Dipesh Chaulagain
Financial literacy is the ability to use knowledge and skills to manage ones financial resources effectively for the lifetime financial security. Financial Literacy education should include the ability to understand the financial choices, plan for the future, spend wisely and manage, and be ready for the life events such as job loss or saving for retirement. It is the effective use of the information in the decision making process that separate the more literate from the less literate decision. Saving is defined as the income not spent in the consumption. Consuming less out of the given resources in the present in order to consume more in the future is saving. Saving therefore is the decision to defer consumption and to store the deferred consumption in some form of the assets. Due to uncertainties that may be faced in the future money should be saved for unexpected events and emergencies. Saving implies different meaning to different people. To some, peoples it means putting money in the bank. To other, it means buying stocks or contributing to the pension plans. Investment involves employment of funds with the aim of achieving additional income or growth in the values. Lending money to others to earn interest, purchasing of gold for value appreciation of the value, purchase of the insurance plan for the promised future benefit, purchase of the stocks etc are all some of the examples of the investment. Thus, expectation of the return is an essential element of the investment.
Savings and investments by individuals are as vital to personal financial well- being and security as to the healthy economy. People with savings are better able to weather economic shocks such as a loss of the income, to build assets for the future, and are less reliant on credit to cover unexpected expenses. Savings also enable further welfare enhancing actions such as entrepreneurial activities and access to the education and the training. At the macroeconomic level, household savings drive growth by enabling banks to lend to the businesses, and by financing – directly ir indirectly – investment in the companies.
In more advanced financial markets, savings and investment products have become more complex, and individuals face more responsibility and risk for their own financial well-being. The shift from the defined benefit to the defined contribution pensions is one expample of thus. As a result, the need to manage personal money effectively has grown. This is particularly true of the longer- term savings and investment products, where the opportunities to ‘learn by doing’ are infrequent, and the consequences of a wrong decision- or no decision at all – can have an adverse impact on the individuals and their families, and ultimately on the social welfare net.
At the same time, distruibution channels for the saving and the investment products have become more sophisticated. Innovations such as smart cards and mobile phone banking can open up access to formal savings opportunities for the people who previously lacked access to the fiancial services. People increasingly buy even quite complex investment products online, including across borders. But technological innovation also carries risks that consumers may be exposed to the fraud or scams, or that products brought through non- traditional channels may not be adequately regulated. In many economies, people are, for this reason that policy makers are looking to a range of the tools to encourage saving ans enable households to provide themselves with a financial cushion. These tools notably include a robust financial regulatory framework, financial consumer protection, incentives, choice architecture, as well as fiancial education, information and awareness campaigns.
Factors causing variation in saving rates at household level
The extend of welfare provisions
Economic stability
Level and rate of growth of Per Capita Income
Interest rate and Inflation
Avaibility of Credit
Age Structure of the population
Why People Save
There may be individual socail economic factors such as income level or gender; or behaviour which can in turn be influenced by prevailing culture and norms. The way fiancial markets operate can act as a barrier, by making it complicated or difficult to save. This may be compounded by the financial exclusion, lack of financial literacy and low levels of trust in the fiancial institutions. There is an extensive literature on the saving motives, which suggests that saving may be precautionary, for defined goals, or for more abstract reasons like self-esteem, or the need to feel independent. Some of the main motives of saving are:
The life-cycle motive, that is, to provide for anticipated future expenses during old-age, when individuals will not be able to rely on earnings and their income is likely to decrease. This include pension saving, as a particular type of long-term saving.
The precautionary (‘rainy day’) motive. This includes money put aside to cover unforeseen events or to provide a buffer against events like job loss, illness, relationship breakdown, or accidental damage to household goods.
The improvement motive, that is to enjoy a gradually improving lifestyle. This can include short term saving for consumer durables, holidays, or gifts, or longer-term saving for, say, a child’s education or wedding, or the deposit on a car or house (sometimes called the ‘down payment’ motive). Loan repayment is also a form of ‘improvement’ saving: for example, repaying a mortage or a loan on assets such as property, livestock or machinery. Similarly, repayment of a student loan is a form of saving. In this case, the asset is human capital, which can be used to generate an income stream.
The enterprise motive. This is saving to accumulate enough money to carry out speculative or business activity, i.e. saving for the purpose of generating more money.
The bequest motive. Some people save with no intention of using the money in their lifetime- they put money aside, or keep assets, explicitly to pass on to children or other family members. The bequest motive explains why people save more in old age than the life-cycle model would predict.
Other issues may also be relevant to the development of the financial education and awareness policies, in particular:
‘Motiveless’ saving. Some people build up savings simply because their income is consistently greater than their expenditure, and they do not actively manage the surplus. In this case, people may not be maximizing their fiancial well-being.
‘Windfalls’. People occasionally get a sum of money unexpectedly, for example through an inheritance, redundancy payment, or even winning it. This requires active decision-making and perhaps consideration of the products which have not been used before.
