Canadian Council on Learning | Conseil Canadien sur l'Apprentissage

Why is financial literacy important?

The well-being of Canadians depends partially on their ability to understand, analyze and use financial information that will help them to make good decisions in their day-to-day lives and to plan for the future.

Financial literacy, however, is intertwined with other forms of literacy and involves the use of multiple literacies—prose, document, numeracy—often simultaneously. Research has demonstrated that literacy and numeracy skills are one of the key determinants of economic inequality.

As well, a number of social and economic factors are contributing to the need for advanced financial literacy skills, such as increased participation in post-secondary education and changes in consumer spending and saving patterns.

Demographics

Recent data indicates that the Canadian population is aging. In 1981, 9.6% of the general population was 65 or older but by 2007, that proportion had reached 13.4%. The average life expectancy of Canadians has also increased, from 76-years-old in 1981 to 81-years-old in 2007.

These trends suggest that more Canadians will need to rely on pensions and retirement savings in the coming years. As a result, planning and saving for retirement is becoming increasingly critical and Canadians will need strong financial literacy skills to make informed and effective decisions.  .

But understanding the variety of retirement plans available can be a daunting task.

Many employers are switching their retirement plans from defined benefit schemes to defined contribution plans to lessen potential costs and risks to the employer. In a defined benefit plan, the employer guarantees a certain benefit level at retirement based on the employee’s years of service and history of earnings. In a defined contribution plan, both the employer and the employee make contributions to the plan, which are then invested with the employee receiving the full value of the investment upon retirement.

The difference between the two plans is that the employee absorbs 100% of the investment risk in a defined contribution plan; if the investments do not perform well, retirement benefits are directly affected, potentially affecting the retirement plans of millions of retirees.

The change from defined benefit to defined contribution plans has been slower to take hold in Canada than in other countries, but a transition is definitely occurring. Between 1991 and 2006, the proportion of Canadians contributing to a defined benefit plan fell from 41% to 30% while the proportion covered by a defined contribution plan increased from 4% to 6%.[2] As pension plans shift toward the defined contribution model, it is increasingly important for plan members to have strong financial-literacy skills. Without these skills, they will be less prepared to make sound decisions regarding their retirement investments.

Post-secondary education

Enrolment in post-secondary education (colleges, universities or apprenticeship programs) has increased significantly over the last two decades. In the 1990–1991 school year 15% of 17- to 29-year-olds were enrolled in full-time PSE studies. By 2005–2006, that number had grown to 23%.[[3]

As PSE participation rates have increased, tuition fees have followed. For example, in 1990–1991 the average tuition for a university undergraduate in Canada was $1,464. By 2009–2010, the average tuition was $4,917—more than triple the amount.[4]^{, 5]} This means that tuition fees increased at an annualized rate of 6.6%, triple the rate of average inflation (2.2%).[6]

As a result of this increase in tuition, PSE graduates are incurring higher levels of debt. For example, undergraduates who completed their programs in 2000 owed 68% more (in constant 2002 dollars) than graduates in 1990; while college students owed 63% more. Meanwhile, the median debt-to-earnings ratio—the percentage of a consumer's monthly gross income that goes toward paying debt—increased from .28 in 1990 to .44 in 2000 for university graduates, and .21 to .33 for college graduates (over the same period).[7]

Importantly, for students and parents, strong financial literacy skills are critical to help make informed decisions related to the pursuit and completion of post-secondary education.

This includes navigating through the complexity of student financing options and associated costs of attending; understanding economic returns on career choices; and day-to-day management of living expenses on housing, car loans and credit cards. It also requires that Canadians comprehend and comply with repayment of student loans; and make financially responsible saving choices for the future such as saving toward further education, a home purchase, contributions to savings and pension plans and savings to alleviate periods of unemployment.

Studies, however, have suggested that parental expectations are also not realistic for post-secondary financing resulting in inaccurate financial planning:

• 40% of parents expected their child to receive a scholarship (based on academic performance) compared to 15% of those whose child actually received one.
• 29% of parents expected children to receive a grant or bursary (based on financial need) compared to 15% of those whose child actually received one.
• 11% of parents expected their child to need a bank loan or a personal loan to finance their PSE; in fact 27% of students obtained a bank or personal loan to finance their education.

Consumer spending and saving

Over the last three decades the use of credit cards to finance consumer spending has increased substantially among Canadians. On a per capita basis growth in consumer spending has outpaced growth in disposable income. In 1980, Canadians spent 82% of their disposable incomes; by 2005, they were spending 96%. As spending has increased relative to incomes, personal savings rates have fallen from 20.2% in 1982, to 1.2% in 2005.

These changes leave many Canadians in more perilous financial circumstances and increase the importance of financial literacy skills. As Canadians balance larger debt loads, it becomes ever more important for individuals to understand the implications of using different kinds of credit, such as payday loans, credit cards and lines of credit.

