World. Their report measured financial literacy using questions assessing basic knowledge of four fundamental concepts in financial decision-making: knowledge of interest rates, interest compounding, inflation, and risk diversification.
The same report indicates that financial ignorance carries significant costs, such as consumers who fail to understand the concept of interest compounding, spend more on transaction fees, run up bigger debts, and incur higher interest rates on loans. They also end up borrowing more and saving less money. Meanwhile, people with strong financial knowledge do a better job planning and saving for retirement as well as financially savvy investors are also more likely to diversify risk by spreading funds across several ventures.
Worldwide, more than 150,000 nationally representative and randomly selected adults in more than 140 economies were interviewed, The S&P Global FinLit Survey in 2014, found that only 1-in-3 adults were financially literate. Not only was financial illiteracy widespread, but there were big variations among countries and groups. People with relatively higher financial literacy also tended to have a few things in common, regardless of where they lived.
- Adults who use formal financial services like bank accounts and credit cards generally have higher financial knowledge, regardless of their income.
- Even poor people who have a bank account are more likely to be financially literate than poor people who do not have a bank account.
- And rich adults who use credit also generally have better financial skills than rich adults who do not.
This suggests the relationship between financial knowledge and financial services may work in two directions: While higher financial literacy might lead to broader financial inclusion, operating an account or using credit may also deepen consumers’ financial skills.
The overall financial literacy score in 2018 measured a set of basic financial skills, behaviors, and attitudes; scoring the maximum of 21 effectively meant that an individual had acquired a basic level of understanding of financial concepts and applied some prudent principles in their financial dealings. Achieving the maximum thus suggested a basic knowledge of and use of finance. Individuals across the entire sample on average scored only 12.7 or just under 61% of the maximum financial literacy score.
The numbers may be slightly or even significantly different today but given the many ways financial literacy affects financial behavior, it is important to understand the extent of people’s understanding of basic financial concepts as well as the degree to which financial skills fall short.
Financial Well-being:
In the OECD/INFE 2020 International Survey of Adult Financial Literacy (2020), financial knowledge is reported as an important component to help individuals compare financial products and services as well as make appropriate, well-informed financial decisions. Basic knowledge of financial concepts and the ability to apply numeracy skills in a financial context ensures that consumers can navigate with greater confidence financial matters and react to news and events that may have implications for their financial well-being.
The same report mentions that consumers’ actions and behavior are important in shaping their financial situation and well-being. Some types of behavior, such as failing to actively save money, putting off payment of bills, failing to plan future expenditures, or choosing financial products without shopping around, may negatively impact an individual’s financial situation and well-being.
The Organization for Economic Cooperation and Development / International Network on Financial Education (OECD/INFE) definition of financial literacy is described as “a combination of awareness, knowledge, skills, attitudes, and behavior necessary to make sound financial decisions and ultimately achieve individual financial well-being.” This recognizes that even if an individual has sufficient knowledge and ability to act in a financially prudent way, their attitudes will influence their decision of whether or not to act. This definition also suggests that the goal of financial education is then to boost financial literacy, which in turn would enable individuals to enhance their financial well-being.
In looking to define financial well-being, the Consumer Financial Protection Bureau (CFPB) found that “consumers perceived financial well-being as a state of being wherein a person can fully meet current and ongoing financial obligations, can feel secure in their financial future, and can make choices that allow them to enjoy life.” The CFPB definition of financial well-being, therefore, implies having financial security and financial freedom of choice, in the present and the future.
Financial Inclusion and Resilience:
It is globally recognized that financial literacy and financial inclusion, along with a robust financial consumer protection framework, are vital to the empowerment of individuals and can contribute to the overall stability of the financial system. It is therefore valuable for policymakers to have information about the levels of financial inclusion of consumers alongside a measure of their financial literacy. Financial inclusion is a two-sided process, requiring the provision of appropriate financial products on the supply side and awareness of those products on the demand side at the point of consumers making decisions.
Financial education aims to make individuals better prepared at managing their money, reaching their financial goals, and avoiding stress related to financial problems, thus ultimately improving their financial well-being. Financial education policy is widely recognized as a core component of the financial empowerment and resilience of individuals, as well as contributing to the overall stability of the financial system.
Financial resilience is an essential characteristic for citizens everywhere. It is needed to ensure individuals can cope with the predictable financial choices and difficulties in life, such as saving enough over an exceptionally long period for a comfortable retirement, but also with unpredictable and highly unexpected shocks such as the current COVID-19 pandemic.
Individual financial resilience can be thought of as composed of six elements:
- Keeping control over money: keeping a regular watch on one’s financial situation and avoiding indebtedness can minimize the risks of financial stress.
- Watching expenditures: a mark of financially prudent and thus resilient individuals is making good expenditure decisions; considering the need and /or affordability of purchases.
- Availability of financial cushion: the availability of savings and the ability to support oneself for a period without income is important. Individuals are likely to experience periods when they must live on their savings and while some are planned (periods of study or training, for instance), others like the currently unfolding economic crisis caused by the COVID-19 pandemic are unplanned and likely to result in loss of income for segments of societies globally.
- Coping with a financial shortfall: the frequency of experiencing a shortfall and the worry about one are revealing of the financial resilience of individuals.
- Planning individual finances: actively saving and pursuing long-term financial goals tend to be actions that boost the financial resilience of individuals.
- Fraud awareness: being aware of financial scams and possible fraud and taking care not to fall victim to one is a characteristic of a financial resilience (and literate) individual.
Statistics:
In a report on literacy rates around the world, the 10 most financial literate countries include Denmark, Norway, and Sweden each with 71% literacy, Canada and Israel follow with 68%, the United Kingdom with 67%, Germany and Netherlands with 66%, Australia with 64% and Finland with 63%.
The report goes on to suggest that at the highest level, financial literacy around the world appears strongest in countries with developed and advanced economies, especially in Western Europe and English-speaking countries. There are no countries in South America where more than 50% of people are financially literate and only one country in all of Africa.
In North America, financial literacy improves the further north one travels. Mexico’s 32% compares favorably to countries further south, but it stands in stark contrast to the US (57%) and Canada (68%). In South America, Uruguay and Chile post the best rates at 45% and 41%, respectively, but most places fall between 21%-30%. There is no doubt lots of historical explanations for this disparity, but Nicaragua (20%) stands out as it has the lowest score in all of Central and South America excluding the Caribbean, and that is indicative of the desperate economic situation in that country.
Africa scores the worst of all the continents. Only one country, Botswana, breaks the 50% barrier, with more places falling in the 31%-40% range. The worst country for financial literacy on the entire continent is Somalia, at 15%. The situations in Asia and the Middle East are comparable to Africa. Yemen (13%) and Afghanistan (14%) are at the rock bottom of the worldwide rankings, Kyrgyzstan (19%), Nepal (18%), Bangladesh (19%), and Cambodia (18%). China scored 28%, the most interesting standout countries, were Myanmar and Bhutan, where a relatively impressive 50%+ of the population counts as financially literate. These rates are immediately next to some of the worst scores on the planet, proving that local factors can make a significant difference.
Concluding thoughts:
Every economy worldwide may not share definitions of these financial concepts, as concluded, local factors have influenced their conceptualization. However, I can comfortably deduce that financial knowledge and financial literacy can improve with financial education as individuals get to appreciate their financial situation and make informed decisions to improve their financial well-being. Therefore, in recognition of the variances across the world, this hopefully motivates you to seek out unbiased financial education and share what you learn with others; this will increase the overall world coverage of financial literacy.
Our financial literacy badges program includes self-paced training on our website which is a good place to start efforts to improve or share financial knowledge.
