A lack of financial literacy (aka money skills) can be embarrassing but it can also be disastrous when decisions about wealth are concerned, and can come at a cost to the whole community. Sadly, there’s no formal finance tuition as a compulsory class for high schoolers, so don’t be too hard on yourself if you still don’t feel confident about money matters as an adult.
Fortunately, a few key tips can prevent a lot of unnecessary and expensive grief. Here are seven of the essential ones, below.
Even those officially categorised as “sophisticated investors” on account of their income or assets can go very wrong. They can breach the basic rules of caution and often forget the old saying, “If it seems too good to be true, it probably is.”
In Australia, we have the case of self-styled financial planner Melissa Caddick, who vanished owing $23 million, allegedly stolen from her friends and clients. (Some of her remains later washed up on a NSW South Coast beach.) On Wall Street in the US there was Bernie Madoff, who died in jail in April last year, having run a not-dissimilar Ponzi scheme worth US$65 billion!
In both cases, financially literate investors lost their shirts because they were too trusting and didn’t ask themselves or others the tough basic questions: is this trustworthy, and can I afford to lose all of my investment?
There’s no such thing as too many questions when it comes to trusting someone with your money to invest or manage on your behalf. Some of the questions may be impossible to answer, such as the “return on investment” over 10 years. But the way your questions are answered or deflected may give you valuable clues as to how trustworthy your advisor – or the scheme – is, and if you should proceed. You may also learn even more profitable lessons along the way, or identify new financial opportunities.
Maybe no one ever taught you about money, but families can hand down plenty of lessons, and not all of them are true, up-to-date, or even applicable. The old chestnut “take care of the pennies and the pounds will take care of themselves” might have applied in the 19th century but certainly doesn’t any longer. Many online resources, such as Life Sherpa and the government’s Moneysmart site, can help, but beware of those looking to flog you a financial product instead of practical wisdom.
An Australian survey of financial literacy in 2005 found that while 67 per cent of people claimed they understood the meaning of compound interest, only just over a quarter could demonstrate a good level of understanding. It’s well known we mostly reckon we are above-average drivers, but we can’t all be in the top 50 per cent of anything. A little learning can be dangerous, so look it up (i.e. compound interest is simply the interest you earn on interest. Technically it is when the interest on a principal balance is reinvested and generates additional interest.)
Albert Einstein is quoted as calling compound interest the “eighth wonder of the world” with the relevant warning: “he who understands it, earns it; he who doesn’t, pays for it.” The sentiment is valuable, but I checked, and it’s unlikely Einstein said any of the many quotes about compound interest attributed to him. So be curious and check, check and check again!
Cryptocurrency is a case in point. If you understand what you are investing in, fair enough. If not, write it off as a gamble. Remember the complexity of the Collateralized Debt Obligation (CDO)? Investopedia describes it as “a complex structured finance product that is backed by a pool of loans and other assets and sold to institutional investors.” Like some Australian local government before the world financial crisis who lost a motza and did not appreciate what they were getting into.
A leading financial regulator, perhaps with tongue in cheek, once told me 50 per cent of people don’t know what 50 per cent means. An exaggeration, maybe, but poor numerical skills naturally undermine your degree of money comprehension.
You’d hope even the school-aged Monopoly player would appreciate these simple, understandable pieces of advice: don’t put all your eggs in one basket and diversify your portfolio. A residential portfolio may be on a roll now, but when the market turns – as they inevitably do – you risk more significant losses than if you had spread your risk with non-property investments.
My other is favourite is the “greater the return, the greater the risk”. The higher the promised interest rate or appreciation connected with your handing over your money comes with an evident sting in the tail. The risk it may all fall over is higher too.
Our attitudes and hence understanding of money are distinctly personal.
What type of person are you? What are your values? How do you see money? Are you someone who loves to take a risk and is willing to lose a year’s worth of savings in a dicey investment, or someone who prefers taking calculated risks?
The type of person you are determines the actions you choose.
Ask this one question first to the person who might be advising you on how to invest your money: Do they have my best interests at heart or perhaps their own? Then ask yourself, how do they behave and make you feel?
Is your self-proclaimed money guru someone who looks down on you or is keen to impress others with complicated terms and concepts? Or someone who makes things easy for you and can have a laugh sometimes?
Answering these questions will help you “filter” the information we get inundated with daily: news, social media posts, advice from parents and peers, etc. Learning the difference between good and bad advice will empower you always to know where to find the correct information that builds your money skills.
IMPORTANT LEGAL INFO This article is of a general nature and FYI only, because it doesn’t take into account your financial or legal situation, objectives or needs. That means it’s not financial product or legal advice and shouldn’t be relied upon as if it is. Before making a financial or legal decision, you should work out if the info is appropriate for your situation and get independent, licensed financial services or legal advice.