Financial literacy levels in Australia and around the world are low, but it may be eye-opening to learn just how low they are. It’s an important issue for financial advice. There’s no point providing a 70 page Statement of Advice if the client does not understand the basic concepts in there.
How is financial literacy measured? Annamaria Lusardi and Olivia Mitchell (from Dartmouth College and Wharton School, University of Pennsylvania) have led the development of financial literacy survey designs. There are two assessments most commonly used – a basic and an advanced literacy test. Here are the ‘Australianised’ versions of these tests (created by Bateman and research partners*). Answers can be found at the end of this article.
Test 1 – basic financial numeracy
Test 2 – advanced financial numeracy
- Diversification: When an investor spreads his money across different assets the risk of losing money...
(Answers: a. Increases, b. Decreases, c. Stays the same, d. Do not know, e. Refuse to answer)
Lusardi and Mitchell subsequently identified the three underlined questions as most significant for a shorter test which is known as the ‘financial literacy instrument’. It is used in academic studies around the world and in government body surveys in the US.
Table 1 shows the survey results for basic financial literacy for Australia and the US.
| |
Australia |
US |
| 1. Numeracy / interest rate |
88.4% |
91.8% |
| 2. Compound interest |
71.8% |
69.0% |
| 3. Inflation |
78.4% |
87.1% |
| 4. Time value of money |
54.9% |
73.8% |
| 5. Money illusion |
86.7% |
78.4% |
| All Five Correct |
36.5% |
43.8% |
Table 1: Basic financial literacy results: Australia: Bateman et al (2011)*, US: Lusardi & Mitchell (2009)
In addition, Julie Agnew and research partners (2013)** performed the shorter financial literacy instrument test across a survey group of over 1,000 Australians. They found that only 43% achieved three correct answers.
Most industry participants should find the basic financial literacy questions quite simple, so the numbers in the final row of Table 1 should be alarming. Only 36.5% of Australian participants answered all five questions correctly, especially since the academic literature indicates that people with higher levels of financial literacy are more likely to plan for retirement.
There are many areas where the industry could make use of financial literacy tests, such as:
- At a financial planning level: When assessing risk tolerance do financial planners also assess financial literacy? Financial literacy levels may distort risk tolerance assessments used across industry. Should risk tolerance be independent of financial literacy (ie a true measure of our tolerance for risk)? Does the way that advice is delivered take into account financial people’s level of financial literacy?
- For SMSF’s: Are people capable of being effective trustees of their own SMSF if they do not have basic levels of financial literacy? Is there a way that basic financial literacy assessment can be included in a checklist on whether it is appropriate for someone to establish an SMSF?
- For institutional super funds: Should there be a basic financial literacy requirement for trustees of super funds? While the diversity of skill arguments across trustees are well made, surely a minimum level of financial knowledge should be a pre-requisite.
The results of this research are worrying. As an industry we have to be careful to understand that financial literacy levels of non-industry participants may fail to even reach basic levels. The way that we communicate complex information is very important and an ongoing challenge for regulators, product manufacturers and financial planners.
Answers:
Basic financial literacy: 1 – a, 2 – a, 3 – c, 4 – a, 5 – b
Sophisticated financial literacy: 1 – b, 2 – a, 3 – b
* Hazel Bateman, Christine Eckert, John Geweke, Jordan Louviere, Susan Thorp and Stephen Satchell
** Julie Agnew, Hazel Bateman and Susan Thorp