FINANCIAL LITERACY

This section will define financial literacy and discuss the determinants of financial literacy. Furthermore, this section will elaborate on previous research on financial literacy.

4.2.1.1 Defining financial literacy

“Financial literacy” can be defined as an individual’s knowledge of financial concepts, and the skills and attitudes to translate this knowledge into behaviours that result in good financial outcomes (OECD 2011:3; Sebstad et al. 2006:5-6). Financial literacy encompasses the knowledge of basic economic and financial concepts, and the ability to use that knowledge and other financial skills (such as budgeting) to manage one’s financial resources effectively for a lifetime of financial well-being (Hung, Parker & Yoong 2009:12). The knowledge of financial concepts can include understanding the purpose of a budget or the aspects that make up a savings plan. Other financial literacy concepts include understanding loan terms and conditions, or the difference between various types of financial institutions. (Marcolin & Abraham 2006:2; Sebstad et al. 2006:6-7). There are also financial skills that are required to translate financial knowledge into financial behaviour. This might involve knowledge about how to open a savings account, calculate an interest rate, or obtain information on the financial products/services offered by financial institutions. (Sebstad et al. 2006:6-7).

It is clear that there are different aspects relating to financial literacy, and financial literacy includes budgeting skills, determining interest in financial matters, basic financial numeracy, awareness of financial products, and financial attitudes (Calderone, Mulaj, Sadhu & Sarr 20013:10). Financial literacy has also been defined as a specific form of knowledge that requires the ability or skills to apply that knowledge. Financial literacy can also be the perceived knowledge an individual has about finances; and it encompasses good financial behaviour and financial experiences. (Hung et al. 2009:12). Hall (2008) states that financial literacy pertains to the capacity of an individual to understand when to seek professional financial advice and where to go to find that advice. Although there are various definitions of financial literacy in the literature, PISA (2012:12) states that financial literacy incorporates a combination of awareness, knowledge, skills, attitudes, and behaviours

necessary to make sound financial decisions for an individual to ultimately achieve financial well-being (PISA 2012:12).

4.2.1.2 The determinants of financial literacy

Financial literacy can be determined and implemented through proper financial education, financial skills, and financial behaviour. Therefore, a discussion of these determinants follows.

(a) Financial education

One of the main determinants of financial literacy is financial education. Sebstad et al. (2006:5-6) explain that financial literacy requires the input of financial education, including training programmes, seminars, campaigns, and other types of learning events for individuals. Financial learning experiences also play a key role in shaping the financial knowledge, skills, attitudes, and behaviours of individuals. These financial learning experiences include what individuals learn informally about the management of money from friends, parents, other family members, peers, or teachers (Hogarth, Beverly & Hilgert 2003:11).

It is possible to state that education and financial literacy are important predictors of financial and retirement planning. Individuals need to know how to decide how much they need to save for retirement, and how to invest their savings. During the post- retirement period, individuals must know how to allocate their portfolios and withdraw their savings and income. Given the link between income and education, prior studies found evidence of a distinct pattern of higher savings for higher educated groups; and there have been wide disparities in wealth holdings across different educational groups. (Kock & Yoong 2011:867; Marcolin & Abraham 2006:4). Lusardi and Mitchell (2011:8) state that individuals who have little knowledge of financial concepts will not be able to save adequately for retirement.

Calderone et al. (2013) found that financial education has a significant impact on savings, and also indicated that attitudes towards financial planning were positively influenced by financial education. Financial education has been identified as one of the most significant factors influencing financial attitudes and behaviours (Sabri 2011:70; SEDI 2008:8). Therefore, education in general may be correlated with

financial literacy and financial skills, which is expected to aid the retirement planning process (Brucker & Leppel 2013:4; Hibbert et al. 2012:299; Denaeghel, Mortelmans, & Borghgraef 2011:114-115; Ng, Tay, Tan & Lim 2011:199; Noone, Alpass & Stephens 2010:719; Clark, d’Ambrosio, McDermed & Sawant 2003:28; Joo & Pauwels 2002:3).

Those with low levels of education are less likely to engage in any retirement planning. This may explain why individuals with low levels of education accumulate little wealth, or why they do not invest in high return assets such as shares (Lusardi & Mitchell 2011:8; Marcolin & Abraham 2006:4). Lusardi and Mitchell (2006) found that those who were financially literate when they were young are more likely to plan for retirement. Studies have also revealed that financially illiterate individuals are unlikely to plan and save for retirement, as those who cannot do simple and compound interest calculations are also less likely to calculate their retirement needs (Beh & Folk 2012:8345; Lusardi & Mitchell 2006). This shows that financial literacy might affect retirement planning. In addition to financial education shaping an individual’s financial literacy, following the definition of financial literacy, financial skills also form part of an individual’s financial literacy.

