April is Financial Literacy month in the US. What occurs in the US often filters down to us in T&T so it is quite likely that the issue of financial literacy will be discussed here during this time. The obvious question that many will pose this month is: are you financially literate?
When we refer to financial literacy we often talk about a level of financial knowledge. This is because the drive for financial literacy usually comes from financial institutions and its regulators and the industry as a whole is geared towards your participation in the products and services that they offer.
There is, of course, nothing wrong with that approach. It is reasonable and even practical to want people to understand how a mortgage works and how a credit card works. It is also important that people understand concepts such as inflation and compound interest since these terms are not only common place but also affect our daily lives. Then there are, of course, other products such as mutual funds, exchange traded funds, bonds, stocks, annuities, life insurance, medical insurance and this list can go on and on.
Knowledge is important in the world of finance so the idea that financial literacy is linked to financial knowledge is quite reasonable. Most people find it difficult to keep up as products become more and more sophisticated and increasingly complex.
Another aspect of financial literacy that is often touted is the ability to utilise the products on offer. For example, the idea of opening a bank account may sound simple enough. However there are specific requirements in order to do so and these requirements are becoming increasingly complex as financial institutions have to deal with increased regulation.
Proof of identity, residence, address, income, source of funds are all requirements under law and these matters require regular updating. Some people are faced with issues related to international tax compliance, being politically exposed by virtue of association, working in a high risk job. If you have multiple relationships across various banking, insurance and investment entities then you have to go through this process and more with each entity, sometimes for each account.
Many see this as a hassle and some may have real difficulties coping. In the end this leads to individuals either being unserved or underserved as it relates to key financial products and services. It also in some way contributes to an informal economy (as distinct from illegal economy) where persons opt to exist outside of the established system.
I think we can be clear that the issue of financial literacy is important but very much underestimated. In the United States based on various surveys, they have concluded that as many as two thirds of Americans are financially illiterate. That means that they cannot calculate things like the interest on a loan or understand the financial product that they own. One would expect that in an emerging market such as T&T rates of financial literacy will be much lower.
The side bar offers up what is the standard test used by many to assess financial literacy. If you have not already done so take a few minutes to answer the three questions on this page.
The first question deals with your ability to do a basic calculation related to compounding of interest rates. The second question deals with an understanding of inflation and the third question assess your appreciation of financial risk. All of these issues are important and it is better to know that to not know.
A lack of knowledge means that you can be easily duped into a financial product that is not suitable for you. More than that, a lack of financial knowledge leaves you very susceptible to scams.
There are ponzi schemes and “get rich quick” offers all around. It all comes down to a basic rule. If you can’t understand the product then don’t purchase. If you lack the knowledge then you range of suitable products is limited.
Beyond knowledge
Financial literacy is important and represents a core starting point. Of even greater importance is financial capability. This speaks to our ability to make financial decisions. You can have all the knowledge of finance that may be considered necessary but if you can’t apply that knowledge then your financial capability is still limited.
Many would have studied physics in school and would have been taught the principles associated with momentum. However we still had to be reminded to wear a seatbelt despite having the knowledge to understand what would happen if we don’t.
Similarly, our knowledge of biology and chemistry allows us to understand what alcohol can do to our body, but that does not prevent you from deciding to drink and sometimes get drunk.
Your financial capability speaks to your ability to apply your financial knowledge within the context of your attitudes and your psychological traits. This is far more complex as it now includes a mix of your skills, attitude towards money, attitude towards life and your financial behaviour and how they interact with each other.
It may sound daunting but there is still more to contend with. To make proper financial decisions and so be considered financially capable you need to be financially literate as well as manage your internal dynamics but there is also another factor that sits outside of you.
This is financial transparency where information on product that is being offered to you is either withheld or made difficult to understand. In those circumstances, regardless of how much knowledge you have if the product itself lacks transparency then there is a problem.
The financial crisis of 2008 and our own experiences with CL Financial drive home this point. Many were investing in mortgages in the US but despite being financial professionals who had the knowledge didn’t fully understand the assumptions that went into some of the derivative products and how they would function under various conditions.
Similarly many who invested in an EFPA product from Clico did not understand how the product actually worked and so could not truly assess the risks.
As you can now appreciate financial literacy is just the tip of the iceberg. To manage your affairs requires a lot more. You also have to be able to understand and manage yourself as well as understand the nuances associated with the products and services that will serve as vehicles for your money.
The objective here is not to overwhelm you but rather to highlight the intricacies of finance. Many think that this is a “do it yourself” affair.
At a student “question and answer” famed investor Warren Buffet was asked: what surprises him the most?
He replied pointing to Bill Gates who was standing next to him:
“People look at Bill Gates and think they can’t do what he did. They look at me and think they can do what I did.”
The best investor knows that it’s not as easy as it looks.
Ian Narine
