Financial Literacy

Why Financial Illiteracy Hurts Everyone

So what do you write for your first post on a website that is filled with bloggers who have much more investing experience that you do and have been recognized throughout the rest of the personal finance blogging community and the media at large?  As I racked my brain for a topic that I felt authoritative about, as well as one that was interesting, I decided upon a constant wonder of mine: How the widespread epidemic of financial illiteracy hurts everyone.

These Guys Will Be In Charge Of Your Pension

As a teacher I see students every day who I know will soon become adults that have no real grasp on how to manage their personal finances.  I’m not talking about grade seven students, I mean the upperclassmen who will soon be out in the adult work handling fairly large sums of money.  I’ve written before on the inadequacies of our current education system in terms of producing financially-literate students.  Perhaps I’ll address the subject at length here another day, but for now I want to explore the point that these students won’t just go out into the world and harm their own well-being (they will most certainly do that though), but they will indirectly hurt me as well.

A Silent Disease

So how does a person not knowing the difference between a stock and a bond hurt everyone else in society?  Like any epidemic, the effects of financial illiteracy are widespread and vary greatly.  First and foremost, on a large scale, every capitalistic society relies on efficient distribution of resources.  Supply and demand only works if consumers understand exactly what they are demanding and how much they should be willing to pay for it.  When people do not understand how to best ration the money they receive from their labour, they make illogical (re: dumb) decisions with their money that distort the market for the rest of us.  For example, if everyone drove vehicles that were more fuel efficient the demand on gasoline would be much less and everyone would experience lower gas prices.  Undoubtedly there are many people out there that need certain types of trucks and other fuel-intensive vehicles, but there are many more who simply buy them for reasons that make no real sense and this distorts the most efficient market for the rest of society, as well as costing them quite a bit of money in the long run.

Duh… He Said Taxes Were Bad – I like Him

The second way that society as a whole suffers from this epidemic is due to the fact that we live in a democracy.  We are responsible for choosing the political leaders that set the fiscal policy for our country (or at least they in turn pick someone that determines financial policy).  If we are not sure what the real consequences of rising interest rates are, how are we supposed to elect someone that will choose the best path for us to follow?  More and more, all government policy is predicated on sound bites instead of truly informative approaches.  How often do we hear things like, “He only cares about the 1%,” or, “She is for big government and that’s bad for the economy.”  Those two statements mean very little without some context to put it in.  Sometimes government involvement can be great for the economy (that one was a little tough for this conservative boy to admit) and if anyone thinks that there is a single politician out there who is not intensely worried about the now infamous “1%” in their country, then they are kidding themselves.  Learning basic financial principles would allow our political leaders to actually have real debates because they would realize that they could reach voters this way.  Right now, they have seen time after time that the best way to swing voters is to produce a snappy quip like the ones above because the majority of people don’t care about something like the long-term effects of raising the income tax versus consumer taxes.

Your Dollars At Work

The most direct way that I can see (and here is where my admittedly conservative bias will shine through) that the financial illiteracy of those around me hurts my own situation, is through the over-taxation I experience due to a strained social safety net.  Now I’m not quite the hardcore conservative you might see on TV that is in favour of axing healthcare or anything like that, but seriously stop and think about the problems we could solve simply by teaching people how to take care of themselves.  I believe that there should definitely be a social safety net and I love that we have a great one in Canada, I just think the less we all use it, the better off everyone is.
The best example is probably the mortgage crisis that took place in the USA and throughout many other parts of the world.  While the banks certainly deserve their fair share of the blame in regards to giving out sub-prime mortgages, people that properly understood cash-flow percentages and how rising interest rates work would never have signed on to those dotted lines.  This would have prevented all kinds of money from coming out of their pocket.

Teach a Man To Fish…

By showing people how essential saving a portion of their income is to help fund their future needs, we could eliminate much of the old age poverty that plagues our country.  If a person knows this information, and decides to buy a luxury they don’t really need instead of saving for their own retirement, isn’t this a freedom we should allow instead of taking taxes from everyone at relative gun point?  The fact that we feel we need to protect these people from themselves means that the government must get involved on a large scale.  When the government gets involved on a large scale there are inevitably inefficiencies in the system and vast personnel hiring that would never have to be done if people simply knew how to take care of themselves and then either chose to take one path or the other.
Whenever someone declares bankruptcy because they didn’t understand how quickly credit card debt can compound against them, or because they didn’t understand the mechanics of a student loan (woo-hoo… my cheque came in, beers all around), this directly takes money out of society’s collective pocket.  When people build homes that are too big or buy vehicles that are too costly they hurt themselves and then eventually they hurt everyone else as well.
Then again, some of those Gordon Gekko-types out there single-handily do more damage to the economy than any one or two person who think dividends only occur in the board game Monopoly.  Maybe there is such a thing as too financially literate?  