(b) Financial skills

Financial skills involve the ability to deal with day-to-day money management issues and the process of thinking about planning for the future (Personal Finance Education Group 2000:6). Financial skills enable individuals to apply knowledge and to understand financial matters across their personal situations and across situations beyond their immediate control (Financial Services Authority 2005:14; Personal Finance Education Group 2000:6). Financial skills allow individuals to plan, monitor, manage, and resolve any financial problems or opportunities (Financial Services Authority 2005:14). Therefore, financial skills should enable an individual to identify and address financial problems or issues with confidence. In addition, the ability to manage financial situations effectively and efficiently is an outcome that arises from the acquisition of financial skills. (Financial Services Authority 2005:14; Personal Finance Education Group 2000:6).

Financial skills enable individuals to navigate the financial world, make informed decisions about their money, and minimise their chances of being misled on financial matters (Financial Literacy Foundation 2007:1; Marcolin & Abraham 2006:2). The need for financial skills has grown rapidly: financial markets have been deregulated, and credit has become easier to obtain as financial institutions compete strongly with each other for market share (Marcolin & Abraham 2006:2). The readily availability of credit cards, together with easier access to personal loans and other financing options, has led to an increase in spending and a rapid rise in both personal and household debt levels. Moreover, the development and marketing of financial products and services have grown rapidly. (Glick & Lansing 2011; Marcolin & Abraham 2006:2). These developments have led to the increased need for financial skills. Having financial skills is an essential basis for both avoiding and solving financial problems, which, in turn, is vital to living a prosperous, healthy and happy life (SEDI 2008:34; Financial Literacy Foundation 2007:55; Marcolin & Abraham 2006:3). According to PISA (2012:145), financial skills include generic cognitive processes such as accessing information, and comparing, contrasting, and evaluating information applied in a financial context. Furthermore, basic skills linked to mathematical literacy such as the ability to calculate a percentage or to convert from one currency to another, and language skills such as the capacity to read and interpret advertising and contractual texts, are important financial skills. (PISA 2012:145).

Through improved financial skills, individuals become more efficient at:

• budgeting, saving money, and controlling spending (Financial Literacy Foundation 2007:4);

• handling mortgage and other debt (Lusardi & Tufano 2009; Sebstad et al. 2006:6-7);

• participating in financial markets (Disney & Gathergood 2013:2246; Van Rooij, Lusardi & Alessie 2011:598); and

• successfully accumulating wealth and planning for retirement (Refera, Dhaliwal & Kaur 2016:3; Financial Literacy Foundation 2007:4; Lusardi & Mitchell 2006:10; OECD 2006:2; Sebstad et al. 2006:15).

Although financial literacy incorporates financial skills, individuals’ actual financial behaviours are also an important part of their financial literacy levels. These financial behaviours are necessary in making proper financial decisions such as planning for retirement (PISA 2012:12).

(c) Financial behaviour

Improved financial knowledge, skills and attitudes should contribute to changes in financial behaviour (Sebstad et al. 2006:7). One example of behaviour change relates to being proactive with one’s finances instead of reactive. Setting a budget to plan ahead for expenditure, or using a spending plan to manage money, are forms of proactive financial behaviour. Sebstad et al. (2006:7) add that proactive financial behaviour can also involve negotiating the terms of a purchase or the sale of an item, rather than simply accepting the terms of the sale or purchase given. Other examples of behaviour change include the reduction of wasteful expenditure, such as an increased resistance to spending income on impulsive purchases. Sebstad et al. (2006:7) explain that financial behaviour can also refer to the discipline of making regular savings. Opening a savings account or saving more regularly displays positive financial behaviour. (Sabri 2011:39; Sebstad et al. 2006:6-7).

Positive financial behaviours are linked to financial literacy. According to Sebstad et al. (2006:7), individuals who are financially literate can experience changed financial behaviours, and the outcome can include the achievement of a specific financial goal such as reaching a savings target, establishing an emergency savings fund, decreasing debt, or purchasing a home or another asset. Outcomes of financial literacy can also involve the financial behaviour of reducing financial stress levels, such as feeling the pressure of financial demands and concerns (Sebstad et al. 2006:7). Murphy (2013) mentions that another outcome of financial literacy could be greater financial satisfaction as an individual gains a sense of control over their financial well-being. Therefore, financial literacy outcomes relate to financial stability, when an individual has the perception or expectation that their financial situation is improving. Kim, Sorhaindo and Garman (2004:129) state that improved financial outcomes or behaviours might also be indicated by a reduction in the amount of time spent on financial matters, or on the number of times that personal financial issues interfere with work or the accomplishment of other tasks. Financial behaviours have

also been stated to be one of the most significant components of financial literacy affecting the retirement planning of individuals (Sabri 2011:70; Clark et al. 2003:1; Joo & Pauwels 2002:8).

