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Are you planting the seeds of financial stability?
Australia’s debt problem isn’t exactly breaking news. Consumer debt has been consistently high for most of the last ten years. But 2011 figures from the Reserve Bank of Australia show that we’re sinking to record lows: Australians owe some $49 billion, spread across almost 15 million credit cards. The numbers have never been higher.
Of this, $35.5 billion—more than two-thirds of the total—continues to accrue interest at an average of 19.7% p.a. This is almost the highest the rates have been in 20 years, according to the RBA. What this means is that Australian consumers are forking over $7 billion a year on credit card interest.
According to the latest Australian Debt Study by Veda Advantage, one out of five Australians in debt are struggling to make monthly repayments, or are not sure where the next payment would come from. A separate report by Loan Market, a mortgage broker, showed that over 40% of Australian consumers are spending half their income on debt repayments.
Our first instinct is to blame the banks. They are, after all, the ones who entice people with 0% p.a. credit cards and artificially cheap debt, who hide predatory terms in fine print, who are pocketing the $7 billion worth of interest we’re paying yearly. Then again, it is the borrowers who sign blindly and skim through the terms. You’d think we should know better, but obviously we’ve got some learning to do ourselves.
It starts with the way we look at money and debt. Whereas our parents worked long hours, saved most of what they made, and refused to borrow if they could help it, their kids are coasting through life with a “buy now, pay later” mentality, according to an article on financial coaching website Money Solutions. With debt so readily available, today’s consumers see little point in saving up for a new car when banks practically trip over themselves to lend them the money.
So how much do we really know about the business of money? Not enough, as the Mercer 2006 Financial Literacy and Retirement Readiness study showed. Mercer Wealth Solutions, an investment planning firm, found strikingly low levels of financial literacy in 802 working Australians. Only half of them said they had given their retirement options any thought, and that same half were resigned to a lower standard of living upon retirement.
Mercer classified people into six types according to their understanding of money. Less than a quarter had “reasonable understanding,” and only 3% were classified as savvy gurus with “sophisticated understanding. One in five of the respondents had only a basic grasp of the basics, and 14% lacked even that.
A more recent survey, the ANZ Financial Literacy Report in 2008, showed that Australian adults had somewhat improved: they are generally financially literate, but certain groups were at a disadvantage, and certain areas left lots of room for improvement. And it brings us back to the issue at hand: the need for better financial literacy.
What is financial literacy?
Generally speaking, financial literacy is an understanding of finance. The term is as broad as finance itself, encompassing credit, savings, investments, retirement, and buying choices. Someone who is financially literate can make sound decisions based on what they know about money.
Financial literacy is important because it affects our decisions, from where we get our milk to whether or not to buy a house. According to Financial Literacy: Australians Understanding Money, a 2007 report by the Financial Literacy Foundation, the benefits of being financially literate include greater personal independence and wellbeing for individuals, and better productivity and staff welfare for businesses. A financially literate public also benefits the economy by ensuring that consumers make confident choices and aren’t pouring money into all the wrong places (like credit card interest).
Get Smarter About Money identifies five key abilities that make up financial literacy:
- Understanding financial products
This includes savings accounts, mortgages, retirement plans, and investment products such as stocks and bonds—things a person is likely to use and need throughout his life. The Financial Literacy Foundation survey in 2008 found that not many Australians consider themselves informed enough to invest smartly, and only 18% actually have investment property. However, they are willing to learn: about 70% said they want to learn more about investing. - Understanding basic financial concepts
Compound interest, risk levels, return of investment, diversification—these are all terms that one needs to be familiar with in order to make sound decisions. The FLF survey showed that while Australians are confident about everyday things like credit and budgeting, they aren’t too sure about complex activities like investing. Eighty-three percent know how credit cards work and between 88% and 90% say they can budget, save, and manage debt. However, less than 70% think they can invest and only 63% think they can save up enough to retire. - Ability to discuss financial issues
The good news is that Australians recognize the importance of financial literacy, even if they’d rather not talk about it. In fact, many would rather learn about investment strategy than get tips on everyday money management, something they believe they know enough about. Forty percent are thinking of making improvements in their money management. - Ability to make good choices
These choices cover spending, saving, and debt management, including major decisions like going to college, choosing a career, or buying a house. Australians are confident that they can budget their money, but many take an informal approach—48% said they didn’t do so regularly, and 27% have trouble saving up for big-ticket items. And although most claim to be able to save, only 64% actually do so regularly. - Ability to respond to changes
The economic slump has proven that changes do tip the balance. Things long considered stable, such as real estate, proved to be among the riskiest investments. That’s why it’s important as well to be able to protect one’s money. Most Australians trust themselves to choose good insurance and spot scams, but the study shows that they miss out on several key considerations.
