Financial literacy: The guide to a secure future

Financial literacy is a crucial life skill that is often overlooked. With the increasing complexity of financial markets and the importance of financial planning for long-term stability, it is becoming increasingly important to understand basic financial models essential to make informed financial decisions and avoid financial insecurity.

According to the S&P Global Financial Literacy Survey, only 33 per cent of adults globally are financially literate. Financial illiteracy is an issue that impacts all nations alike.

Among the major advanced economies — Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States — the average adult literacy rate is 55 percent. Comparatively, only 28 per cent, on average, of individuals in the leading growing economies are financially literate. The Scandinavian countries— Sweden, Norway, Denmark, and Finland — are leading the planet with an average of 69 per cent financially literate adults.

The continually evolving financial ecosystem has caused mature and developing nations to fret more and more in recent years about the degree of financial literacy among their citizens. The financial crisis, both the subprime crisis of 2007 and the recent Covid-19 pandemic, added to the concern as it was realised that poor financial literacy was one of the contributing factors to poor financial decisions, which in turn might have extremely detrimental knock-on effects.

Financial literacy is increasingly being recognised on a global scale as a crucial component of economic and financial stability and development.

Why financial literacy matters now more than ever

With the soaring cost of living globally, and the changing dynamics of the job market due to technological advancements — the introduction of complex financial products (huge variety of debt & saving instruments), and countless new investment vehicles — cryptocurrencies, non-fingible tokens (NFT)s, hedge funds, exchange traded funds (ETFs) — just to name a few — the choices made regarding these economic issues, financial products, and investments have severe implications for any individual’s financial well-being.

At large, financial decision-making/financial literacy can be broken down into three universal concepts, which are applicable to every context and economic environment. These are — the time value of money (calculating interest rates and comprehending compound interest), the risk-return tradeoff (describing the inverse relationship between investment risk and investment return), and the quantity theory of money (understanding the impact of inflation).

Financial literacy is a core life skill and a crucial intellectual competency. Financial literacy enables individuals to improve their critical thinking, conceptualising, and judgment skills. It is a must-learn skill for youth — school and college pupils - before they enter into their financial life.

The influence of financial literacy on people’s decisions and financial behaviour is well-documented in the economic literature. Studies show that financial literacy plays a critical role in influencing borrowing and debt management, saving, and investing behaviour.

The writer is Associate Professor of Finance, University of Wollongong in Dubai.