4.2.1.3 Previous research on financial literacy

Following the discussion on financial education, financial skills, and financial behaviour, it is important to summarise how financial literacy can influence the retirement planning of individuals; and it is also important to discuss financial literacy in South Africa.

(a) Linking financial literacy with retirement planning

Retirement planning links with financial literacy as those who can accurately undertake simple calculations, that are aware of the impact of inflation, and are knowledgeable about risk diversification, are all more likely to plan for their retirement (Brucker & Leppel 2013:4; Hibbert et al. 2012:299). Planning for retirement is imperative for retirement wealth (Lusardi & Mitchell 2011:7), and individuals who have calculated how much they need to save for their own retirement reach retirement age with three times the wealth of those who have not done these calculations (Lusardi & Mitchell 2011:14). Moreover, the OECD (2006:2) states that financial literacy is crucial to helping to ensure that consumers save enough to provide an adequate income during retirement, while avoiding high levels of debt that might result in bankruptcy. However, Lusardi and Mitchell (2011:8) state that, despite the importance of retirement planning, individuals fail to plan for their retirement, because they are financially unsophisticated. Planning requires making calculations, many of which are facilitated by financial literacy. For example, less financially sophisticated individuals who do not have a good grasp of compound interest might engage in high-cost credit card borrowing, or they might be more likely to pay high fees when using financial services (Lusardi & Mitchell 2006:12). Lusardi and Tufano (2009:22) found that financially illiterate individuals are more likely to have high levels of debt and to have problems with debt repayment. On the other hand, more financially literate individuals tend to include shares in their portfolios, as they better understand the principle of risk diversification (Lusardi & Mitchell 2011:8; Van Rooij et al. 2011:597).

Although the importance of financial literacy is clear, many individuals remain financially illiterate. Evidence shows that a large number of individuals lack even basic financial understanding. Individuals generally score poorly on financial literacy assessments (Lusardi & Mitchell 2013:10; Malcolm 2012; Harnisch 2010:7) and fail to understand financial instruments (Disney & Gathergood 2013:2246; Van Rooij et al. 2011:597). As a result, financially illiterate individuals are unable to answer simple questions on inflation and compound interest. (Meier & Sprenger 2013:160). The existing literature on financial literacy finds that individuals who participate in financial markets exhibit a better understanding of core financial concepts relevant to those markets than individuals who do not participate in financial markets. Such studies relating to financial literacy have been carried out on saving plans for retirement (Disney & Gathergood 2013:2246; Lusardi & Mitchell 2011:8).

The results of a study conducted by Disney and Gathergood (2013:2253) reveal that even relatively small improvements in financial literacy – such as the increased ability to make a simple interest calculation – are associated with increases in financial confidence. This can be achieved through financial education programmes. However, it is still unknown why many individuals are financially uninformed, when acquiring financial information is so critical to financial well-being (Meier & Sprenger 2013:160).

Lusardi and Mitchell (2011:15) state that financial illiteracy is a global concern, and that financial literacy is critical to retirement security. Financial literacy has been shown to be closely tied to retirement planning and retirement wealth accumulation (Van Rooij et al. 2011:598; OECD 2006:2; Sebstad et al. 2006:15). However, many individuals are often unaware of the basic economic and finance concepts, and these shortcomings can lead them to make serious and often irreversible mistakes in their financial decisions (Lusardi & Mitchell 2011:1). Therefore, the financial literacy of individuals can lead to and influence their retirement planning. Table 4.1 highlights the benefits that can arise from being financial literate, as identified in the literature.

