Society is moving faster and faster and our everyday lives are becoming more and more complex. This is currently also evident in the work environment, and many employees are confronted with increased insecurity with regard to their jobs. This is further exacerbated by the fact that the traditional employment relationship is changing. Employees are increasingly changing their employer and looking for new professional challenges instead of staying in one job. In such an environment, the importance of consciously managing one’s own assets or income increases. This raises the question of how pronounced financial literacy is within society and how people can benefit from basic financial education. This post will look at what skills are needed to secure oneself financially, accumulate wealth and benefit from the wide range of financial products available.
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Everyone needs some form of income or wealth to secure their own existence. The most important instrument in this context is money, since almost every transaction or exchange is conducted with money and it thus dominates our everyday life as the most important medium of exchange. In order to be able to use this scarce resource efficiently and purposefully, a basic financial education is required. However, it is striking that ignorance regarding financial markets and financial products is very pronounced worldwide. It is interesting to note that differences in terms of development and access to capital markets do not have a significant impact on the financial literacy of the individuals concerned. Instead, however, there is a dependence on the economic circumstances that the individuals have experienced in recent years and they are better educated in those aspects that they have been able to observe in everyday life. Moreover, significant differences exist when considering the financial literacy of different genders or of different age groups. Women are often significantly less educated than men when it comes to finances, and many researchers attribute this to outdated role distributions within families. In terms of age, financial literacy can be represented using an inverted U-curve. Both young people and old people exhibit lower financial literacy. What is striking here, however, is that young people are more willing to admit to insufficient knowledge than old people, who often (wrongly) believe that their financial knowledge is extensive enough.¹
When people talk about basic financial literacy, they are essentially referring to three components: the ability to make appropriate calculations, the ability to understand inflation, and the ability to assess and diversify one’s risk. However, as described above, these skills are poorly developed within the population worldwide. Such ignorance is a particular problem because people are increasingly on their own when it comes to retirement planning and wealth accumulation, and they need to be proactive in doing so. Sufficient financial education enables people to protect their own assets in times of crisis, avoid unnecessary costs related to financial products and promotes independence, as people are no longer dependent on the advice of professional advisors or their own environment or circle of acquaintances. This predominantly results in higher personal wealth compared to that of people who are not financially literate.² Even though basic financial knowledge is correlated with higher wealth, however, having wealth does not mean that a person will be able to use it responsibly. For example, in December 2019, the Washington Post published an article showing that about 70% of all lottery winners are bankrupt within a few years.³
The increasing complexity of financial markets combined with the growing number of financial products can bring both advantages and disadvantages for private individuals. First, it is conceivable that the complexity here acts as a kind of barrier to entry and people feel unable to participate in the financial market. The large number of financial products also makes it almost impossible for a non-professional to know and understand all the products and then select the most suitable ones according to his or her own situation. When amateurs do try their luck in the financial market, they often overestimate their own competence and incur significant losses because they are unable to assess the risk correctly or process the available information adequately. On the other hand, access to the financial market has become much easier for a private person, so that almost everyone has the opportunity to participate. Competition among providers of financial products can also result in falling costs for consumers, as providers compete for new customers or investors. Even though investing one’s own assets always involves risk, investors have the opportunity to achieve higher returns than if they were to deposit their money in a savings account or a comparably safe financial product.
Moreover, in the current low-interest environment, a savings account is not even able to compensate for inflation and is therefore not suitable for wealth accumulation. Instead, alternative investment products are needed to realize significant capital gains. For capital to be available to begin with, one’s standard of living and individual budget must be consciously chosen so that income exceeds expenses and the surplus can be saved or invested. If a person pursues the goal of accumulating a high level of wealth at an early stage, this can usually only be achieved through a certain level of sacrifice. However, it is important to emphasize at this point that there is no “right” or “wrong” way to do this. Rather, it is always one’s own situation in conjunction with individual preferences and priorities that determine how capital should be deployed. Setting priorities is perhaps the most important approach when it comes to achieving one’s financial goals. In addition, it can pay to invest in financial education at an early age and acquire the aforementioned skills. Young people, for example, can develop appropriate routines for managing their own capital that can benefit them throughout their lives. Moreover, as people get older, their income usually increases up to a certain point, and it is probably easier to increase one’s standard of living only slowly than to have to cut back again at a later stage. However, the strongest argument for early financial education is almost certainly the power of compound interest and its importance for long-term wealth accumulation.
Financial literacy is an important success factor when it comes to building one’s own wealth and financial security. The key skills make it possible to secure one’s own assets even in uncertain times, to avoid unnecessary costs and to maintain one’s own independence. Although this may seem desirable, financial illiteracy is widespread around the world. Although the complex financial markets are becoming increasingly difficult to understand, the associated financial products also open up many new opportunities from which private investors can benefit. While there is no one-size-fits-all approach to financial decision-making, everyone can benefit from a basic financial education, as it provides a foundation for making informed and appropriate decisions. The earlier people begin to educate themselves financially, the greater the long-term, positive impact.
¹ Lusardi, A., & Mitchell, O.S. (2011). “Financial literacy around the world: an overview”. National Bureau of Economic Research Working Paper Series. Nr. W17107.
² Lusardi, A., & Mitchell, O. S. (2014). “The economic importance of financial literacy: Theory and evidence”. Journal of economic literature. 52(1): 5-44.
³ Loewenstein, George. (2019). “Five myths about the lottery”. Washington Post. Accessed March 7, 2021. https://www.washingtonpost.com/outlook/five-myths/five-myths-about-the-lottery/2019/12/27/742b9662-2664-11ea-ad73-2fd294520e97_story.html