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A model of consumer financial numeracy
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New Mexico State University, Las Cruces, USA, and
Bruce A. Huhmann Shaun McQuitty Athabasca University, Athabasca, Canada
Received July 2008 Revised February 2009 Accepted March 2009
Abstract Purpose – The purpose of this article is to develop a theoretical explanation – financial numeracy – for consumer proficiency with financial services. With sufficient financial numeracy, consumers benefit fully from financial services and make competent choices in regard to financial management. Design/methodology/approach – The article builds theory by combining consumer cognitive capacity and customer knowledge theories with findings from prior studies of consumer difficulties with financial services to introduce a comprehensive model of the antecedents and consequences of financial numeracy with testable propositions for many psychographic and cultural influences and moderators. Findings – Financial numeracy demands that consumers possess sufficient financial information processing capacity and ability as well as sufficient prior knowledge of financial concepts. Although partly a function of individual cognitive ability, it can be enhanced through appropriate experience with financial instruments and familiarity through personal financial materials when consumers are motivated to process them. Financial numeracy directly affects financial management outcomes related to borrowing, saving, and taxes. It indirectly affects higher-order financial consequences, such as a consumer’s credit score, interest rates charged on subsequent loans, net worth, likelihood of bankruptcy, and size of inheritance. Originality/value – Consumers around the world are increasingly experiencing difficulties with financial services. To advance research in financial services marketing beyond documenting troublesome financial behaviours of consumers, this conceptual model provides insights to help increase consumer proficiency in comprehending and managing financial services based on knowledge about consumer information processing, learning, memory and the cultural and psychographic influences on these internal processes. Keywords Financial services, Consumer psychology, Modelling, Consumer credit Paper type Research paper
International Journal of Bank Marketing Vol. 27 No. 4, 2009 pp. 270-293 q Emerald Group Publishing Limited 0265-2323 DOI 10.1108/02652320910968359
Introduction Even before the current economic downturn, financial difficulties for consumers were rising throughout the developed world. In fact, some might argue that these difficulties heralded the downturn. For example, the UK household saving rate in the first quarter of 2008 was negative (2 1.1 per cent of income) for the first time since 1958 (Office for National Statistics, 2008). US personal savings rates are also extremely low (Fox et al., 2005). Further, retirement savings are insufficient to cover the needs of the growing elderly population. Only 27 per cent of UK workers without a defined benefit pension plan are adequately saving for retirement and 49 per cent of all UK workers face inadequate or no retirement income outside of any state pension (Kane, 2008). In the USA, almost half of all workers have less than $25,000 saved for retirement; yet, 71 per
cent are confident that they are doing a good job in retirement preparation (Helman et al., 2007). Owing to insufficient savings, many consumers rely on high-interest loans or credit card debt to make ends meet. The average Briton has 2.8 credit cards. Debt for the average British household is rising by £13 a day, which has increased UK household debt to 173 per cent of income in 2008 versus 129 per cent in 2003. Personal debt is increasing throughout the developed world. Such debt is 142 per cent of income for US consumers and 109 per cent of income for German consumers (Henderson, 2007; Office for National Statistics, 2008). Personal debt as a proportion of Australian Gross Domestic Product grew at a near-record 4 percent in 2007 (Washington, 2007). In Ireland, personal debt increased 600 per cent from 1994 to 2004 to e85 billion (O’Laughlin and Szmigin, 2006). Also, debt is quickly growing beyond many consumers’ ability to pay in Asian nations such as Korea (Park and Burns, 2005). Required minimum payments on this debt are becoming a larger part of consumers’ disposable income, up to 18 per cent in the USA, for example. Consequently, more consumers are missing minimum payments. The US credit card delinquency rate has remained around 4.5 to 4.8 per cent in recent years (Mills, 2007). Such high-cost debt is contributing to more households facing home mortgage default or bankruptcy, which has adversely affected the loan portfolios of banks around the world. Whereas the severity of the UK housing market correction and the US subprime mortgage default crisis have gotten attention for their impact on the stock market, mortgage loan defaults are increasing for consumers in other developed nations. The number of Australian households in mortgage default, among both prime and subprime loans, has climbed to historic highs despite stable economic conditions (Washington, 2007). In the first half of 2008, over 125,000 UK homeowners had mortgage arrears of three or more months, up 4 per cent from the previous six months. High-cost debt is a significant portion of debt for many consumers declaring bankruptcy (May and Young, 2005). The number of individual insolvencies (i.e. bankruptcies and Individual Voluntary Arrangements) in England and Wales was above 110,000 per year from 2006 to 2008 after rising rapidly from between 30,000 to 40,000 per year before 2003 (Insolvency Service, 2008). Two views are commonly espoused concerning the growing financial problems for consumers: (1) consumers are accountable for responsibly using financial services, and those who get in over their heads must find a way to manage fiscal responsibilities; and (2) financial service marketers do not provide customers with full information about the consequences of inappropriate financial management and, therefore, share the blame for many consumer bankruptcies and associated consumer issues. The validity of these views depends on the degree to which information is provided to and understood by consumers of financial services. It would appear that information is either not provided or not understood, because far too many consumers face mounting debt and bleak prospects for retirement. Furthermore, financial service marketers stand accused of profiting from and increasingly targeting consumers who lack sufficient understanding of financial services and are less likely to benefit from their
