There are serious problems with the concept of 'financial literacy'

As the world of finance becomes more complex, most of us aren’t keeping up. In this series we’re exploring what it means to be financially literate.

The federal government’s financial literacy strategy shows how serious the idea of improving financial decision-making is. But the concept of what it means to be “financially literate” may be problematic.

It is certainly tempting to think that simply learning about money management could improve financial well-being. But the reality is there are a whole host of economic, political and cultural issues that play into whether someone fits the definition of “financially literate”.

This ranges from simply not earning enough to save or qualify for favourable bank terms, to cultures that incentivise the collective well-being over the individual.

Read more: Cutting through political spin requires a new approach to financial literacy

The Australian government defines financial literacy as:

A combination of financial knowledge, skills, attitudes and behaviours necessary to make sound financial decisions, based on personal circumstances, to improve financial well-being.

However, there is doubt about what aspects of financial decision making and well-being are a result of being financially literate. The ability to make sound financial decisions and improved financial well-being are two very problematic aspects of the widely used definitions.

These definitions of financial literacy fail to consider the increasingly complex financial environment, or factor in significant life events. Someone could be considered financially illiterate for reasons beyond their control, let alone their knowledge or skills.

For example, some researchers have proposed that those on low incomes have the same “attitudes and natural proclivities, weaknesses and biases” as those from other walks of life, their margin for error is just lower.

Someone living in poverty may also find it hard to change their financial circumstances (by landing a higher paying job, for instance) despite being financially literate.

Other researchers found that individuals on low income may be adversely affected by financial products as they fall into the “bank fee poverty trap,” as they do not hold mortgages or have the minimum bank balances for fees to be waived.

Read more: Two million Aussies are experiencing high financial stress

Certain cultures also promote behaviour that could lead to individuals being deemed financially illiterate. For example, sharing food and money with those in need, even if there is little to be shared.

Indeed, researchers in Australia and the United States have found some Indigenous communities associate “wealth” or “success” with strong family networks, shelter and food; rather than lots of money in the bank.

What is also lacking from conventional definitions of financial literacy is how others are affected by an individual’s financial decision-making. For instance, supporting a local store or market could mean the continued employment of local staff and wider benefits for the community. Shopping online may be a more financially sound decision in the short run, but it could have knock on effects to individuals and others.

Read more: Almost 3 million adult Aussies lack basic financial services

Perhaps, financial literacy should be thought of as more about an individual’s capacity to acquire financial knowledge, critically reflect on what influences their financial decision-making and their ability to apply their knowledge to “financial dilemmas”, such as unemployment or a sudden expense.

In fact, research has shown that people living on low incomes both in Australia and overseas are among the “best budgeters” because it is a practised survival skill.

Definitions of financial literacy also need to reflect on what influences financial decision-making, as well as how others may be affected by the decision. These factors could be socio-economic status, educational level, personal and cultural values, life stages, social standing and professional associations, media and marketing, and/or the environment.

For example, a financial decision affecting others could be about the choice between paying the rent or feeding the family. A lack of knowledge may not be the problem for the individual deciding between rent and food but a low income often is.

Thus, the limits of financial literacy need to be exposed. And, a move towards a compassionate approach to financial education should be adopted in schools, so that financial worth is not equated with self worth.