Over the last couple of weeks I've found myself in discussions with 3 different people about different parts of the financial world. None of these people were involved in finance but I would class them all as being smart people. There was a severe lack of knowledge or in some cases a misinterpretation in their knowledge about the workings of different aspects. To me this seems to represent the population as a whole when it comes to managing their finances. Finance forms such an important part of all our daily lives that one would imagine we would all take it upon ourselves to gain an understanding, or look to someone else to give us an understanding, about either planning for the future or the impacts of financial events. As per one of the previous examples, we wouldn't look to self-diagnose ourselves as to what symptoms of all but the basic illnesses we had represented and we certainly wouldn't be able to go to the pharmacy to buy all but basic over the counter drugs to self cure. Yet often when it comes to financial matters we look to seek the solutions ourselves without first seeking the methods to fully understand both how what we are looking at works and whether it is indeed the best cure for our issues.
The situation is rather neatly summed up by Morgan Housel of The Motley Fool in his article '77 Reasons You're Awful at Managing Money':
"People usually get better at things over time. We're better farmers, faster runners, safer pilots, and more accurate weather forecasters than we were 50 years ago. But there's something about money that gets the better of us. If you look at the rate of personal bankruptcies, financial crises, bubbles, student loans, debt defaults, and savings rates, I wonder whether people are just as bad at managing money today as they were in previous generations, maybe even worse. It's one of the only areas in life we seem to get progressively dumber at."
The issue is not solely one of a lack of want for people to understand. True, there are many who consider finance, and it's relation - economics, to be tediously boring and would shirk away from reading any article, leaflet or book on the matter. But the majority of those, when the consequences involved are explained to them, find themselves thoroughly interested and wanting to learn more. But, as Housel talks about, even when we do find ourselves reading about it we still enable ourselves to make the same behavioural mistakes as others and ourselves have made in the past. To take just a few of the examples he states:
There's plenty of other snippets in there which are amusing but the core point is important.
Forty, maybe even thirty years ago, the requirement for most people to have a broad understanding of finance was a lot lower. Investing in anything beyond savings accounts was often only the preserve of the wealthy and many pensions were still final salary based, so the need to understand much beyond the current interest rate and mortgages for the average person wasn't particularly necessary.
Nowadays this is no longer the case. Most people are now responsible for their own pension choices, having to decide how much and what to invest in. The creation of ISAs in the UK has encouraged more and more people to look to save their money and invest for the medium term of up to £11,500 a year (£11,880 from April). Mortgage choices are all the more complicated and even the provision of financing for cars and other personal items, which are popular to allow people to "afford" the things they don't have the up front cash for, should require better understanding. A much larger percentage of the population now has disposable income with which to use and is also more likely to be susceptible to being taken advantage of through their lack of knowledge, as the recent PPI and Interest Rate Swap scandals prove. There's only a certain amount further that proclamations of ignorance can go when trying and failing to manage our own finances.
The obvious starting point for this education would be to include the basic concepts of finance, economics and money management as a compulsory element of the school curriculum. The complications of this are that within a society, especially in the UK, where there is already continuous debate over getting the most out of an existing curriculum, the proposal to add an additional compulsory subject on personal financial management is unlikely to get much traction for many years. This, coupled with the traditional laissez faire attitude of students to the subjects they deem as boring, would perhaps not add much more to the knowledge of the general populace.
Another point of education could be advice provided by employers through professional educators as part of an employees benefit package. Firms themselves are often affected by their employees inability to keep their personal finances in check and would benefit from their employees having a better grasp of their own finances and pension options. Certainly larger firms could provide ongoing advice or courses to employees helping to properly understand the various funds available under their pensions schemes and the amounts they should contribute to their pension to realistically have an opportunity of achieving their financial aims. This, as well as assisting employees in understanding other financial concepts affecting them and how to best assess the right options for them would at least give each employee equal opportunity in using their options. Everyone, of course, is different and their personal situation and risk profiles will vary wildly. But at least some level of formal education will ensure people have been given the opportunity to make better decisions.
There is also the opportunity for the individual to seek professional advice in the form of an Independent Financial Adviser (IFA) if they feel the capacity of understanding their options to be too overwhelming. I believe there is vast scepticism amongst the majority of the population in using an IFA, which given the scandals of the past is understandable. Regulation nowadays makes it harder for an IFA to sell only specific products which they would receive a kickback on, but the fear is still there. As with any adviser though, just because they have been in the industry for 10-20 years, doesn't mean what they recommend you invest in will necessarily see you outperforming on your investments. It would still be important for the individual to understand what it is they're using their money for and a good adviser should ensure that the client is aware of this. Unless fraud is involved though, people must accept that if investments didn't perform as hoped for, they are as much to blame as their adviser because the ultimate investment decision rests with them, emphasising further the need for understanding.
The reality is, unless we are truly missold by being told certain investment risks didn't exist, or that a product would definitely perform a certain way which ultimately wasn't true, we cannot blame someone else for us making the wrong financial investments. For me it seems incomprehensible that Richard Desmond, for example, can successfully sue GLG for £20m for his misinvestment into a complex product known as a CPPI (Constant Proportion Portfolio Insurance) now that it's lost him money. If he truly didn't understand it to begin with, then he should never have gone through with it. We can't blame others when we lose money on our decisions which we'd wrongly assumed we were bound to win on. It doesn't mean that fraud doesn't happen. Of course it unfortunately still does. But we do need to understand the difference of when we have been missold something and when we have purely made an underperforming investment or taken out a disadvantageous loan through our own choice. Even with medicine it is sometimes not clear what the cure is, if there even is one, but we trust that the doctor will use the best of knowledge available to him/her to improve the situation.
The world has become an ever more complex place and, in terms of finance, it's impact on us and our need to understand these complexities only continues to increase. Pleas of ignorance, boredom and a lack of understanding will only help us so far in failing to grasp the personal implications of the management of money. To paraphrase Morgan Hounsel, you can hate finance, think it's confusing, and not want anything to do with it, but ultimately by loving money you should feel necessitated to try to understand how to make it work. There are no definitive answers in how best to manage your money and ensure you'll have what's required at the various stages of life. The unpredictability of markets, interest rates and global economic events mean that we can only try to strive to do what's best for us in various circumstances. But we owe it to ourselves to ensure we truly understand the financial decisions we are going to make and their implications, or get the advice to understand these decisions, before it's too late.