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use (Wolberg, 2005). The UK housing market and US subprime mortgage debacle provide excellent examples, as do consumer difficulties in handling credit card debt worldwide. Such consumers may be described as having poor financial numeracy, which is a lack of proficiency or expertise in managing financial matters. Poor financial numeracy stems from difficulty in grasping financial concepts (e.g. insufficient capacity for processing financial information) or lack of sufficient prior knowledge about financial concepts and products. Unfortunately, the number of consumers with poor financial numeracy appears to be growing. One indication is the rising debt-to-income ratio, which jumped 34 per cent for UK households from 2003 to 2008 (Office for National Statistics, 2008). Another indication of declining financial numeracy comes from surveys measuring consumer proficiency in financial matters. A national survey of US high school seniors sponsored by the JumpStart Coalition for Personal Finance found that financial knowledge has declined since the survey was first administered in 1997. The average score has fallen from 57.3 per cent in 1997 to 52.4 per cent in 2007. Most (62 per cent) students fail this assessment of financial knowledge (less than 60 per cent correct). Although considerable financial education efforts have targeted US high school students over the past decade, scores on the survey have only worsened (Mandell, 2007). The problem is world-wide. A study of Korean high school students found that their financial knowledge was as poor as US students (OECD, 2005). A British survey found that 70 per cent of consumers were weak in three or more of the five areas of financial capability as measured by the Financial Services Authority (Atkinson et al., 2006). Despite the wealth of research documenting the growth of the financial services industry and problems that consumers have managing financial services (e.g. Atkinson et al., 2006; Brown and Taylor, 2008; Che´ron et al., 1999; Elliehausen et al., 2007; Fox et al., 2005; Hilgert and Hogarth, 2003; Hill and Kozup, 2007; Huhmann and Bhattacharyya, 2005; Lusardi and Mitchell, 2007; O’Laughlin and Szmigin, 2006; Park and Burns, 2005; Panther and Farquhar, 2004; Warwick and Mansfield, 2000), financial institutions, policymakers, and researchers interested in improving consumer financial management behaviours could benefit from a more unified theoretical approach to explaining consumers’ difficulties in managing financial services. Because of the recognized importance of the growing societal problems caused by poor consumer decisions about financial services, the purpose of this article is to propose a conceptual model of financial numeracy. First, the financial numeracy construct is defined. Then, antecedents influencing financial numeracy, psychographic and cultural influencers and moderators, and the consequences of financial numeracy are outlined and theoretically based propositions are derived to advance research. A conceptual model of financial numeracy Much has been written about the related constructs of financial literacy and financial capability. However, these construct have been variously used or defined in the literature. For example, Britain’s Financial Services Authority describes financial capability as encompassing the outcomes of “managing money”, “planning ahead” or retirement planning, “choosing products” or financial service usage, and product familiarity or financial literacy, which they termed “staying informed” (Atkinson et al., 2006). Thus, financial capability tends to refer to both financial knowledge and financial management behaviour (e.g. Atkinson et al., 2006; Personal Finance Research
Centre, 2005). Financial literacy tends to refer to financial education (e.g. Fox et al., 2005; Hill and Kozup, 2007) and/or financial knowledge (e.g. Hilgert and Hogarth, 2003; O’Laughlin and Szmigin, 2006; Warwick and Mansfield, 2000), but at times broadly refers to the process of obtaining, understanding, and evaluating financial information (e.g. Mason and Wilson, 2000; Willis, 2008). Unfortunately, previous research has rarely tied the financial literacy construct to a theory of how consumers process information or learn and use prior knowledge. To address this shortcoming, we apply consumer psychology theories of processing, learning, and knowledge to the ability to comprehend, acquire, and use financial information and concepts. We extend the notion of numeracy, which is the ability to comprehend and a sufficient understanding of mathematical concepts and methods, to financial numeracy. We develop a conceptual model of financial numeracy that incorporates and is rooted in the broader theoretical constructs of cognitive capacity and prior knowledge. Financial numeracy will be used to refer to the global construct of proficiency in processing, understanding, acquiring, and using financial information and concepts based on a consumer’s capacity and prior knowledge in this area. Financial numeracy has two distinct components that are frequently conflated in the literature: financial capacity and financial literacy. Financial capacity is the ability to process and comprehend information and statistics related to financial products, whereas financial literacy involves adequate knowledge about financial concepts and how financial products work. In other words, financial capacity is learning-based, whereas financial literacy knowledge is memory-based. The memory-based component best mirrors financial literacy as it is most often discussed in the literature. Financial capacity is, in