The impact of COVID-19 has shone a light on a weakness in household finances. Whilst it would have been difficult to anticipate the pandemic and the subsequent government response of a nationwide shutdown, many lack emergency funds to manage through a disruption to their income.
People were living pay cheque to pay cheque and perhaps not expecting to need something for a rainy day. It's understandable, given Australia had just experienced a long period of economic prosperity. However, with financial stress a leading cause of anxiety, not being in control of your finances can harm your health and well-being.
Our health and our finances are interrelated, providing additional compelling reasons why we need to get on top of our personal budget.
Is it a knowledge gap or an implementation gap?
How do we solve this? It is both an education issue and an action issue. It is like dieting. If we want to lose weight it is conceptually quite simple: eat less and move more. Most people know this yet struggle to lose weight. Why? It's not a knowledge issue, it is the implementation that's the hard part.
It's the same with finances. Conceptually it is not really that hard: spend less, save more and pay down debts; but like dieting, it is the implementation that is difficult.
From little things big things grow
The positive message is implementing changes requires no monumental shift in behaviour. The key is to make some small changes. Incremental changes can add up and make big impacts in the long term.
My grandmother used to say, "save your pennies and your pounds will look after themselves". Skip buying that extra cup of coffee, don't pay for parking, walk more and make your lunch rather than buying it. All of these little changes will save money, which can add up to a lot over time.
Edward Lorenz, who discovered Chaos Theory, posed this question “Does the flap of a butterfly’s wings in Brazil set off a tornado in Texas?”. This neatly captures his discovery that one small action can cause a powerful reaction. Chaos Theory is sometimes described as the science of surprise as it captures those non-linear, unpredictable outcomes that are complex and chaotic because of the many moving parts within an ecosystem. This resonates in many aspects of life including investment markets. The butterfly effect is applicable to your personal finances, including the small changes you make can add up to really big changes in the future.
There was a great study recently undertaken by behavioural economists Shlomo Benartzi, Hal Hershfield and Stephen Shu titled Temporal Reframing and Participation in a Savings Program: A Field Experiment. The study found that people were four times more likely to save if the saving was presented, or in economics terms, 'framed' as a smaller amount of $5 a day rather than $150 a month. These dollar amounts are the same, but to the participants in the survey, $5 a day seemed a more achievable undertaking versus $150 a month. That is a lot of money to many people.
So simple things like breaking your savings goal into bite-sized chunks are more likely to garner success. It reminds me of the quote: "What’s the best way to eat an elephant? One bite at a time." Framing it in a way that shows that it's doable encourages people to just get started. To save successfully doesn't require big amounts, it doesn't have to be thousands of dollars. The key is to just get going and you can build from there. There is an old Chinese proverb that says, "When is the best time to plant a tree? Twenty years ago. When is the second-best time? Now."
Financial literacy is low and women are most affected
Studies have shown there is a financial literacy knowledge gap in Australia. Melbourne University’s Household Income and Labour Dynamics in Australia survey (HILDA) surveys 17,500 people or 9,500 households. They ask basic questions around financial concepts such as interest, diversification and inflation to gauge the level of financial literacy in the community. They found that while half of male participants could answer basic financial questions, only 35% of women could answer the same questions correctly.
Women are at a disadvantage not only from a financial literacy perspective but also because of wage inequality and higher instances of career breaks to have and care for children. And then because they're not earning as much, they're less willing to take as much investment risk, and there's a link between risk and return in investing. To generate a higher return you typically need to take on higher risk, facing a loss along the way. Because women have less to start with and earn less, if they do experience a loss it has a much bigger impact as it takes longer to recoup that loss than if they were earning more. So they are more cautious.
Lower income means lower appetite for risk. Additionally, women's superannuation savings are lower because their income is lower and because of the career breaks. Women also have a higher propensity to work part time.
It's a perpetual circle of disadvantage for women.
Sure, education is part of the problem but it's also a structural issue relating to access to affordable childcare, equal wages, workplace flexibility and unconscious bias. It's a policy issue since workplaces and superannuation are set up for full-time employees who don't take career breaks.
The good news is the superannuation sector is well represented by women in senior management and they recognise the shortcomings of the current system and are lobbying for change to make it fairer for women. KPMG has also highlighted that the current retirement income policy needs some structural changes to help women better navigate retirement. This is crucial as older women are becoming homeless at a faster rate than any other cohort.
Australia has a financial literacy pandemic; women are more adversely affected than men; and encouraging people to make small changes can have surprisingly large future impacts.
Erica Hall is a Senior Manager Adviser Solutions at Morningstar Investment Management. This material has been prepared for educational purposes only, without reference to your objectives, financial situation or needs.
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