Comment: Financial illiteracy isn’t why most people struggle

By Stuart Trow and Marcus Ashworth / Bloomberg Opinion

Hardly a week goes by without a call to improve our financial literacy. Last week, the European Union commissioner for financial services, Mairead McGuinness, advocated for making such education a priority for Europe. She noted that one in three EU households couldn’t handle unexpected financial shocks in regular times; and the pandemic has only made things worse.

We’re all for better financial education. But a lack of knowledge is hardly the main reason why some families struggle so much with money. Low incomes, the economic environment and inflation all make budgeting challenging and falling into debt easier. If policymakers want to improve people’s financial well-being, they have to start with addressing these issues.

Surveys supposedly highlighting our financial illiteracy test us on arcane matters such as estate and inheritance-tax planning or what is the maximum lifetime allowance for pensions contributions. The Great British Financial Literacy Test, for example, surveyed more than 2,000 people quizzing them on the precise meanings of a number of financial acronyms and determined that 48 percent “failed.” The rate rose to 80 percent on issues related to retirement.

The United Kingdom is no outlier here; S&P Global puts it on a par with North America and the richest European countries. Its “FinLit” survey describes 2 in 3 adults globally as being financially illiterate.

The problem is these quizmasters tend to measure a narrow type of know-how; one that doesn’t often help people understand their financial situation. Many difficulties around money are caused not by a lack of financial knowledge, but by low and unpredictable incomes.

For people on low real wages, simple budgeting can be a struggle, let alone retirement planning. Things get especially difficult when real wages fall; a near certainty this year with inflation running at above 7 percent. When this happens, a previously affordable debt can quickly become unmanageable.

Such situations are not helped by the average credit-card rate in the U.K. rising above 21 percent in December for the first time this century. According to a paper published last year on distressed credit-card borrowers, more than a third of Americans have a debt in collection, showing how a combination of falling incomes, rising inflation and higher borrowing costs can deepen the debt trap.

The traditional missives to up one’s financial literacy are unlikely to help much under these conditions. Tackling uncontrolled debt is difficult and immensely stressful; it’s easy to become despondent, especially as few, if any, independent financial advisers will take you on if your net worth is already negative. In the U.K., 84 percent of financial advisers require clients to have at least $136,000 (100,000 pounds) of assets.

So what can help? Learning specific strategies for managing debt is a good start; and this goes beyond basic financial literacy. That’s because it’s human nature to pay the creditors who shout the loudest, rather than tackling the problem in an organized fashion.

The most straightforward way to stay on track is through the “avalanche” method: Take stock of all your debt and focus on keeping up minimum payments on all of it. Any cash over and above that should be targeted toward your most expensive debt first. If you have a personal loan costing 10 percent, but a large credit-card balance compounding at above 21 percent, focus on bringing down the credit-card debt first.

Then there’s the “snowball” method, which adds a behavioral twist. Instead of targeting the most expensive debt, you pay off the smallest loan first, regardless of its cost. That way it’s possible to register an early “win” and get encouraged to stick to the plan. As you regain financial control and confidence, this can morph into the avalanche approach.

There’s also debt consolidation, which involves replacing all your existing debt with a single, more manageable loan, ideally at a lower, fixed interest rate. This can be done in parallel with either the avalanche or snowball methods.

On top of creating a plan for managing debt, another important financial strategy involves claiming benefits to which you’re entitled. Entitledto, a provider of online benefit calculators, estimates that in the U.K., over $20 billion (15 billion pounds) of benefits are left unclaimed by low-income households. It also finds 2.8 million families fail to claim support to help them with local property taxes.

Efforts to improve financial health would be much more effective if they improved communication around government support; not only would it put more money in people’s pockets, it would perhaps help curb the stigma around claiming benefits as well.

All this is a world away from managing capital gains and estate planning. But it’s time finance advice actually matched the problems that need solving.

Stuart Trow is a credit strategist, pensions blogger, radio show host and member of numerous retirement, finance and audit committees.

Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. He spent three decades in the banking industry, most recently as chief markets strategist at Haitong Securities in London.