Financial literacy - easy as ABC

Seven hundred and ninety thousand dollars is a lot of money in anyone’s language, but especially for someone earning only $36,000 a year. Remarkably, that is the amount an individual on such a modest salary could be missing out on over their lifetime simply because they do not have a basic understanding of their financial affairs.

Finding the figures too extraordinary to be true? Then consider this: they come from the Federal Government itself, through its newly established Financial Literacy Foundation.

Government intervention

In June this year the Government created the Financial Literacy Foundation, the first-ever national body set up to address the deficiencies in consumer literacy levels regarding personal money management.

To date, the Government has committed $16 million in grants for a public awareness campaign (see page 19), and $5 million a year through to 2009 to “raise the bar” on consumer financial literacy.

While the foundation says it is not focusing on any one particular group, in addition to the adult population it plans to target the education system, believing school curriculums should teach and encourage financial literacy. Advocates from various government, business and community groups agree that financial education should be for all ages and all classes.

Closing the gaps

While the campaign’s long-term goals are varied, the foundation principally aims to close gaps in consumer financial knowledge and help Australians better manage their money now and in retirement.

For the country’s younger population, the foundation aims to instil in them an understanding of how their future will be funded after they have left the workforce, how to fund it during their working years, and even how to manage their finances in the event that their employment years are cut short due to the unexpected.

There are so many unknowns in life and, while we can’t prepare for them all, knowing how to stay in control in the face of adversity, or simply augmenting our superannuation, can’t begin early enough.

“Consumers experience many difficulties with financial issues as they move through each stage of their lives,” says foundation chair Paul Clitheroe.

“From a child’s first bank account to the retirement savings of an ageing Australian population, a better understanding of how to manage money is critical to an improved savings culture.”

He adds: “A consumer’s journey from the first cents of pocket money, to teenage years, into adult life, and through to retirement, is littered with traps.” Traps that have cost Australians millions of dollars.

Simply being unaware can contribute to bad decisions. Children see their parents put a card in to a machine to obtain money or pay for goods, and do not realise that purchasing decisions are made from within a budget, Clitheroe says. They miss that critical part of the equation and see only the spending side of things, quite literally, as if money were being spat out of a bottomless hole. If not made to understand how banks and ATMs work, this impression of a “bottomless pit” of money will certainly influence the way the younger generation later view and manage their assets.

Soaring debt levels

According to recent data released from the Reserve Bank of Australia (RBA), Australian’s have managed to build up an alarming credit card debt of $30 billion, $5 billion of which is interest on that debt. Credit cards are one of the most expensive ways to borrow money, incurring exorbitantly high interest charges if the card balance is not cleared each month. They are more than twice as expensive as a home loan.

If all of Australia’s credit card holders ‘maxed out’ their cards, the RBA figures show that they could go on a $47 billion shopping spree. So without even a basic understanding of money management, which Clitheroe has likened to basic hygiene, Australians could face catastrophe.

The Foundation says there is an onus on policy makers, financial institutions and advisers to educate the Australian public about the increasingly complicated marketplace, and equip them with the skills to take control of their financial future.

Understanding the money markets

Research also tells us that consumers already investing don’t seem to know much about financial assets. Almost 50 per cent of those surveyed by the RBA believe money market funds are comprised partially of stocks, 49 per cent believe money markets are comprised partially of bonds, nine per cent know money markets contain only short-term securities, and only 25 per cent understand the inverse relationship between interest rates and bond prices. This is the type of basic knowledge everyone ought to know before entering into the investment playing field.

Australians spend over $450 billion on goods and services every year, with $29 billion being spent on finance and insurance services alone. At the same time Australians have fallen prey to, and lost significant amounts of money to, investment scams in the last three years.

Value of education

As an indication of the importance of financial literacy to a person’s financial wellbeing, the foundation has modelled the effects of bad decision-making over the course of a person’s life. It was discovered that a person on a salary of $36,000 per annum stands to lose $790,000 in wealth over the course of their life (see below), and this trend can be expected to continue unless remedies for more effective management of capital reach average Australians.

Andrew Penn, chief executive of AXA Australia and New Zealand, says: “Today people want to be involved in the decisions that affect their lives, they want to understand and know that they are making the right decisions with their finances. Consumer over-spending, over-borrowing, under-insuring and, again the most alarming, the number of Australians living on credit card debt, is raising awareness across the board, including for consumers themselves.”

“How to manage money is critical to an improved savings culture for all stages of life,” adds Clitheroe. In a perfect world, where consumers properly managed their finances, a portion of disposable income would be put into investment and savings, Clitheroe says.

But because income is not properly managed initially, any money left over, which should provide a disposable income, is often inadequate for meeting other expenses and obligations. As a result, consumers retreat to an expensive lifestyle funded via their credit cards.

“This is where financial literacy and the role of quality financial advice comes in. They are two ends of the same spectrum, both focussed on helping us to make the right financial decisions,” says Penn.

A national approach

Part of the Foundation’s platform is to look at ways of developing a collaborative approach to redefining and enhancing the financial skills of ordinary Australians. It will further examine how it can streamline, augment, and add to the over 700 existing literacy information initiatives being produced by public, private and community sector bodies throughout Australia.

There is clearly no shortage of good consumer information available to assist Australians, but not properly targeted or understood, it can potentially frustrate or cloud Australians’ investment choices and management of those choices. The foundation’s motivation stems from a recognition that there is a need for an overarching, national approach to improving money management awareness, and a need to streamline information networks so that the information and products are properly understood before interaction with either even begins.

The role of planners

On the role of financial advisers and other financial providers, Penn says: “While the Government is taking the lead with its literacy program, advisers also have a role to play, making sure their clients are involved and understand the choices they are making.”

In other words, the financial services industry needs to step up and better promote advice for what it is — an effective way to help fund standards of living in retirement.