part, a function of cognitive capacity, which is limited and innate. When information processing demand exceeds cognitive capacity, comprehension suffers (Hu et al., 2007). Consumers differ in cognitive capacity, but even those consumers with less cognitive capacity can learn to utilize it more efficiently to benefit processing by improving processing skills, such as language and mathematics skills. Such skills should also help increase financial capacity efficiency. The efficient use of one’s financial capacity depends on one’s ability to: extract financial information from texts, charts, figures, and graphs; accurately forecast expenses and returns based on probabilities; convert prices and yields from currency to percentages and back; recognize differences in numbers outside of one’s everyday experience; learn heuristics or rules of thumb to simplify and organise financial information; understand financial terminology and jargon; etc. Achieving perfect financial capacity efficiency is an insurmountable task (Willis, 2008), but every step that consumers take to improving financial capacity efficiency should improve their ability to gather useful and accurate financial literacy knowledge and apply this prior knowledge as well as their financial capacity to the task of financial management. The model presents financial numeracy’s antecedents (see Figure 1) that should influence financial capacity efficiency. The memory-based, prior knowledge component of financial literacy can be viewed as a specific instance of the broader construct of consumer knowledge (Alba and Hutchinson, 1987, 2000). Weak financial literacy should be improved through increased exposure to financial concepts and financial products and services. More experience with financial services or familiarity from processing personal finance materials should also help correct misconceptions and erroneous or fallacious beliefs already stored in memory.
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Figure 1. A conceptual model of the antecedents and consequences of financial numeracy
A consumer’s financial capacity (i.e. processing capacity or cognitive ability in regard to financial information) and financial literacy (i.e. prior knowledge of financial products and services) should interact in determining that consumer’s financial numeracy (i.e. proficiency or expertise in comprehending financial information during decision making). As shown in Figure 1, financial numeracy represents the internal processes of financial learning ability and knowledge stored in memory. Due to the difficulty of distinguishing the boundaries of the distinct but related constructs of learning and memory, a dotted line separates them. The dotted line also implies that each component construct reinforces the other to affect overall financial numeracy. For example, despite a large financial capacity, a consumer could still evince numerous misconceptions due to inaccurate prior financial literacy knowledge, because new information that does not fit with prior knowledge may be distorted to make it congruent with existing knowledge. Also, prior financial literacy knowledge will be used to filter, comprehend, organise, and encode new information that passes through the constraints imposed by one’s financial capacity (Bartlett, 1932; Brewer and Treyens, 1981; Kintsch, 1988). Finally, improving the learning efficiency of financial capacity increases the likelihood that a consumer will be able to add to the store of financial literacy knowledge. Insufficient or inaccurate financial knowledge due to inadequate capacity or the lack of prior knowledge to comprehend or categorise new information for easy recall means that the consumer may rely on incorrect conclusions, misconceptions, or erroneous and fallacious beliefs about financial products or concepts (e.g. compound interest, back-end load mutual funds, finance charges, etc.) during financial decision-making. Thus, the components affect each other in their relationship to financial management consequences. Although financial capacity and financial literacy share many antecedents and consequences, some cultural and psychographic differences may affect financial capability and financial literacy in different ways. In such cases, a proposition will refer to one component. In propositions where both financial capacity and financial literacy should be similarly influenced by an antecedent or similarly affect a consequence, the proposition will refer to the global financial numeracy construct. Antecedents of financial numeracy Experience with financial instruments Experience with financial instruments reduces behavioural outcomes associated with poor financial numeracy more than financial education courses (Hilgert and Hogarth, 2003). Using age as a surrogate for experience with financial instruments suggests that experience benefits many debt and savings-related consequences of financial numeracy. Head-of-household age has been shown to directly decrease the probability of having a negative net worth in the UK, USA, and Germany (Brown and Taylor, 2008). Similarly, data from a recent Financial Services Authority study (Atkinson et al., 2006) show that the proportion of UK consumers who hold debts equal to more than half their monthly income declines with age. On the other hand, the proportion of UK consumers who are debt free or have accumulated savings equal to at least half their monthly income increases with age. In the broader consumer behaviour literature, experience is seen as an important influence on prior knowledge. Thus, experience with financial instruments should obviously enhance financial literacy as experience can be a source of prior knowledge. However, experience can also help develop skills to more efficiently use one’s financial
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capacity. As consumers gain experience, they should become more capable processors of financial information, just as experience practicing mathematics or language skills aids processing numeric or verbal information. In fact, the role of experience in reducing cognitive effort requirements is well established (see Alba and Hutchinson, 1987 for a brief review): P1.
