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Financial literacy proves an elusive monster

Laments about the lack of financial literacy are a common refrain whenever anyone discusses any financial regulatory issue.

india Updated: Dec 13, 2009 21:09 IST

Laments about the lack of financial literacy are a common refrain whenever anyone discusses any financial regulatory issue.

There is an explicit assumption that if only customers of financial products did not suffer from this condition of financial illiteracy, then they would make better choices with their income, savings and investments.

It sounds logical, but is it actually true? A few days back I came across an article on the Bloomberg website that referred to a study that had discovered the opposite. The study learned that people who were ripped off by fraudulent investor schemes outscored those who hadn’t been by a “statistically significant” 27 percentage points when it came to financial literacy.

I couldn’t find the actual report on the web but I had an “Aha” moment when I read it. It fitted perfectly with my own anecdotal impressions of what kind of individuals who make the wrong investment and savings choices. How could this be? Why would knowledgeable people make poorer investment choices?

There are two ways of modelling these conclusions. One of them simply boils down to the old saying, ‘A little knowledge is a dangerous thing.’ Those who have a certain understanding of financial matters assume that they know it all and get too adventurous with their money.

The other problem that this points to is deeper. It raises the question of what exactly is financial literacy. If those
that are financial literate are poorer investors then the definition of financial literacy must be wrong. They must not actually be financially literate by a functional and outcome-driven definition of financial literacy.

I spend a good amount of time listening to people’s investment problems and answering their questions and take it from me: this is not a solvable problem. More active selling of ever-more complex financial products is running way ahead of what customers can understand. It’s a sort of an arms race between complexity and understanding and complexity is pulling ahead by an ever-widening margin.