Gauging the financial literacy of Canadians

In 2009, Statistics Canada conducted the first survey designed to directly measure the financial literacy of Canadians. The survey examined Canadians’ ability to make ends meet and balance their home budgets, to keep track of their finances, to choose financial products, to plan ahead (i.e., for retirement or future purchases), and to stay informed about matters of personal finance. The survey also included a factual quiz to measure respondents’ knowledge of topics like stock markets, credit reports, and the effects of inflation.

Though Statistics Canada has not yet published its final report on their findings, the Task Force on Financial Literacy reported select key findings in August 2010.8]Findings suggest that:

• More than one-third of Canadians are struggling to keep up with their finances
• 30% of Canadians are not planning ahead for retirement
• Only 35% of Canadians know that their stock market investments are not insured
• About one-third of Canadians do not understand the effect of inflation on their buying power.

These preliminary results strongly suggest that Canadians are not sufficiently financially literate. Other evidence supports this conclusion. For example, the Canadian Centre for Financial Literacy reports that only 10% of respondents to a survey on financial literacy were “very knowledgeable” about basic financial issues.[9] While Sun Life Financial reports that 43% of Canadians were unsure how much they needed to save for retirement.10]

Evaluations of government programs suggest that many Canadians are not aware of, or do not understand, the government benefits that are available. For example, Statistics Canada estimates that 150,000 seniors in Canada are eligible for the Guaranteed Income Supplement, yet do not receive it—largely because they do not properly file their annual income tax returns.[11]

EKOS Research estimates that only one-third of families making less than $38,000 have heard of the Canada Education Savings Grant; and only one-quarter correctly understand those grants. While only 10% have heard of the Canada Learning Bond and fewer than half understand the program.[[12]

Lessons in Learning: Improving financial literacy among Canadians

Financial education has been shown to be a useful tool for helping Canadians improve their financial literacy skills. There are two general approaches to financial education: informational and behavioural.

Informational approaches

When the target audience simply requires information to make appropriate and informed decisions, the informational approach is appropriate. For example, first-time home buyers require information on; how to shop for the lowest mortgage interest rate, how much to save for closing costs, and how to assess the affordability of housing options. The success of informational programs depends on the clarity of accessibility of the information presented.

A number of informational programs are currently available to Canadians. For example, the Financial Consumer Agency of Canada was created by the federal government to strengthen consumer protection measures and expand consumer education activities across Canada. Their website provides information and interactive tools to help consumers learn about credit cards, mortgages, loans, credit scores, banking, insurance, rights and responsibilities when dealing with federally regulated financial institutions.

The Canadian Bankers Association provides resources for students, teachers and parents that are designed to help young Canadians learn about financial literacy. Through the organization’s Your Money website, young Canadians can learn about budgeting, saving, investing, borrowing and credit profiles by watching videos and using interactive tools. As well, teachers can register for in-class seminars presented by volunteers from within the banking community.

Behavioural approaches

But for some audiences, clear and accessible information is not sufficient. The behavioural approach to financial education is designed for audience who need more than just information, but rather need to change their financial behaviours.

For example, debt-reduction education programs focus on helping participants learn to distinguish between needs and wants with he goal of reducing their unnecessary expenditures and avoiding compulsive or emotional spending.

Programs designed to change financial behaviours often rely on incentives. For example, learn$ave is a federally-funded program currently being evaluated by the Social Research and Demonstration Corporation. The program is designed to encourage low-income adults to save for education or training or to start a small business. When program participants make deposits in a special accounts, their savings are matched. For example, participants receive $3.00 in matched saving credits for every $1.00 they deposit in their accounts. Participants also receive financial management training; however, the financial incentives appear to be far more effective than the informational component of the program.[13]

Insights derived from the study of behavioural economics can also contribute to the success of financial education programs. Classical economics assumes that people make rational decisions to optimize their financial well-being, while behavioural economics assumes that people often use less-than-optimal heuristics (or “trial-and-error”) approaches when making financial decisions.

One important insight is that people find it less difficult to forego future income increases than foregoing corresponding proportions of their current incomes.14] This is the basis for the Save More Tomorrow retirement plan which encourages participants to commit in advance to allocate a portion of their future salary increases toward retirement savings. This approach has been shown to be very successful. In one assessment, 78% of those offered the plan accepted it. Of those who joined the plan, 98% stayed with it through at least two pay raises, increasing their savings rate from 3.5% to 11.6% in a two-year period.[15]

Canadians can anticipate an increase in the availability of opportunities to learn about financial issues in the near future. In 2009, the federal government appointed a National Task Force on Financial Literacy to provide advice on a national strategy to strengthen the financial literacy of Canadians. In September 2010, the Task Force released a report called What We Heard which summarized their public consultations which were held across Canada and online between February 2009 and May 2010. This will be followed up by a final report scheduled for the end of 2010 that will include recommendations for a  national financial literacy strategy.