Increasing a consumer’s experience with financial instruments should increase financial numeracy.
Personal finance materials and familiarity Personal finance materials include personal instruction and audio/visual or text presentations designed to teach consumers about financial concepts, products and services. These materials may be externally selected or self-selected by the consumer. Some externally selected materials are supplied by firms to tell consumers about their financial product offerings. But the most researched source of externally selected materials is financial education programmes. Financial education programmes have been touted as the answer to consumers’ problems with credit cards, debt, investments, insurance, taxes and other financial products. As a result, the number of financial education (often referred to as “financial literacy”) programmes has grown. The most common target audiences for financial education programmes are immigrants, women, renters, home buyers, the unemployed, individuals starting small businesses, and students in elementary and high school or university (Elliehausen et al., 2007; Fox et al., 2005; Hilgert and Hogarth, 2003). Financial education materials are even mandated in the US federal government’s No Child Left Behind legislation. Of course, some groups of consumers (e.g. white collar professionals) are not exposed to these financial education programmes because they are assumed to be well enough educated to avoid financial problems, despite the pervasiveness of poor financial outcomes in these groups (e.g. Brown and Taylor, 2008; Willis, 2008). The lack of financial education is related to negative financial management outcomes (e.g. Elliehausen et al., 2007; Hilgert and Hogarth, 2003). The current model explains this relationship through poor financial numeracy. Of course, financial education programmes are most effective when they differentiate between financial capacity and financial literacy. The financial numeracy of those in the programme who lack prior knowledge should improve by familiarizing them with financial concepts, products and services. For the remainder, their financial capacity-related inability to process and comprehend financial information must be addressed to improve their financial numeracy. Financial education programmes and other sources of personal finance materials should increase familiarity with processing financial information, which should improve the efficiency of one’s financial capacity and add to one’s store of financial literacy. In the broader consumer behaviour literature, familiarity is seen as another important influence on prior knowledge and required cognitive effort in the same way that actual experience impacts prior knowledge and efficient use of one’s cognitive capacity (Alba and Hutchinson, 1987, 2000). When cognitive effort is reduced, consumers are less likely to experience cognitive overload and, hence, will be more likely to engage in information search and processing (Hu et al., 2007). Just as consumers with less innate cognitive capacity can learn to use their limited processing
ability more efficiently, so too should consumers with less financial capacity be able to hone their ability to process and comprehend financial information. Thus, personal finance materials should help consumers develop skills to more efficiently use their financial capacity as well as familiarize them with financial concepts, which should increase their ability to accurately encode new financial literacy knowledge. Thus:
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Personal financial materials should improve financial numeracy via increased familiarity.
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P2.
