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DOES FINANCIAL LITERACY MATTER FOR DEVELOPED COUNTRIES?

Consumers need awareness, understanding, and knowledge about various types of rapidly evolving financial products and services.

 

The global financial crisis highlighted the importance of financial literacy and capability because the lack of consumer knowledge played a role in the genesis of the crisis. To become more active and confident participants in the financial sector, consumers need awareness, understanding, and knowledge about various types of rapidly evolving financial products and services and associated risks, such as fraud and over-indebtedness. 

As the variety and complexity of financial products and services increase, the importance of the financial capabilities of consumers becomes even more significant for the smooth functioning of financial markets.

There is ample evidence of the impact of financial literacy on people’s decisions and financial behavior.

There is ample evidence of the impact of financial literacy on people’s decisions and financial behavior.

A growing number of financial instruments have gained importance, including alternative financial services such as payday loans, pawnshops, and rent-to-own stores that charge very high-interest rates. Simultaneously, in the changing economic landscape, people are increasingly responsible for personal financial planning and for investing and spending their resources throughout their lifetime.

We have witnessed changes not only on the asset side of household balance sheets but also on the liability side. For example, in the USA, many people arrive close to retirement carrying a lot more debt than previous generations did. Overall, individuals are making substantially more financial decisions over their lifetime, living longer, and gaining access to a range of new financial products.

These trends, combined with low financial literacy levels around the world and, particularly, among vulnerable population groups, indicate that elevating financial literacy must become a priority for policymakers.

People’s decisions and financial behavior

There is ample evidence of the impact of financial literacy on people’s decisions and financial behavior. For example, financial literacy has been proven to affect both saving and investment behavior and debt management and borrowing practices. Empirically, financially savvy people are more likely to accumulate wealth. 

There are several explanations for why higher financial literacy translates into greater wealth. Several studies have documented that those who have higher financial literacy are more likely to plan for retirement, probably because they are more likely to appreciate the power of interest compounding and are better able to do calculations.

Financial literacy is also associated with higher returns on investments and investment in more complex assets, such as stocks, which normally offer higher rates of return. This finding has important consequences for wealth, in the context of a life-cycle model of saving with many sources of uncertainty, from 30 to 40% of US retirement wealth inequality can be accounted for by differences in financial knowledge. 

Critical role in saving and wealth accumulation.

These results show that financial literacy is not a sideshow, but it plays a critical role in saving and wealth accumulation.

Financial literacy is also strongly correlated with a greater ability to cope with emergency expenses and weather income shocks.

Financial literacy is also strongly correlated with a greater ability to cope with emergency expenses and weather income shocks.

Financial literacy is also strongly correlated with a greater ability to cope with emergency expenses and weather income shocks. Those who are financially literate are more likely to report that they can come up with $2000 in 30 days or that they are able to cover an emergency expense of $400 with cash or savings.

With regard to debt behavior, those who are more financially literate are less likely to have credit card debt and more likely to pay the full balance of their credit card each month rather than just paying the minimum due. 

Individuals with higher financial literacy levels also are more likely to refinance their mortgages when it makes sense to do so, tend not to borrow against their retirement plans, and are less likely to use high-cost borrowing methods, e.g., payday loans, pawn shops, auto title loans, and refund anticipation loans.

Several studies have documented poor debt behavior and its link to financial literacy. 

The least financially literate are also more likely to have costly mortgages. The least financially savvy incur high transaction costs, paying higher fees and using high-cost borrowing methods. The less knowledgeable also reported excessive debt loads and an inability to judge their debt positions. 

Similarly, those with low financial literacy were more likely to engage in costly credit card behavior and were more likely to borrow against their retirement and pension accounts. Young people also struggle with debt, in particular with student loans.

Millennials 

The average user of mobile payment apps and technology is a high-income, well-educated male who works full-time and is likely to belong to an ethnic minority group.

The average user of mobile payment apps and technology is a high-income, well-educated male who works full-time and is likely to belong to an ethnic minority group.

Millennials know little about their student loans and many do not attempt to calculate the payment amounts that will later be associated with the loans they take. When asked what they would do, if, given the chance to revisit their student loan borrowing decisions, about half of Millennials indicate that they would make a different decision.

New and rapidly expanding mobile payment options have made transactions easier, quicker, and more convenient. The average user of mobile payment apps and technology is a high-income, well-educated male who works full-time and is likely to belong to an ethnic minority group. Overall, users of mobile payments are busy individuals who are financially active holding more assets and incurring more debt. 

However, mobile payment users display expensive financial behaviors, such as spending more than they earn, using alternative financial services, and occasionally overdrawing their checking accounts. 

Additionally, mobile payment users display lower levels of financial literacy. The rapid growth in fintech around the world juxtaposed with expensive financial behavior means that more attention must be paid to the impact of mobile payment use on financial behavior. Fintech (financial technology) is not a substitute for financial literacy.

 

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