‘Dissaving’. An array of products becomes available when people start to draw down their wealth in old age. Pension assets and other long-term savings are generally used to generate an income in the retirement. People may also have property, which can be used to release cash, either by ‘trading dowmn’, or making use of equity release financial products. Decumulation brings people may also come into contact with different sst of products from those which they have seen before and that require a different set pf decision-making skills, including annuities and reverse mortgages.
Behavioral Influences on Saving
People do not always act rationally. Deep-rooted behavioral biases and external influences can affect both the decision to save and how to save. Typically, impatients individuals prefer instant gratification (i.e. immediate comsumption) rather than keeping their resources for future enjoyment, leading to lower saving. Starting to save is often perceived as difficult or time consuming, and procrastination is a common reason for not saving (O’Donoghue and Rabin, 1999). People know they should save, and have the best intentions of doing so but, when faced with complexity and choice overload; decide to ‘do it tomorrow’. Another driver of apparently irrational behavior is ‘mental accounting’, or the tendency of people to virtually put money into different pots. This can explain, for example, why people may simultaneously save at low interest rates and borrow at high rates (Shafir and Thaler, 2006). Moreover, people tend to be highly loss-averse, that is, they place more weight on losing money than on an equivalent gain. Evidence suggests that people with a high degree of loss aversion are less likely to invest in the stock market in genaral, and specifically, less likely to buy equities directly rather than invest in mutual funds (Dimmock and Kouwenberg, 2010). Some of the behavioural influences in saving are described in short.
Social Norms
In many countries there is a pressure to consume. Conspicuous consumption can be associated with higher social status. Saving can be seen as ‘dull’. In others, there is a culture expectation that money will be shared with family or community. Saving behavior is influenced by friends and family. Children and young people, in particular, are likely to pick up money management habit in childhood. One Dutch study based on two fianancial capability surveys found some significant correlations between parental saving habits and those of their children (CentiQ, 2008). Children of financially illiterate parents were particularly likely to spend money rather than save it, to ask their parents for money and have debts. They perceived their parents as more generoud than children of financially capable parents, who were less likely to give out extra money.
Finacail Financial Literacy
Financial literacy is a combination of the awareness, knowledge, skills, attitude and behavior necessary to make sound financial decisions and achieved individual financial well-being. A number of countries have now carried out financial literacy surveys of their adult populations, which provide insights into savings-related knowledge, attitudes and behavior. These survey suggest that people are ill-equipped to take complex financial decisions, do not plan ahead sufficiently, and have poor understanding of the investment concepts like risk and diversification. For example, in the UK financial capability baseline survey 40% of people with stocks and shares Individual Savings Account (ISA) were not aware they were exposed to stock market risk (Atkison et al., 2006). People were poor at planning ahead. Seventy percent of people had made no provision for a sudden drop in income; 81% thought the state pension would be inadequate for their retirement, but 37% of this had not made additional provision.
Financial Exclusions
May 2011 article in The Economist estimated that 2.4 billion adults (62%) in developing countries were unbanked and even in developed countries 95 million (12%) did not have a bank account. In the developing countries, mobile telephone banking is revolutionizing access to the transactional banking, allowing users to receive payments into ‘mobile wallets’, send payments to other users, and obtain cash. These virtual accounts are of limited use as saving vehicles – they do not pay interest and usually have limits on the amount of money that can be held – but they do offer a potential route into the formal financial products. Using savings products, therefore, requires access to the banking system. However, people on the lowest incomes often cannot afford bank charges, or fear penalties if they go overdrawn. Banks are concentrared in wealthier urban areas so many people do not have access to a local branch. Internet use is also less prevalent amongst those on low incomes. Banks do not actively seek low-income current customers, as they are not profitable and the opportunities to ‘cross-sell’ other products are very limited.
Choice
Too much or too little: choice is good because it will make a market operate more efficiently and hence benefit all the consumers. This relies on people baing able to make the best choice from the options on offer and to buy (or switch to) that choice.
In the complex market there are too many choices and they are too complicated. For exaple, in the UK there are over 2,000 retail savings products on the market. The costs of obtain in and analysing the relevant information are high (Agnew and Szykman, 2005; Iyengar and Kamenica, 2010). The decision may also be further complicated by the tax treatment of products: some may be tax-incentivized, others, which perform apparently the same function, are not. Faced with too much choice, people will make the wrong decision or no decision at all: they will not buy a product or stick with what they already have.
Complexity
The way financial servies providers’ present choices can also act as a barriers to saving. Firms make extensive use of jargon, and may interpret disclosure requirements in a legalistic way. This means that the ‘small print’ can run to dozens of pages, and be incomprehensible to the consumer. In consequence, products may look more complicated than they actually are, or people may not understand important product features, like charges and risks. Faced with information they do not understand, many consumers may be deterred form buying products which could be useful to them. Language may also be a problem. For example, around 60 countries have English as an official language, and disclosure and other financial documents are likely to be written in English. These documents are difficult enough to understand for native English speakers. For those for whom English is a 19 second or third language, the lack of clear documentation in their local language can act as a significant barrier.