Motivation to process personal finance materials Declining financial numeracy in spite of increased financial education efforts demonstrates that many financial education programmes are not providing personal finance materials that are relevant to their audience’s perceived current needs. Further, one-fifth or fewer of financial education programme attendees actually improved their financial management outcomes (Lusardi and Mitchell, 2007). Many of these programmes assume that any exposure to personal finance materials will improve consumers’ financial management behaviours (Hilgert and Hogarth, 2003). Although familiarity should aid financial numeracy, familiarity depends on sufficient processing effort during exposure. Exposure without processing limits one’s ability to acquire, use and retain concepts covered in personal finance materials. Consumers process and retain only a fraction of the information to which they are exposed. Consumers are more likely to acquire and process information, such as personal finance materials, when they have the motivation as well as the capability to process that information (see MacInnis et al., 1991 for a review). Therefore, a one-size-fits-all approach to presenting personal finance materials is likely no more effective than a one-size-fits-all approach to advertising detergents. For example, teens are not likely to be interested in processing personal finance materials related to retirement strategies. But if knowledge of financial concepts is related to personally relevant topics (e.g. saving for and buying a first automobile or financing a university education), then teens’ greater attention and interest should translate into improved retention of these financial concepts. Unfortunately, most financial education programmes do not take the target audience’s motivation to process into account. This may explain why, despite the plethora of financial education programmes, most consumers report that their primary sources of financial knowledge are experience, friends or family, and the media, rather than financial education programmes (Hilgert and Hogarth, 2003). However, given sufficient motivation, consumers should process personal finance materials from financial education programmes as well as those received from financial service providers. Consumers with sufficient motivation search for and select materials for financial self-education from a variety of media (e.g. personal finance-oriented web sites, magazines, books, television programmes): P3.
The audience’s level of motivation moderates processing of externally selected and self-selected personal finance materials.
P4.
Increased motivation to attend to externally-selected or self-selected personal finance materials should moderate the negative effects of the lack of experience with financial instruments on financial numeracy.
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Cultural differences Dominant groups in a society tend to have more experience with financial instruments than non-dominant groups. In part, their lack of experience stems from non-dominant groups’ tendency to be considered a bad risk or low profit margin target market; so, many financial service providers avoid or discourage serving them. Thus, non-dominant groups often must overcome exclusion or disfranchisement to gain access to even basic financial services (e.g. Che´ron et al., 1999; Sharma and Reddy, 2003). For example, in the UK, immigrants have less experience with financial services than citizens and, hence, evince behaviours associated with lower financial numeracy (Atkinson et al., 2006). Similarly, minorities in the USA, such as African Americans and Hispanics, have not had the same positive experiences with financial instruments that are typically afforded to White Americans (Andreasen, 1982; Olney, 1998). Greater experience with financial instruments should, therefore, create greater financial numeracy among White Americans than minorities. This is evident even among high school seniors, when White Americans tend to score higher on measures of financial knowledge than minorities (Mandell, 2007). White American adults also exhibit greater financial literacy knowledge than minority American adults (Lusardi and Mitchell, 2007). Although financial numeracy is not measured, Brown and Taylor (2008) provide evidence that an important outcome – net worth – is higher for dominant (White Americans or native-born Germans) than non-dominant groups (minority Americans or immigrants to Germany). These results imply that dominant groups’ greater financial experience pays off in better financial decisions, management, and rewards by training them to better use their financial capacity and increasing the financial literacy knowledge on which they may draw when encoding new financial information into memory or optimizing financial management behaviours: P5.
Culturally dominant groups in a society will have more experience with financial services and products than non-dominant groups.
One’s culture can also encourage or discourage financial numeracy. Members of cultures that emphasize individual determination and a Protestant Work Ethic tend to have an internal locus of control (e.g. British, Northern Europeans and Whites in former African colonies, Australia, Canada, and the USA), whereas those that emphasize destiny as a determinant of an individual’s place in life tend to exhibit an external locus of control (e.g. Black Africans, Hispanic Americans). Culture influences the use and perception of money or financial products. Those from external locus of control cultures tend to believe that their financial wellbeing is out of their hands. However, those from internal locus of control cultures tend to take more responsibility for their own financial wellbeing and believe that processing effort is rewarded (Falicov, 2001; Reimanis and Posen, 1980). Thus, consumers from cultures with an internal (external) locus of control should place greater (less) emphasis on developing one’s own financial numeracy through processing personal finance materials as well as be more (less) likely to rely on one’s own financial literacy (financial service providers’ advice and expertise) during financial decision-making: P6.
Locus of control should: directly affect motivation to process personal finance materials; and moderate the financial literacy/financial management outcomes relationship.
Other cultural factors may also affect financial numeracy. For example, power distance affects the level of trust that customers place in financial service providers (Dash et al., 2006). Deference to authority is more common in cultures that value high power distance (Hofstede, 2001). Greater deference to authority should increase the reliance on the advice and expertise of financial service providers in determining financial management behaviours vis-a`-vis one’s own financial literacy. Therefore, the greater a culture’s power distance, the less consumers in that culture will rely on prior financial literacy knowledge when engaged in financial decision-making: P7.
Power distance moderates the relationship between financial literacy and financial management outcomes.