What you can do
What is YOUR attitude towards money?
Other studies have repeatedly proven that our attitude towards money is closely tied to our personality. In short, how you handle your money speaks volumes about the kind of person you are. These traits may be inborn, or they may be developed over years of experience and acquisition, according to Generation X Finance, a money blog for young adults.
GenX Finance points to a certain attitude in which people blame money problems on circumstance. People always say they don’t make enough, that they’re a victim of the economy because their house lost value, that they’re still paying for debt incurred years ago. But these same people, studies show, tend to have the buy-now-pay-later mentality that has made credit cards so popular. Before blaming external factors, the site says, it may help to ask what we ourselves are doing wrong.
For example, losing money from the stock market will not hurt so much if one had set money aside when times were better. A more financially literate investor would allocate his assets and spread out the risk. Some might simply have joined the market too late, at a point where they could not afford the loss.
Signs of low financial literacy, according to GenX, include unwillingness to wait and save up; trouble refusing the requests of others, especially family members; shopping as a way to combat depression; spending too much on alcohol, tobacco, and gambling; and avoiding making a budget, assuming that having money in the bank is enough. These “unhealthy traits” don’t mean that one is a bad person—they simply get in the way of financial goals.
Avoiding risk
One thing that may have affected financial decisions in recent years, in Australia and elsewhere, is the influx of financial products that are increasingly complex. In a March 2011 article, MSN Money suggests keeping things simple by sticking to “plain vanilla” products—straightforward deals with no extra offers or teaser rates. Simple 25-year fixed-rate mortgages and four-year auto loans with the standard 20% down payment, standard life insurance, low-cost index funds that match rather than exceed market performance—these are all products that have existed for decades and have been proven safe. Wrong decisions are often made based on low offers (such as the honeymoon rate on a credit card or an adjustable-rate mortgage), which never last.
This isn’t to say that non-conventional products are bad—some of them may offer tangible savings. It’s just that the terms become more complicated, and subsequently there’s more likely to be loopholes that can end up being costly. Again, this calls for a good level of understanding. You want to be able to know what’s on offer, read the fine print, and figure out the real value of a product. Financial literacy in this sense isn’t so much about avoiding risk, but understanding it and knowing one’s way around it.
Keeping tabs
Frugal living blogger Kerry K. Taylor also puts importance on staying informed about one’s finances. Taylor, who writes at Squawkfox.com, suggests requesting your credit report and knowing your net worth, among other first steps. After all, you can’t figure out how to fix your money problems if you don’t know what needs fixing.
Surveys show that only a small percentage of Australians know their credit scores and have requested their credit reports outside of a loan application. Most only become concerned after being denied credit. But doing a self-credit check is easy, not to mention cheap. Veda Advantage and Dun & Bradstreet are the two main consumer credit bureaus in Australia. Both are generally required to provide credit reports for free, according to the Office of the Australian Information Commissioner. The average Australian has a credit score of 750, according to this Creditcards.com report.
Another element worth keeping tabs on is one’s net worth. Whereas credit scores are useful for short-term goals like getting a credit card, net worth is a good indicator of one’s progress in life, says Taylor. Your net worth tells you whether you’re on the right track to retirement, ready to start a family or buy a home, or fit to go back to school. A quick net worth calculator can be found on Invest Smart.
Staying on track
Taylor’s final tip takes us back to basics: starting a budget. Only about half of people in the developed world have budgets, according to studies. But Taylor says even a basic budget can go a long way, especially when it comes to weeding out big, unnecessary expenses. It helps you see where the money is going, and if it’s going in the right place. And that’s an essential first step to fixing bad financial habits.
Financial adviser James Randle, in an article for Parenting Australia, says family budgets should be thorough—every single expense, from candy stores to mortgage payments, should be taken into account. St. George Bank has a detailed budget planner you can use to get started. He advises logging all expenses for one month, then figuring out how the money is being allocated. For many people, the direction of the cash flow can be surprising, he says. Money seldom goes where we think it’s going.
Kid Spot, an Australian family and parenting website, also suggests creating budgets based on time frames, which in turn are defined by goals. For example, if you want to save up enough for a mortgage down payment in five years, your budget should define target savings and expenses for that period. Once you reach your goal, you can set the next one and adjust your budget accordingly. The site also mentions the importance of adjusting the budget to suit changes in the family—a new child, a new job, or a change in plans or preferences.
All this may make financial literacy seem more complicated than it is. To be sure, it isn’t simple. Scott Pape, who runs the money blog Barefoot Investor, says it goes beyond basic common sense—anyone can learn how credit cards work, but it takes more to learn how to use them right. What’s more important, he says, is taking these skills with you when you step out of the classroom—and that’s up to you, not your financial adviser.
