Financial literacy is key

The mandatory nature of Australia’s super system means that most people are responsible for making important financial decisions about their retirement. But how well equipped is the average Australian to make decisions about super and retirement planning? Research into the financial literacy of Australians, suggests that most are not well equipped at all and that financial literacy is key to successful retirement planning.

The research paper Financial Literacy and Retirement Planning in Australia1 (based on The Big Three2 measure of financial literacy) highlights those groups which are least financially literate. The Big Three measure has also revealed that people with poor financial literacy, or gaps in their financial knowledge are less likely to plan for retirement, or make sound financial decisions regarding their super and retirement income.  While those with higher levels of financial literacy are more likely to plan for their retirement.

What is The Big Three?

The Big Three is a widely used measure of financial literacy, which asks respondents just three simple questions. The first two questions cover economic concepts related to saving for retirement, including calculating interest and understanding inflation. The third question tests the individual's understanding of diversification and risk.

Here are the questions:

1 Understanding of Interest Rate (Numeracy)

Suppose you had $100 in a savings account and the interest rate was 2% per year. After 5 years, how much do you think you would have in the account if you left the money to grow?

More than $102
Exactly $102
Less than $102
Do not know
Refuse to answer

2 Understanding of Inflation

Imagine that the interest rate on your savings account was 1% per year and inflation was 2% per year. After 1 year, how much would you be able to buy with the money in this account?

More than today
Exactly the same
Less than today
Do not know
Refuse to answer

3 Understanding of Risk Diversification

Buying shares in a single company usually provides a safer return than buying units in a managed share fund.

True
False
Do not know
Refuse to answer

What are the trends?

Lusardi and Mitchell, who developed the questions, used these questions in research to explore financial literacy and retirement planning across eight countries - Germany, the Netherlands, Sweden, Japan, Italy, New Zealand, United States and Russia their findings are discussed in detail in the National Bureau of Economic Research report Financial Literacy Around the World: An overview.2  

Their research has led them to the belief that financial literacy is critical to retirement security and has also revealed patterns of financial literacy levels, specifically:

  • younger people have lower levels of financial literacy
  • women are less financially literate than men
  • more educated people have higher levels of financial literacy, but education does not necessarily equate to financial literacy
  • those people with higher levels of financial literacy are more likely to plan for their retirement.

Local results

As we’ve mentioned, Australians are responsible for making the super investment and management decisions required to optimise their retirement income. For these decisions to be effective, the individual needs to understand financial concepts around investing, inflation and longevity risk.

Unfortunately the Australian research (Financial Literacy and Retirement Planning in Australia) conducted by Agnew, Bateman and Thorp) shows that despite the fact that Australians are more responsible for their retirement income than people in other nations, the gaps in financial literacy are similar. The research, conducted via a customised online survey, was administered to a representative sample of 1,024 Australians in June 2012. The findings show correlation across the major patterns, of age, gender and education.

The survey revealed that only 31% of respondents aged 35 and under correctly answered all three questions, this percentage increases with age to reach 58% for those over 65.

Women are less financially literate than men with 34% of Australian women correctly answering all three questions as compared to 52% of men. It’s also interesting to note that women more frequently answered ‘I don’t know’ to the questions - indicating that they know they have a knowledge gap.

And, when you look at the impact of education in Australia, those who have tertiary education in the form of Bachelor’s or Graduate degrees were more likely to answer the three questions correctly than those who  have high school education or less (38%).

People closer to retirement are more financially literate

By asking a further question of participants, the Australian study was able to show a link between financial literacy and planning for retirement. They asked people who had not yet retired:

Have you ever tried to work out how much you need to save for retirement?

Overall they found that only 32% of the group had tried to work out what they needed to save for their retirements, starting the retirement planning process. Of this group,  55% correctly answered all of the Big Three questions, while of the 45% of respondents who had not tried to work out how much they would need to save for their retirement, only 35% answered all three questions correctly.

Super funds can help to empower their members to make sound financial decisions through targeted and tailored education and advice aimed to improve their financial literacy. For more information on SuperEd's financial literacy and education solutions, give us a call.

 

1 Agnew, Julie R; Bateman, Hazel and Thorp, Susan (2013) “Financial Literacy and Retirement Planning in Australia, “Numeracy: Vol6: Iss 2, Article 7 available at http://scholarcommons.usf.edu/numeracy/vol6/iss2/art7

2 Annamaria Lusardi Olivia S. Mitchell Working Paper 17107 http://www.nber.org/papers/w17107