Psychographic influences Psychographic constructs (e.g. values, lifestyle, and personality) are under-researched in relation to consumer financial management. Although financial capability research does recognize that personality may influence financial confidence and attitudes (e.g. Atkinson et al., 2006; Personal Finance Research Centre, 2005), it does not provide much detail. This may be because much consumer financial management research has used secondary data sets, such as the British Household Panel Survey, German Socio-Economic Panel, University of Michigan’s monthly Surveys of Consumers, the Federal Reserve Bank’s Survey of Consumer Finances, the Freddie Mac Consumer Credit Survey, the International Institute of Banking and Financial Services’ Financial Well-Being Survey, or consumer credit reports (e.g. Brown and Taylor, 2008; Elliehausen et al., 2007; Ironfield-Smith et al., 2005; Lee and Hogarth, 2000; Lusardi and Mitchell, 2007; Hilgert and Hogarth, 2003). These externally valid, readily available datasets describe attitudes toward financial service issues and financial behaviour, but they are better suited for investigating relationships between financial knowledge, financial service usage, and demographic variables. Use of these datasets has expanded understanding of these issues; however, the lack of values, lifestyle, or personality measures means that psychographic explanations of individual differences related to financial numeracy have gone largely unexplored. Psychographic variables better explain consumer behaviour than demographic or usage variables (e.g. Becherer et al., 1977; Brody and Cunningham, 1968; Reynolds and Darden, 1972). Numerous psychographic constructs deserve investigation for their role in directly influencing financial numeracy, motivating the processing of personal finance materials that enhance financial numeracy, or moderating its effects on financial management outcomes. First, need for cognition represents one’s propensity to engage in and prefer activities that require considerable amounts of thinking (Cacioppo and Petty, 1982). Need for cognition represents a generalized internal motivation to process. Enduring involvement or personal relevance also increases motivation to process (Celsi and Olson, 1988), but is product or issue specific rather than general. Situational involvement (e.g. when a consumer needs to make a financial product purchase) should also increase motivation to process, but is not proposed to have a sufficient indirect effect on financial numeracy due to it temporary nature. Thus, the following is posited:
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P8.
Higher (lower) need for cognition should increase (decrease) motivation to attend to personal finance materials regardless of the materials’ personal relevance.
P9.
More (less) enduring involvement in financial products/services should increase (decrease) motivation to attend to personal finance materials regardless of a consumer’s need for cognition.
Consumers’ level of self-control should also impact financial numeracy. Self-control involves a consumer’s ability to delay gratification. Some consumers have myopic self-control (i.e. they succumb to impulse and choose immediate short-term pleasure at the expense of long-term costs), because they weight the present more than the future to an exaggerated degree. Myopic self-control leads consumers to make greater than optimal purchases of hedonic or leisure goods and less than optimal purchases of investment goods (Ainslie, 1975; Mukhopadhyay and Johar, 2005). Those with myopic self-control are less likely to devote sufficient effort to the utilitarian task of improving their financial capacity efficiency and adding to their store of prior financial literacy knowledge. Conversely, other consumers have hyperopic self-control and are excessively future-oriented. Such consumers make purchases primarily of utilitarian goods or necessities, with fewer purchases of hedonic or leisure goods and greater purchases of investment goods (Kivetz and Simonson, 2002; Kivetz and Keinan, 2006). Those with hyperopic self control should be more likely to devote sufficient cognitive effort to improving their financial capacity efficiency and acquiring financial literacy knowledge, which is a utilitarian rather than hedonic task. Because consumers with hyperopic self-control should be able to delay gratification in regard to leisure and impulse purchases and be more focused on investing for the future, their borrowing should be less and savings should be more than the average consumer regardless of financial numeracy. Thus, they should also have more optimal financial management outcomes, ceteris paribus. Alternatively, consumers with myopic self-control should tend to mismanage finances regardless of financial numeracy. Therefore, the relationship between financial numeracy and financial management outcomes will be most evident for consumers in the middle of the myopic/hyperopic continuum, but will be more tenuous for consumers nearer the extremes of myopic or hyperopic self-control: P10. Owing to the utilitarian nature of developing financial numeracy, hyperopic self-control should lead to greater financial numeracy than myopic self-control. P11. Self-control should moderate the effect of financial numeracy on financial management outcomes. Learned helplessness is an expectation or perception that events are uncontrollable (Abramson et al., 1978). Interestingly, financial service providers may inadvertently increase learned helplessness in consumers. For example, credit card agreements often include “universal default” clauses whereby credit card issuers can raise a consumer’s interest rate automatically due to late payments on other cards or loans, or if an issuer believes the consumer has too much debt, even if there have been no late payments. Thus, consumers with higher learned helplessness will expect that they will suffer the same consequences regardless of financial service usage or attempts at financial
