Over the years, we have been very proud and boastful of our education standards. After all, Sri Lankans’ literacy rate is over 90%, almost comparable with any developed nation. And in recent times, we started focusing on IT literacy, correctly recognizing it as a basic skill (almost as basic as ability to read and write) if we are to compete in a global economy.
It was none other than Bill Gates himself who recently congratulated Sri Lanka on the strides made in this regard. However, as evident from the recent spate scandals ranging from outright Ponzi schemes, mismanagement at finance companies and glaring lack of corporate governance in some of the best known financial institutes of the country it is clear that the country is lacking another form of literacy which is as critical in this day and age: that is, Financial Literacy.
Q.What is Financial literacy?
While there is no universal definition, financial literacy generally refers to a person’s ability to comprehend basic concepts of finance. They may include basic notions such as compounding of interest, trade-offs between risk and return, effect of inflation, and diversification. Obviously, finance is an extremely complex subject, the intricacies of which are well beyond somebody who is not a specialist in the area. But just like being literate does not mean that an individual has to be a literary genius or a scholar, being financially literate does not mean that one has to be a specialist. Basic understanding can go a long way in making substantial improvements in some of our most important life decisions.
Q. How Financial literacy can avert disastrous personal decisions?
The number of investment scandals experienced by the Sri Lankans over the past few years have been almost too numerous to mention. Gold Quest fiasco, duping of investors by Sakvithi, Danduwam Mudalali and many others like them, as well as difficulties experienced by the depositors of numerous finance companies are some pertinent examples.
The woes of many people who have undergone tremendous sufferings in recent times due to their investments going awry can be directly attributed gross lack (or absence) of financial literacy. For example, if one was somewhat aware of how finance and economy works he would have known that:
I. There is a pertinent trade-off between risk and return. If somebody is offering you very high return he must be exposing you to a very high level of risk no matter what he says (if something is too good to be true it probably is)
II. Collecting money from Peter to pay Paul is never a sustainable way to make returns. Investments can generate sustainable returns only if they are employed in activities that generate economic value. (And being sucked into buying grossly overpriced (albeit, nice looking) coins (or whatever it maybe) believing there are an even bigger sucker out there who will buy them from you is never a value generating economic activity!)
III. Diversification of investments is essential if you are to minimize the possibility of big, unpleasant surprises (never put all your eggs in one basket). Many unwise investment decisions could have been avoided or their impact minimized had the general public been more aware of these basic concepts.
Financial literacy is also critical in evaluating and uncovering alternative investment opportunities. Some argue that high inflation coupled with low interest rates offered by banks enticed investors into finance companies and individuals with questionable reputation. While there is some merit to this argument, it needs to be noted that government treasury bills offering significantly higher interest rates (when compared to bank deposits) were available as alternative investment instruments. These government issued debt instruments carry almost no risk and are easily accessible through many commercial banks. Unfortunately it seems that much of the general public is unaware of these alternatives.
Q. How to improve financial literacy?
Government and related professional bodies need to take measures explicitly aimed at improving the financial literacy of the general public. Such measures are taking place in a number of developed countries (passing of The Financial Literacy and Education Improvement Act (2003) in the USA is a case in point). Possibility of introducing the knowledge of basic financial concepts at middle school level (Grades 9, 10, 11) needs to be explored since the education at higher grades tend to focus entirely on specialized areas of tertiary education.
Public media (both print and electronic) can be utilized in educating the general public on basic financial concepts in a lucid manner. Such efforts should be in Sinhala and Tamil languages as vast majority of general population do not access English media for news and information.
Furthermore, when professionals and policy makers make investment recommendations to the public, they should make sure that all costs, benefits, and risks are adequately explained. For instance, I have seen calls from many quarters urging the public to invest in the stock market. Given the current lack of general public participation, such calls are indeed welcome. However, along with possible benefits, potential risks needs to be explained as well. For instance, while stock market is a sound investment in the long-run, the possibility of large adverse price movements in the short to medium term needs to be clearly disclosed. Failure to do so will result in large-scale loss of confidence in legitimate financial institutions in periods of turmoil.
Q.Will financial literacy cure all ills?
Improvement of financial literacy will not solve all the issues relating to unwise investment decisions for sure. Finance and economics theorists are increasingly admitting the limits of human rationality and how factors such as unfettered greed, peer pressure, and limited memory can lead to less than optimum decisions. However, basic understanding of finance will most definitely enable the general public to avoid some of the most glaring mistakes made in money matters, and limit their losses even if such mistakes are to be made once in a while.