Trust
Lack of trust in financial instituitions is often cited as a reason why people do not save. This may arise due to a lack of confidence that the bank will look after the savers’ money. For those unused to dealing with the financial instituitions, this could be due to an unspecified fear of the unknown (Deshpande, 2008). In other cases, lack of trust may arise from financial markets crisis. In some countries, the financial crisis of 2007-08 led to banks and other financial instituitions, even large ones, going bust. Although governments stepped in to ensure ordinary depositors did not lose money, the belief that government money was always safe in the bank was shattered, and some investors lost considerable sums.
Trust also appears to be an issue in relation to stock market investment. A worry abot being cheated may be part of the reason, reinforced by high profile fraud cases. However, research suggest that stock market participation may be related to a more generalized comcept of trust (Guiso, Sapienza and Zingales, 2008). The researchers suggest that less trusting individuals will buy less stock, even after allowing for different degrees of risk aversion and loss aversion. If true, this may help explain why levels of stock market investment vary widely between countries, even those where people have similar income levels.
Policy Response to Influence Saving
At the macroeconomic level, National authorities can potentially influence overall saving rates by a combination of income tax and welfare policy, ensuring financial markets are well regulated, and keeping inflation under control. In practice, however, the policy drivers for such changes are more usually directed at economic reform and financial stability and any changes in saving rates are a by-product. The following universal intervention may be done;
Financial Regulation and Consumer Protection: Well-regulated financial markets are important to maintain confidence in the financial system. People need to know that deposits are safe, and that capital markets are well run and trust worthy. Financial consumer protection – rules about products and how they are sold, and redress mechanisms – can help offset information asymmetries by attempting to ensure the market doesnot operate to the disadvantage of the consumer.
Product Regulation: Production regulation may include pre-approval, banning products considered to have the potential to cause widespread consumer detriment; or withdrawing products which are already generating detriment.
Sales and Marketing: Many countries regulate the advertising and promotion of financial products, with rules specifying, for example, that promotional material should not mislead the consumer. Investment products are often sold through an intermediary. This may be a financial instituition or an independent adviser.
Disclosure: Disclosure documents can at times be confusing and full of jargon. So a specific directives should be made that covers product which offer exposure to underlying financial assets; have the main function of capital accumulation; and are designed to be medium- to long-term, and marketed directly to retail investors.
Redress and deposit guarantee Schemes: Redress mechanisms provide for the mediation of disputes between consumers and firms; and for paying compensation where appropriate. They provide an alternative to legal action, and are normally free to complainants. Some countries also have investor protection schemes. These do not compensate for losses due to investoment risk, but, subject to limits, may pay out where an investment firm becomes insolvent and cannot pay the investor, or where fraud is involved.
Compulsory Savings: In a compulsory saving scheme there will usually be an element of choice- e.g. over allocation of fund- and the money belongs to the individual, even though access may be restricted, or prohibited, until maturation date.
Incentives to Save: Incentives typically provide a financial benefit, sometimes over and above the interest earned on the savers’ money. This may be in the form of matched funding or tax advantages. Many countries have savings incentives, some universal, and some targeted at particular groups.
Financial education and awareness: Financial education includes instruction in personal finance concepts and the financial services landscape, and the development of the skills, attitudes and behaviors needed to make the right decisions for the individual. Elements of the landscape might include types of financial institution, products, how consumers are protected, and getting advice. Skills would include, for example, understanding risk and reward, planning and budgeting, evaluating information, and comparing products. Attitudes and behaviors are particularly complex in the area of savings and investments, as individual risk preferences vary widely. It is important that education leads to a self-awareness of risk appetite and other drivers of saving behavior.
The barriers to saving and investing are considerable, perhaps even more so that for other financial products and services. As well as the usual financial market problems of access, complexity and information asymmetries, there are behavioral and cultural factors which dter people from saving or investing, even when they are aware of the benefits of doing so. Knowledge and understanding of investment concepts is particularly low in many countires, which may inhibit the use of stock-market based vehicles. Lack of trust in financial institutions is also an issue, particularly amongst the financially excluded.
The risk of informal saving, or saving with unregulated firms, need to be made more explicit, as does information about what is covered by consumer protection regulation (e.g. deposits), and what is not (investment risk). The issue of trust is partly about the regulatory framework, but also about how financial institutions treat their customers. Financial education and awareness initiatives cover a wide spectrum of activities. Increasingly, countries are incorporating personal finance education into their school curricula, and supporting teaching with innovation and imagination resources. There is also widespread use of websites, seminars, advice and other channels to equip people with the knowledge and skills to make choices about saving. There is little empirical evidence, as yet, of the cost-effectiveness of different approaches, although research evidence suggests that financial education and awarenesscan encourage saving and improve financial decision-making. In particular, investor education can have an impact on stock market participation.