management, which should reduce the motivation to process personal finance materials. Learned helplessness also decreases external search behaviour (Motes, 1982) and should reduce self-motivation to select and process personal finance materials from the media. The decreased motivation of consumers with greater learned helplessness to process personal finance materials that could help them develop their financial capacity or store of financial literacy concepts in memory results from a perceived lack of control over one’s financial situation. Further, the perceived lack of control associated with higher learned helplessness should decrease consumer use of prior financial literacy knowledge when deciding how to manage one’s finances: P12. Degree of learned helplessness: is inversely related to motivation to process personal finance materials; and moderates utilization of one’s financial literacy during financial decision making. Regulatory focus theory posits that all goal-related behaviours, such as optimizing financial management outcomes, are regulated by either a prevention focus on avoiding losses or a promotion focus on attaining gains. Prevention focused consumers strive for security, whereas promotion focused ones aspire to growth or seek gains (He et al., 2008; Higgins et al., 2001). Consumers with a promotion focus in regard to financial management outcomes should be more likely to invest and use financial leverage appropriately. Thus, they should realize long-term returns on capital and improvements in their net worth. A promotion focus should also lead consumers not to overweight security-oriented financial products, such as low-interest bank saving accounts or insurance, at the expense of growth-oriented financial products. On the other hand, consumers with a prevention focus in regard to financial management outcomes should be more concerned with insuring against loss and maintaining their principle, but less likely to use financial leverage to improve their long-term financial position. Interestingly, educational psychology research (e.g. Elliot and Harackiewicz, 1996; Roney and Lehman, 2008) has found that a prevention focus’ avoidance goals reduce both performance and motivation to process (i.e. a head-in-the-sand phenomenon). Finally, even in the presence of some financial gains, losses should reinforce the prior regulatory focus of prevention-focused consumers, but not promotion-focused ones, due to their more painful emotional response to losses than pleasurable response to gains. Alternatively, even in the presence of some financial losses, the stronger response to gains than losses among promotion-focused consumers, but not prevention-focused ones, should reinforce their prior regulatory focus (Higgins et al., 2001). Thus: P13. Compared to a promotion focus, a prevention focus in regard to financial management should decrease motivation to process personal finance materials. P14. Initial regulatory focus in regard to financial management will be reinforced by losses for prevention-focused consumers but gains for promotion-focused consumers. P15. Regulatory focus should moderate the relationship between financial numeracy and financial management outcomes.
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Materialism also appears worthy of investigation. Materialism is the importance that a consumer places on acquiring possessions and using possessions to achieve happiness or communicate status or success to others. Materialism also decreases motivation to control one’s spending and increases impulse purchasing (e.g. Fitzmaurice, 2008). Thus, consumers with high financial numeracy who would otherwise exhibit exceptional financial management behaviours could end up overspending due to less self-control, which increases borrowing and decreases savings. However, less materialistic consumers should be less likely to be overextended in borrowing and may have more savings regardless of their financial numeracy. Thus: P16. The degree of materialism should moderate financial numeracy’s effect on financial management outcomes. The role of a consumer’s willingness to take risks has long been investigated in relation to consumer choice and behaviour (Brody and Cunningham, 1968; Cox et al., 2006; Kahneman and Tversky, 1979). Highly risk avoidant consumers make suboptimal financial management decisions through excessive conservatism regardless of financial numeracy (e.g. devoting more than optimal amounts to low risk retirement investments with a guaranteed, but lower return). Conversely, consumers who are highly willing to take risks also make unwise financial management decisions regardless of their financial numeracy (e.g. devoting more than optimal amounts to high risk retirement investments that are more likely to lose the investor’s principal). Thus, the otherwise positive effect of financial numeracy on outcomes should be reduced for consumers with extremely favourable or unfavourable attitudes toward risk, but not those with more moderate risk tolerance: P17. Consumers’ willingness to take risks will moderate the relationship between financial numeracy and financial management outcomes. Additionally, some consumers reply to direct mail, internet, and advertised offers for financial products (e.g. credit cards, insurance, mortgage refinancing) because of initially low interest rates or premiums, cash advances, or low-fee transfers. These promotions work because many consumers exhibit deal proneness (Lichtenstein et al., 1995). Such