Oran Hall | Assessing your financial capability
We often wonder why so many people generally acknowledged to be financially literate based on their training and work experience seem to make unsound financial decisions for themselves and others.
Could it be that it requires more than financial literacy to make wise financial decisions?
In some circles, the term financial literacy has given way to financial capability - just a name change. But it is also accepted that there are significant differences between the two.
Ben Rogers, writing in 'From Financial Literacy to Financial Capability', describes financial literacy as having fluency in the language - of finance - to take care of finances and make good financial decisions. He describes financial capability as the ability to implement strategies that will achieve the desired results.
For him, financial capability includes accumulating knowledge, assessing options, making decisions, putting plans into place, evaluating and adjusting appropriately.
The difference is knowing as opposed to doing. Financial capability, therefore, goes beyond having the knowledge or understanding of financial matters to take effective actions to achieve financial goals.
The World Bank in Financial Capability Surveys Around the World - August 2013 adds more to our understanding of financial capability. "Financial capability encompasses the knowledge, attitudes, skills and behaviours of individuals with regard to managing their financial resources and understanding, selecting, and making use of financial services that fit their needs."
The article mentions four financial capability concepts: knowledge, skills, attitudes, behaviours. Knowledge is concerned with financial concepts such as inflation and compound interest; awareness of financial products and services; practical know-how such as how to make payments.
Skills relate primarily to numeracy and literacy skills. The assessment of skills sheds light on the potential limitations to the proper use of financial products and services.
Attitudes and motivations are reflected in the personal views, beliefs or psychological traits of people, which can affect their financial decision-making and thus form a part of their internal financial capability.
Behaviours relate to how people manage their financial resources.
It is important to assess people's knowledge of financial concepts such as inflation, interest rates, taxation and risk diversification because of their role in navigating the formal economy.
Assessing people's awareness of financial products and services, considering the number and complexity of products today, can help to evaluate how much they understand the functions of financial services providers and their knowledge of the risks and advantages linked to these services and products.
KNOWLEDGE OF RIGHTS
In addition to measuring consumers' knowledge of financial products and the measurement of personal resources - including how to save, borrow, invest and protect themselves against fraud - surveys also measure if consumers know their rights and how to seek recourse for unfair financial practices and fraud.
Financial consumer protection complements financial inclusion and financial capability by ensuring that financial markets are stable and inclusive and are particularly vital when users and potential users of financial products lack the necessary knowledge, skills or attitudes to protect themselves.
Attitudes include the reasons for or for not saving, borrowing, budgeting, making long-term plans, attitudes to the future, confidence in one's own plans for old age, and can also be assessed by looking at people's inclination to certain behaviours such as their tendencies to choose between financial products or to prepare for emergencies and manage risk.
Generally, financial capability is expressed and measured in terms of behaviours that result from the interaction of internal capabilities and external factors which include societal factors like family demands and social networks. The financial behaviours generally measured tend to be classified into four main areas: money management (managing day-to-day finances), long-term planning (preparing for retirement, for example), selecting appropriate financial products, and seeking financial advice.
Surveys of financial capability can measure some aspects of internal capability and how they interact with the enabling environment. Among the external factors that can affect how internal capacity manifests itself into actual behaviours are financial resources, access to finance, social norms and obligations and existing financial consumer protection mechanisms.
Financial capability thus means that individuals have the internal capacity to act in their financial best interest in light of socio-economic and environmental conditions like access to financial products and consumer protection mechanisms. These play an important role in facilitating or constraining individual financial capability.
- Oran A. Hall, principal author of 'The Handbook of Personal Financial Planning', offers personal financial planning advice and counsel.