Skip to main content

How much does financial illiteracy cost?

Calculator and coins

Someone recently reminded me of an old business story, the one about Lee Iacocca asking potential recruits what Chrysler and Ford did. The answer, of course, wasn’t make motor cars: it was make money.

I’ve heard that story countless of times. It’s probably apocryphal, but its longevity is partly explained, I think, by the boldness of Iacocca’s mission.

Money. Is that really what it is all about?

It turns out most of us don’t like talking about money. In fact, most people don’t even like thinking about it – and this has enormous implications for us personally and professionally.

In a Health and Retirement Study conducted to understand patterns in financial literacy, the University of Michigan asked participants to answer three questions:

  1. If the chance of getting a disease is 10%, how many people out of a 1000 would be expected to get the disease?
  2. If five people all have winning lottery numbers in the lottery and the prize is $2 million how much would each of them get if the prize was divided equally?
  3. Let us say you have $200 in a savings account. The account earns 10% interest p.a. How much would you have in the account at the end of year two?

These are not difficult questions but the results of the survey are pretty staggering. While 84% of the respondents answered the first question correctly, and about half did so with the second, only 18% got the third right. This demonstrates the large gap between mathematical competence and financial literacy.  What is ever more important, are the consequences of such findings. Households where financial literacy was high (both spouses answered all three questions correctly) were more than eight times wealthier than low financially literate ones (with no correct answers).

The implication for any business, I believe, is very clear. Some of our people make very well-informed decisions with company’s money, while some make very poor decisions with it. Just imagine the impact this has on the bottom line. Indeed, given that the employee is spending ‘someone else’s’ money, the problem could be even more acute.

Financial literacy matters; so why are so many people financially illiterate? Clearly numerical ability is one reason, but there are other, more human reasons why so many people make such poor decisions around money – starting with our relationship with it.

A Seething Mass of Contradictions

Our relationship with money is structured by a series of contradictions: values, beliefs and desires that pull us in different directions. Unresolved, these contradictions shape our behaviours – often not in good ways. Here are three of them.

Contradiction #1: What I need isn’t what I should want

Isn’t money what we all want more of?

‘No’, some cry. Because money – or at least the barefaced pursuit of money – is somehow wrong.

Here lies contradiction #1: we work to be paid, we create to sell our wares, we invest for our future, and yet to be seen to be pursuing the very thing that allows us to do any of these things is morally questionable. You can be proud of what you did with money, but you need to show the world – and probably yourself – that it was just the means to the end.

Contradiction #2: You make me feel so happy; you make me feel so sad

If money really was just a means to an end, we’d treat it like any other tool, like a cup or a spade. Some people might claim that is exactly how they feel about money, but if so, they are highly unusual. For the rest of us, money has as a powerful effect on our lives. Experiments show that if you put a large sum of money in front of people, the mere sight of that cash is exciting: our pulses quicken, our blood pressure rises. But it is a sensation that can become addictive – think of the thrill of getting a bonus, or a pay rise, or sealing a great deal. Money is a pleasure that never fulfils us as we soon get used to the extra cash and start itching for the next rise.

For most people money is rarely associated with positive feelings. In the UK, for example, the emotion most commonly associated with money is anxiety. And if money is a source of distress, how likely are we to spend much time thinking about it?

Contradiction #3: Pay me what I’m worth, but don’t measure my value in money

A former colleague of mine once came up to me at an office party and asked me if I knew what another colleague of ours got paid. I said I didn’t. She said she did and she was furious about it. ‘Why?’ I asked, expecting her to say he was getting paid more than her. ‘He’s getting the same as me’, she replied.

Many companies have rules against talking about salaries and for good reasons: while many employees negotiate their own contracts and in doing so arrive at an agreement they are comfortable with, evidence shows that the mere knowledge of a co-worker earning more (or even the same) for doing a similar role is associated with reduced job satisfaction.

This takes us to contradiction #3: what a colleague gets paid can only affect you if you see money as the way in which your value is measured, but what sort of person would you be if you could be bought?

We need to talk about cash

You may argue that none of these ‘contradictions’ is insurmountable – and you’d be right. Humanity has found ways of managing how money affects us – over time we have forged our own personal relationship with it. For many this may well be a healthy relationship of equals, where we take pride in managing our finances. For others, though, it is a much less positive one, where often financial matters are ignored.

A well-known financial regulatory body in 2006 ran a baseline survey of financial capability that through focus groups and questionnaires examined consumers’ capability in broad categories around ‘managing money’, ‘planning ahead’, ‘making choices’ and ‘getting help’. This research revealed that around a third of consumers had no apparent weaknesses, while two thirds exhibited significant weaknesses in one or more of these areas. The general levels of financial literacy are very low indeed.

This is helpful to unearth the magnitude of the problem, but how can we forensically assess individuals or groups around their level of financial literacy in a way that is useful to an organisation?

We knew we wanted to move away from tests because a test only assesses our ability to recall knowledge. We were not interested only in what people knew about finance, but in what decisions they were likely to take when presented with the sort of financial scenarios they deal with at work (i.e. practically all of them!).

Through considerable research, on-the-job investigation and refinement we created a financial literacy diagnostic tool: a digital questionnaire that is tailored to the sorts of decisions that are made every day in a business around its money. Importantly, the diagnostic asks people not just to make a decision but also to say how confident they are that they got it right. This assessment of both competence (do I know the answer?) and confidence (do I think I know the answer?) is critical.

What have we found so far? There are people who are very confident about the decision they make although their level of competency falls far short of their confidence. There are also people who know the right answer but don’t exhibit the confidence required to put it into action.

This comes together as a financial literacy heat-map that identifies which individuals are likely to be a risk to an organisation and which represent untapped potential, allowing early and targeted development for the people who need it most.

So whether you buy into Iacocca’s red-blooded capitalism or take a broader view of the purpose of business and society, nurturing good commercial decision-making by optimising financial literacy reduces risk and better positions any enterprise to succeed.