Financial literacy with Dr. Marie Racine

(Originally posted in 2021)

When trying to understand how financial, physical, and mental wellness are intertwined, most people identify finance as a high-stress area that causes them to lose sleep and underperform at work. It is intriguing for some but intimidating or overwhelming for most. As a result, people tend to ignore their pension plans until five years prior to retirement. This makes pension retirement discussions more painful than necessary. Improving our financial literacy is an important step in our holistic health and should begin early in life.

Studies indicate that the most influential people in your financial life journey are your parents/guardians. This could be simultaneously good and bad: are we closing the loop with the financially reticent leading the next generation into the same behavior? Financial education can (and should) begin early in life. There is a move towards incorporating finance in high school, but there are some concepts that can be introduced earlier and provide an excellent foundation for future development and refinement. For example, basic skills that we can share with children at an earlier age include: exchange (give and take), distinguishing needs versus wants, and the value of waiting. Throughout the life cycle, these can be enhanced with understanding the roles of money/credit, budgeting, opening an account with a financial institution, and setting (and keeping) goals. Budgeting early in life involves knowing your inflow (gifts, allowance) and your outflow (purchases, donations) and tracking them. Goal setting and working towards achieving goals is excellent experiential learning for things like affording a family pet, cellphone purchase/usage privileges, and car usage/privileges. As with most things we learn, repeated practice and application are important. For the older child/young adult, a useful exercise is to choose a hypothetical career, identify educational requirements for that career and determine how much the education will cost. How will it be financed? Find the salary associated with the chosen career; what food, shelter, and lifestyle choices will it support? Regardless of life cycle stage, these examples illustrate common themes: identify need versus want, determine goals, and set a budget to help achieve the stated goals.

The internet is a vast source of resources, but as part of the life skills we hope to teach those we influence, we need to emphasize the importance of vetting information. Free financial advice from an online site may not be credible and should be investigated before being followed. The credibility will be easier to assess if we are financially literate. Regardless of the source of information, we want to be able to appropriately decipher it and avoid financial misinformation, deception, and fraud.

Financial wellness or literacy also encompasses our ability to deal with decision-making under conditions of uncertainty. Behavioral finance recognizes that we have human tendencies to incorrectly assess the likelihood of an event, get distracted easily, follow the crowd, hate losing, and make decisions based on mood and emotion. We are overconfident in our stock picking and timing ability, which manifests in under-diversified portfolios. In general, we make poor use of data or information because we rely heavily on the most recent data at the expense of other pertinent information (strong financial performance last quarter does not mean next quarter will be equally strong), we anchor on the wrong aspects of the information (we hear what we want to hear, especially if it affirms prior decisions) or we are distracted by irrelevant pieces of the vast amount of information that is available. Herding behavior results when investors follow the crowd rather than doing independent analysis. The GameStop experience, described by Terrance Odean as “It was like a supernova of herding events,” is a recent example, but there are many others, starting with the tulip mania in the 1600s, the 1990s dot com bubble, and now the meme stocks of 2021. Sadness and fear make us more impatient, fear and depression make us more risk-averse, while anger leads to optimism. Behavioral finance experts’ suggestions for combatting these tendencies are: (i) Clearly define goals and reassess in a timely manner, especially in light of an unanticipated event, (ii) focus on the probable, forecasting the future is difficult (many people buy a lottery ticket – do they really think they can win or is there another impetus, such as utility from gambling?), (iii) focus, what helps you focus? Are the posted sticker prices on big-ticket items a distracting ‘anchor’ price? Do your research so you can avoid being led into a decision that is not in your best interest and, (iv) strategically, the most stressful decisions should be made at the start of the day before decision fatigue sets in and not during a state of heightened emotion.

Financial, physical, and mental wellness are connected, but of the three, the role of financial health is often under-appreciated. Financial decisions are important in all stages of the life cycle. Familiarity with basic finance starting at an early age will improve financial wellness throughout our money journey. Fortunately, there is a heightened awareness of the necessity of attention to financial wellness by employers, educators, government, business, and, of course, the finance profession and financial institutions.