Costs of financial illiteracy

Sanderson Abel
The phrase “financial illiteracy” describes the widespread inability of individuals to understand key financial concepts and manage their personal finances wisely. Financial illiteracy is costly to both individuals and society. The cost of financial illiteracy can be viewed from various angles: forgone savings and investment opportunities, lives shattered by financial loss or bankruptcy, higher prices than necessary paid for goods and services, dreams and aspirations that go unfulfilled, and marital discord about money. The collective loss resulting from common financial errors is tremendous and quite devastating.

The lack of financial literacy may prohibit individuals from becoming productive members of the economy and society much like the inability to read or write disadvantaged earlier generations.

On the other hand financial literacy which is the skill necessary to assess financial risks and opportunities, to make informed choices and take effective actions to improve one’s financial well-being, is essential to participate fully in a modern society.

Financial illiteracy handicaps anyone seeking to become financially secure and the country as whole, examples include low savings rates, stock market panics, and increased potential for fraud.

Costly financial errors that people make due to financial illiteracy include high debt loads, substantial income unaccounted for, inadequate insurance, lack of investment diversification, insufficient use of tax-favored investments, inadequate emergency funds, lack of clearly defined goals and/or savings earmarked to achieve them.

Financial illiteracy crosses all economic boundaries from low-income to high-income families, and even well-educated, high-income adults may not know how to budget properly or manage their money well.

This gives scope for concerted effort by all stakeholders to champion financial literacy in the country.

There is need to learn from the statement by the former Fed chairman Ben Bernanke:

“In our dynamic and complex financial marketplace, financial education must be a lifelong pursuit that enables consumers of all ages and economic positions to stay attuned to changes in their financial needs and circumstances, and to take advantage of products and services that best meet their goals.

“Well- informed consumers, who can serve as their own advocates, are one of the best lines of defense against the proliferation of financial products and services that are unsuitable, unnecessarily costly or abusive.”

It is important that financial literacy be introduced at almost all levels. The curricula for financial education should include components to help students develop an understanding of the appropriate skills relating to the roles of money, credit, budgets, financial planning and other relevant personal finance topics in order to permit them to understand and appropriately manage their finances.

Financial education needs to reach adults in the workplace as well as other learning venues, such as libraries and museums.

Specific population subgroups, such as ethnic and gender minorities, require custom-tailored approaches. Such measures can be co-funded by the private sector, which will in turn benefit from more informed clients.

Financial institutions should take the lead as they can amass huge potential as the number of financial literate people in the country increases.

The increasing complexity of our financial system make it clear that strengthening the financial knowledge and skills of the people is critical to the future success and financial stability of our country.

Just like reading and writing, financial education impacts the well-being of every citizen, as well as the economic and social fabric of our communities. If financial literacy is not strengthened, the future of the financial system becomes uncertain with the success rate and efficacy of new financial product development being compromised.

Financial illiteracy limits the scope of financial sector development in the country as most new products end up without takers hence increasing their failure rate and profitability.

Financial literacy is also key in the business environment today. Executives who do not understand finance are harming their own career prospects and storing up future disasters for their companies. These managers are less able to discuss financial performance and investment decisions with operations, marketing, human resources, IT and other departments.

And they are less willing or even afraid, to ask the important questions that could help them to avoid wrong decisions, so their companies’ internal controls are weakened as a result. Hence financial literacy is more important in a country like Zimbabwe currently dominated with SMEs which have no capacity to engage skilled manpower to do finance for them.

The country and its citizens should note that efforts aimed at improving financial literacy are very noble and need to be pursued with vigour given the associated cost of a financially illiterate citizenry. The success of various programmes initiated by government (e.g. various funds such as the youth fund) was hindered because the recipients were not financially literate.

These programs should be based in purely economic terms where for example the borrower should understand the importance of repaying loans and advances at a predetermined interest.

In this way consumers benefit from improved financial literacy directly by being in a position to make better informed decisions; and indirectly by adding to competitive pressures faced by product and service providers.

Sanderson Abel is an Economist. He writes in his capacity as Senior Economist for the Bankers Association of Zimbabwe. He can be contacted on [email protected] <mailto:[email protected]>or on 04-744686, 0772463008.