Comments

  1. KC @ PsychoMoney

    Great point. It would be wise of all of us to raise financial literacy everywhere. Could you imagine a world that everyone took care of themselves, think of how much we would all save not having to pay into all these social programs.

    • Kyle Prevost

      EXACTLY. Teach a man to fish versus give a man a fish right? The downside is that we would have a lot of bureaucrats suddenly looking for work with no discernible skills…

  2. Liquid Independence

    You can earn dividends in Monopoly? ??? ???!!!
    This changes everything.

    • Kyle Prevost

      Haha, don’t you remember the classic Community Chest cards where people either owe dividends, or you have to pay out dividends?!

  3. W-at-Off-Road-Finance

    Unfortunately I think widespread financial literacy is nearly impossible, at least in the US. A prerequisite would be widespread mathematical literacy, and we’ve got a very entrenched public education system which wants no part of that.

    I’ve come to the conclusion that it’s possible to teach very advanced finance to a few people (and I enjoy doing that), but nearly impossible to teach an acceptable minimum level to lots of people.

    • Kyle Prevost

      That’s a sad conclusion that I am unfortunately coming to as well. How do you explain compound interest if you don’t understand how percentages work?

  4. William Jones

    One thing that needs to be implemented in highschool is personal finance. Simple budgeting and savings plans etc. A little less sewing, cooking, wood and metalwork and a lot more money managing for real life. Hell, that’s likely even more important than some of the other school subjects they teach in high school.

    I took an accounting degree in university and rather than forcing students to do X number of arts/social classes in the first two years (yes, i took anthropology, psychology, sociology and philosophy because i had to fill the credit requirements), students would be WAY better off to take some intro financial planning courses that they can apply to their current lives as students and down the road as parents/families etc.

    My wife has 3 sisters, all older than us and married, and I am constantly amazed at how poorly their household finances are handled. We’re talking about couples in their mid-thirties with two decent jobs struggling to make ends meet. My wife is a stay at home mom and I make less than $60,000 a year and we are doing loads better than family members with no kids and household incomes in excess of $70-80,000 per annum. It’s hard to have sympathy for these types of people, but the truth is they have no clue how to properly handle their money.

    One of the things that drives me nuts are those ppl who purposely take more off their paycheques so that they always get a tax refund. They are all so stoked about a $2,500 tax refund in April every year, but all they’ve done is given the gov’t a free loan for the year. I’d much rather owe a little bit than pay too much tax all year long to keep intact the psychological high of receiving a refund. Blows my mind how people don’t “get” it.

    Education in highschool and in the first 2 years of degree programs are key and need to be mandatory.

  5. Kyle Prevost

    Preach it brother. I agree with everything you’ve stated. Unfortunately we are definitely in the minority from everything I have witnessed in the public education field over the last few years.

    I especially love your comment on the “magical $2,500” tax return. You try and explain to these people that they have voluntarily given up the interest on their own money to the government and they look back at you with a blank stare.

  6. Cliff Stevenson

    I’m not 100% sure it’s fair to put any of the blame on the majority of ‘victims’ in the housing crisis in the US (some maybe). Those documents are very difficult to read for the vast majority, and people were relying on the “experts” summary in many cases. Heck, even if it was clearly explained in fine detail, many still wouldn’t have understood what was happening. The banks drafted the documents and policies, and should have had the foresight to see what was going to happen…..and at the very least, the obligation to discuss and disclose more than they did.

    I’m not a fan of the ‘victim card’….everyone should be responsible for understanding what they are signing. But that crisis down there was a different animal.

    Just my opinion.

    • Kyle Prevost

      I agree Cliff, that’s why I qualified the statement a little bit. Banks should have known that this was not good long-term business for them either, but as we now know, they weren’t really concerned about the long-term viability of the loans, just getting as many of them as possible in order to bundle into derivatives.

      • Cliff Stevenson

        Cool. Helluva a blog by the way. Nicely done.

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