How to Become Financially Capable

Co-author: TJ Ryan
You can lead a horse to water, but you can’t make it drink. It’s much the same with personal finance.

Research is emerging that suggests becoming financially successful involves far more than just learning about financial products (financial literacy).

The reality is that no matter how much you teach someone about money, it doesn’t always make them change their behaviour and become financially capable.  That applies to both rich and poor, but the consequences are more serious if you’re poor.

Billions of dollars down the drain

Elaine Kempson, Emeritus Professor of University of Bristol, was down under recently sharing her world-renowned research. She says billions of dollars have been spent around the world on financial literacy programs but these have had little impact.

Government spending has often been targeted at budget advice centres and education programs, which can help people get out of short-term financial problems but often don’t change their behaviour in the long-term.

Diane Maxwell, New Zealand’s Retirement Commissioner points out that if it was just a matter of learning that something was bad for us (like alcohol) or good for us (like vegetables), we would all give up alcohol and turn to a vegetarian diet immediately.

“An alcoholic knows the alcohol is killing them. But that knowledge often isn’t enough to change behaviour. It takes something more.”

Why we need a shove

A paradigm shift in thinking is happening. Worldwide, the goal for governments is moving from the need for financial literacy (which is about what you know) to financial capability (what you can do).

Simply teaching about financial literacy hasn’t worked.

When it comes to doing something concrete about saving for the future, “people need a jolly good shove,” says Maxwell.

Our brains are hardwired to sabotage

One of the biggest problems with financial literacy programmes, says Kempson, is their failure to understand the behaviours that stop people curbing their spending. We have in-built biases that are not connected with our knowledge and skills.

Research by behavioural economists suggests that our brains are hardwired to sabotage our financial futures – or at least to make illogical decisions. For example, we:

  • Separate our money into mental accounts, based on illogical criteria. You may not be willing to spend $100 from your wallet on an unnecessary gizmo, but might “spoil” yourself with the same gizmo if the money came from Fly Buys or a tax refund. The reality is that the money is part of our overall budget, no matter where it comes from.
  • Set anchors. If a salesperson tells us the RRP of an item is $100, but it’s on sale at $50, we think we’ve got a bargain. The reality is that the company probably never expected to sell that item at $100 and the anchor was used to fool us.
  • Fall for the gambler’s fallacy. This failing in our brains makes us buy investments when they are high and sell low, instead of the other way round. We believe, for example, that the more the property market goes up, the more that is going to continue rising, so we buy. Yet eventually there will be a correction and some people will be forced to sell low.
  • Let our losses run, thanks to “prospect theory”. This means that we will sit on losses, hoping they will turn around so we can sell at a profit. Losses hurt far more than gains give pleasure.
Related Article: 70 ways to save money

Ultimately, Kempson says there are many different components in the Pandora’s Box of financial capability. Getting it right, however, will have serious positive implications for individuals and society as a whole.

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