Similarly to traffic accidents the cost of financial accidents can be significant. (Photo: Wiesbaden112, Flickr under CC)

Do we need a finance driver’s license?

When it comes to making choices such as taking on debt and building savings too many people still suffer accidents, big and small, because they are not equipped with the right knowledge. Can a driver’s license for the financial highways provide a much-needed boost to financial literacy levels?

Let’s consider for a moment what we have done to manage traffic. To let us navigate safely on the roads we have implemented many rules. Speed limits. Road signs. Traffic lights. All this regulation is designed to let us drive safely from A to B.

Anyone taking the steering wheel into his or her hands is requested to actually know a little about about how to operate the car and how to drive. Driving education has become mandatory, and a driver’s license is proof that this person knows the fundamentals.

Should we think in the same way before we let people drive on the busy and tricky highways of financial services?

It is clear that people should know a thing or two about money and financial services, also given that finance is becoming increasingly digitized. A basic level of financial literacy can let them operate more safely on the financial roads, both for themselves and for others.

‘‘We don’t want people to be experts – we are not asking them ride in a Formula-1 race. We are just asking them to know a couple of rules so that we can all operate safely on the roads.’’

‘‘We don’t want people to be experts – we are not asking them ride in a formula-1 race. We are just asking them to know a couple of rules so that we can all operate safely on the roads,’’ said Professor Annamaria Lusardi, Academic Director of the Washington-based Global Financial Literacy Excellence Centre, or GFLEC, when addressing the Brussels Kick-Off meeting for European Money Week on 27 March.

Low financial literacy levels are costly and damaging, to individuals and to society at large. It might not directly be reflected in our own bank accounts, but the costs do exist. Excessive interest rates on debts, missed opportunities on the job market, mortgages we should never have bought, even bankruptcies, to name a few. Consequences exist both at the micro and the macro level.

The problem goes beyond understanding the concept of compound interest. Research by Professor Lusardi shows that the general understanding of risk also is particularly low. ‘Financial literacy should not be taken for granted, even in countries with well-developed financial markets.’’

‘‘Financial literacy should not be taken for granted, even in countries with well-developed financial markets.’’

‘‘Financial literacy should not be taken for granted, even in countries with well-developed financial markets,’’ she said. ‘‘When it comes to knowledge, the grasp of the risk concept and of risk diversification are actually very low, and substantially lower than other concepts. The knowledge of risk is particularly low.’’

Lusardi’s latest research is based on 28 questions to measure personal finance, as opposed to a mere five questions in earlier studies. She has identified two groups that are particularly vulnerable: women and the young.

‘‘Women know substantially less than men, and this is true in each of the ten countries. The gap is largest when we look at risk literacy,’’ she said. ‘‘Even in the US, the country with the most developed financial markets, the knowledge of personal finance is low. Only half of the population can answer half of the questions in our personal finance test.’’

To better understand the problem it is important to realize that by the time people are 40 or 45 years old, they normally will have made the fundamental financial decisions in their lives. These decisions often have been based on a very low knowledge base.

‘‘Financial literacy is also linked to making fewer mistakes and to less severe consequences of the decisions that people make.’’

‘‘Financial literacy is very consequential,’’ said Prof. Lusardi. ‘‘It can be linked not just to behaviour. People who are more literate are able to make good decisions, on a variety of topics, such as saving and investing and managing debt. But financial literacy is also linked to making fewer mistakes and to less severe consequences of the decisions that people make.’’

To move the needle on financial literacy we need to educate young people, says Lusardi. ‘‘We need to equip the young with the knowledge that is needed to today to be able to participate in society and in the economic environment.’’

That is happening at some US universities already. George Washington University, where the GFLEC centre is based, now offers a new course on personal finance, and Lusardi et al are encouraging other universities to implement these courses as well.

In the case of the drivers’ license it was obvious. A driver without a license is a danger, to himself and to people around him. So should better financial education and a test of financial literacy become mandatory as well? When I put this question to Prof Lusardi at the European Money Week meeting she said this would make sense because this could benefit tax-payers.

‘‘It is really cheaper if you require people to act on this basis of knowledge before they engage in these decisions that are so consequential for themselves and for society.’’

‘‘This is really the same for financial knowledge,’’ she said. ‘‘I actually would be willing to make this more mandatory, because at the end it is the tax payers that are asked to pay for the mistakes. It is really cheaper if you require people to act on this basis of knowledge before they engage in these decisions that are so consequential for themselves and for society.’’

‘’It is always hard to make things mandatory but I just want to warn you: Asking people to make complex decisions from a very low basis of financial knowledge is dangerous. Be aware of that. Ignorance is costly and dangerous.’’

Lusardi’s message is clear. Personal financial needs to be implemented into our daily lives. To boost financial literacy, it is financial education that needs to be taken seriously, not just by those that are passionately involved in initiatives such as European Money Week, Global Money Week, Financial Literacy Month and various national money week actions in European countries. Leadership is required.

‘‘It is expensive not to do financial education,’’ said Lusardi. ‘‘We are going to pay for the cost of financial illiteracy and we can decide how to pay for that. Normally, prevention is more cost-effective and less painfull.’’

‘‘I hope in Europe as well that we will have visionary leaders who can help us make changes so that our young, women and all of the population are better equipped to deal with all the decisions that everybody has to make.’’


You can listen to Prof Lusardi’s presentation here:

For more about European Money Week, visit www.europeanmoneyweek.eu