Table 4.1: Financial literacy benefits

Description Benefits Reference

Reduction in financial stress

• Feeling of control over one’s financial situation

• Ability to solve financial problems

• Confidence in dealing with financial matters

Financial Literacy Foundation (2007:7); Marcolin and Abraham (2006); Sebstad et al. (2006:15)

Ability to make independent financial decisions

• Satisfaction with financial situation

• Successful financial negotiations

• Ability to assess information and advice accurately Murphy (2013); Financial Literacy Foundation (2007:7); Sebstad et al. (2006:15) Financial stability

• Perception that financial situation is the same or better than a year ago

• Expectation that financial situation will be the same or better next year

• Increased disposable income

Sucuahi (2013:44); Anders, Graddy, Grieve and Visser (2011:107); Sebstad et al. (2006:15)

Setting of financial goals

• Achievement of financial goals • Motivation to plan ahead • Improved financial planning

Botha et al. (2014b:24); Financial Literacy Foundation (2007:7); Sebstad et al. (2006:15) Increased financial numeracy abilities • Reduced debt

• Ability to manage debt • Ability to make estimations

based on interest rates

• Ability to estimate or determine expenses

Anders et al.

(2011:107); Carpena, Cole, Shapiro and Zia (2011:5); Lusardi and Tufano (2009:22); OECD (2006:2); Sebstad et al. (2006:15) Improved financial knowledge • Basic understanding of economic concepts such as compound interest and inflation • Reduced time in management

of finances • Improved understanding of benefits of financial management Calderone et al. (2013:11); Carpena et al. (2011:7); Financial Literacy Foundation (2007:7); Lusardi and Mitchell (2006); Sebstad et al. (2006:15)

Table 4.1: Financial literacy benefits (cont.)

Description Benefits Reference

Improved financial skills

• Dealing with daily money management, planning for the future

• Ability to apply financial knowledge in predictable and unpredictable situations • Ability to discern whether

spending money on products/ services is essential or optional

SEDI (2008:1); Financial Literacy Foundation (2007:10); Financial Services Authority (2005:14); Personal Finance Education Group (2000:6) Increased savings

• Ability to deal with financial emergencies

• Ability to understand terms and conditions related to saving in financial instruments

• Ability to understand the ease of access of different types of investments

• Ability to plan for retirement

Van Rooij et al. (2011:598); Nga et al (2010:278); Financial Literacy Foundation (2007:7); OECD (2006:2); Sebstad et al. (2006:15)

Source: Researcher’s own construction

Table 4.1 provides an overview of the various benefits of financial literacy for individuals, as stated in the literature. Financial literacy can be determined by and improved through financial education, financial skills, and financial behaviour, and therefore financial literacy can ultimately lead to increased savings for retirement. Given the evidence from the literature, it is clear that financial literacy is crucial to the retirement planning of individuals, as it will change individuals’ behaviour with regard to financial issues and situations.

(b) Financial literacy in South Africa

Financial literacy in the South African context encompasses financial planning, the selection of financial products, financial knowledge, and financial control (Financial Services Board 2012b:34). In the context of being financially literate, the Financial Services Board (2012b:34) explains that financial planning refers to setting financial goals, saving for the long term, and having emergency funds in place to make provision for contingencies. In addition, the Financial Services Board (2012b:22-27) reveals that the awareness and use of different financial products encompasses the financial literacy of South Africans. The four primary financial product areas include

banking products, credit and loan products, investment and savings products, and insurance products. Financial knowledge, in the context of financial literacy, includes being knowledgeable about subjects such as basic mathematical calculations, interest paid, interest received, and knowledge of compound interest (Financial Services Board 2012b:31). Finally, financial control pertains to the personal involvement of individuals in their financial matters (Financial Services Board 2012b:9). The results of the study conducted by the Financial Services Board (2012b:37) revealed that a substantial proportion of the South African population are financially illiterate and are not equipped to make sound financial decisions. As the South African population is diverse, the findings of the study by the Financial Services Board (2012b:37) cannot be generalised to all South Africans. Thus, it is important to provide an overview of the financial literacy of the population.

The overall levels of financial literacy of South Africans are lower for women than for men. Black South Africans have the lowest level of financial literacy compared with all the other racial groups (coloured, Indian, and white South Africans). Speakers of isiXhosa, Tshivenda, Xitsonga, and Setswana also possess low levels of financial literacy relative to English, Afrikaans, and isiZulu speakers. This can be linked to the geographical location of the individuals: those in the Eastern Cape and in Limpopo are more financially illiterate than individuals living in the Western Cape, Northern Cape, KwaZulu-Natal, and Gauteng provinces. Furthermore, individuals living in rural traditional areas, rural farms, and urban informal areas are financially illiterate compared with individuals living in urban formal areas. (Financial Services Board 2012b:34). Although research on the financial literacy of South Africans has been conducted, it is yet to be determined, as proposed in this study, how financial literacy can specifically influence the retirement planning and the retirement funding adequacy of black South Africans.