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A sombre reflection on financial literacy

Cuffelinks was established as a forum to improve financial literacy and its readers come from diverse backgrounds. Financial literacy is a topic near to our hearts; unfortunately financial literacy levels in Australia and around the world are disturbingly low. A recent research paper by the global leaders in research into financial literacy, Annamaria Lusardi and Olivia Mitchell, both based in the US, provides the broadest review of the research undertaken on this topic (the full paper is available here). While the results are concerning, Lusardi and Mitchell take the positive view that there is a clear opportunity to improve financial literacy levels and benefit society as a whole.

(In Australia, ASIC has a National Financial Literacy Strategy and with Financial Literacy Australia, they have projects to improve financial literacy, but they announced in late 2014 that the MoneySmart Week initiative will be discontinued).

How do you measure financial literacy?

Lusardi and Mitchell developed a three question financial literacy test known as the financial literacy instrument. The test is simple, brief and relevant, focusing on compound interest, inflation and diversification. This test and the poor results in Australia and around the world have been detailed previously in Cuffelinks (see Do clients understand what advisers are saying?). In short, only 40% of the population (in Australia and in the developed world) display basic financial literacy.

It would appear that individuals are unaware of their lack of financial knowledge: in the US a government study revealed that 70% of respondents self-assessed their level of financial knowledge as 4 or higher on a scale of 1 to 7, but only 30% of the respondents actually passed the basic test of financial literacy.

These results are concerning when we consider the structure of Australia’s financial services industry. The broad philosophy of the Wallis Inquiry and the Coalition Government is that consumer choice and competition lead to a more efficient industry. But are those making the choice sufficiently literate to be able to make important financial decisions? In a country where more than one million people are SMSF trustees, financial literacy, when combined with one’s potentially overstated view of their own level of literacy, is a potentially dangerous mix.

Who are the most vulnerable?

Lusardi and Mitchell review the existing research on which people have the lowest degree of financial literacy. Here we summarise the findings across multiple dimensions:

  • Age: the life cycle profile of financial literacy is somewhat hump-shaped, meaning the lowest levels of literacy exist amongst the young and old. What makes this finding more worrying is other research cited by the authors finding that peoples’ confidence in their own financial decision-making abilities actually increases with age. This potentially makes the aged the most obvious targets for fraudsters.
  • Gender: regardless of age, the research finds a higher level of financial literacy among males than females. Although much research has been undertaken to try and understand why this difference exists it remains unclear.
  • Education and cognitive ability: higher levels of education and higher levels of cognitive ability lead to greater levels of financial ability. Even once the research adjusts for cognitive ability (often highly correlated with the attainment of education levels) higher education levels still contribute to a greater likelihood of being financially literate.

There are a large range of other patterns exist regarding financial literacy, but we already know enough to target financial literacy programmes to the greatest need.

The consequences of financial illiteracy

Lusardi and Mitchell review a large range of research on the consequences of low levels of financial literacy. The picture is disturbing: those with low levels of financial literacy have a greater likelihood of making financial mistakes, including being misled or defrauded. On the other hand those with higher financial literacy undertake sensible actions such as creating diversified portfolios, maintaining a precautionary savings pool and planning for retirement. Those with lower financial literacy levels commonly experienced higher costs for financial transactions and higher rates for loan products.

Some studies have attempted to measure the financial cost of financial illiteracy. Generally it has proven difficult to estimate the lifetime financial impact between two otherwise similarly specified groups of people who only differ by their level of financial literacy.

Despite their clear passion for raising financial literacy levels, Lusardi and Mitchell highlight that any financial literacy program should be considered from a cost-benefit perspective. They note that it could actually prove more effective from a net benefits perspective to simplify investment decision-making through regulation rather than focus on education programmes. While the first reaction might be that it is difficult to consider such an option in Australia with our heavy focus on choice, the majority of the population remains in default-style funds and this has been one of the areas which recent regulation such as Stronger Super has sought to simplify.

Lusardi and Mitchell further consider the role of regulators in controlling for behavioural biases, such as the way information is framed to the public. One well known US case study is illustrative, based on an employer pension plan for new employees with a 3% default contribution rate (if they do not make a contribution rate decision). This default rate appeared to be misinterpreted as a suggested target rate resulting in some new members actually reducing their contribution levels back to this amount compared with the savings plan they had with their former employer.

Financial advice could be an alternative to financial literacy programs. The authors ponder the thought that a population-wide high degree of financial literacy may be unrealistic and that more people would benefit from financial advice. They recognise that it is unrealistic for the entire population to receive quality financial advice in the near term.

Ultimately Lusardi and Mitchell conclude that it would be beneficial for society if financial literacy levels were improved. This can be in conjunction with regulators and industry becoming more educative, user-friendly and aware of how information is framed. I believe all parts of the financial services industry have a contribution to make to financial literacy. In the words of the authors: “While the costs of raising financial literacy are likely to be substantial, so too are the costs of being liquidity-constrained, overindebted, and poor.”


David Bell is Chief Investment Officer at AUSCOAL Super. He is working towards a PhD at University of New South Wales. He has been a lecturer at Macquarie University since 2002.


Tim Richardson
April 21, 2015

David, Do you feel that this low level of financial literacy comes in spite of or (at least partly) because of financial advice from industry planners? Now that advisors are remunerated for delivering advice rather than selling products, is it in their commercial interest to share understanding or render the subject highly complex so that assistance is required?

Rashmi Mehrotra
April 19, 2015

David, did the paper look at the efficacy of financial literacy programs? I find regulators around the world make the information available on their websites, but don't make it interesting for the reader. The attitude is that finace is not meant to be entertaining. How about we take a different tack and make it so?

Craig in Brisbane
April 17, 2015

David, I've done a number of free online uni level courses in economics and Bob's Shiller's excellent Financial Markets course. Free, done as it suits, and from in front of my home computer. See for a host of different courses or google MOOC's. It's changed my financial literacy for life and I recommend these to all, regardless of age. Watch these 2 quick intro videos: and probably an even better course for novices, this one: Cheers, C.

David Bell
April 17, 2015

School-based programs are a good idea for helping the young, but what is the best solution for the elderly? There is no compulsory education forum, mixed take-up of breadth providing tools such as the internet, and this is the segment where people most over-estimate their own degree of financial literacy.

Cheers, David

April 17, 2015

The education process should start in Year 10 at school and end in Year 12. Financial literacy should be a compulsory subject. Also, Maths should continue to be compulsory at Years 11 and 12. Saving people from themselves simply because they have been properly educated is a great investment.

April 17, 2015

Fantastic idea!


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