customers are especially valuable to lenders (e.g. finance companies, pay-day loan providers, and credit card companies) because they shop more often (Garretson and Burton, 2003; Teel et al., 1980). Deal-prone consumers would also be more easily persuaded by advertising that does not contain the full information on risks and fees that is necessary to optimize financial management outcomes, such advertising is common for some financial products (Huhmann and Bhattacharyya, 2005). Greater deal proneness will weaken the otherwise positive financial management outcomes typically associated with financial numeracy. Thus: P18. Deal proneness should moderate the effect of financial numeracy on financial management outcomes. Consumers also differ in the degree of persuasion knowledge they possess in regard to financial services marketing tactics and persuasion techniques (Friestad and Wright, 1994). Consumers with greater financial numeracy should experience more optimal outcomes regardless of persuasion knowledge. This ceiling effect should occur because consumers with greater financial numeracy can adequately process marketing
materials from financial service providers regardless of persuasive devices and have prior knowledge of information and sources to use in evaluating financial products other than marketing materials. More persuasion knowledge about financial services marketing among consumers with poor financial numeracy should result in more optimal outcomes than less persuasion knowledge. Under poor financial numeracy, high persuasion knowledge consumers should be less likely to be deceived or misled by unethical financial service marketers into financial mismanagement or misconceptions about financial concepts than those with less persuasion knowledge. Thus, greater persuasion knowledge should buffer these consumers against unethical financial services marketing: P19. Persuasion knowledge should moderate the relationship between financial numeracy and financial management outcomes. Self-efficacy is one’s perceived ability to successfully perform a task (Hu et al., 2007). If a financially numerate consumer also has high self-efficacy, then he or she should confidently make good financial management decisions. But if a financially numerate consumer has low self-efficacy, then that consumer should be less confident about his or her well-developed financial capacity and prior knowledge and should place more weight on the input of others who do not possess as much financial numeracy nor understand the consumer’s financial situation, but may be promoting their own interests (e.g. friends, family, biased investment recommendation web sites or blogs, unethical financial service providers) to the detriment of financial management outcomes. Alternatively, if a consumer with poor financial numeracy has high self-efficacy, he or she should overconfidently make suboptimal financial decisions to the detriment of financial management outcomes (Hu et al., 2007; Willis, 2008). Such overconfidence is common among German, UK, USA, Australian, and New Zealand consumers (Social Research Centre, 2008; OECD, 2005; Lusardi and Mitchell, 2007). But a consumer with poor financial numeracy and low self-efficacy should seek help from others who may possess greater financial numeracy. More importantly, lower self-efficacy combined with poor financial numeracy should increase caution in financial decisions and external information search to augment financial decisions, which should lessen negative financial management outcomes of poor financial numeracy: P20. Self-efficacy should moderate the relationship between financial numeracy and financial management outcomes. Financial management outcomes As shown in the model (see Figure 1), financial numeracy has direct and higher-order consequences. Direct outcomes result from decisions made on the basis of one’s financial capacity and financial literacy. The direct consequences include borrowing, savings, and taxes. Higher-order consequences result from the quality of these financial decisions. Financial numeracy should have a direct effect on a consumer’s borrowing behaviour (e.g. type and size of home loan, sources of credit used, use or misuse of credit cards) due to greater processing capacity for and prior knowledge of financial constructs (e.g. minimum payments, late fees, fixed vs. variable interest rates, mortgage points, balloon payments). For example, financial numeracy should increase
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the likelihood of paying more than minimum credit card payments, consolidating debt into lower interest rate loans, or not using one form of loan to pay another. Financial numeracy should also directly impact savings behaviour. Savings of all kinds provide an important safety net to help a consumer through hard times or pay unanticipated bills. One important and frequently mismanaged form is retirement savings. The number of consumers who are covered by defined contribution plans rather than defined benefit pension plans continues to increase (Helman et al., 2007; Kane, 2008; Lai, 2006; Willis, 2008). Financial numeracy has a greater impact on retirement savings when a consumer is covered by a defined-contribution than defined-benefit plan. Consumers with defined-contribution plans and poor financial numeracy likely have smaller retirement savings. Financial capacity is paramount because terminal retirement savings in defined contribution plans depend on ongoing optimization behaviours; so, it is important for consumers to understand their statements and market reports. Financial literacy (e.g. prior knowledge about diversification, risk, the power of compounding) also plays a role in savings decisions. For example, suboptimal diversification in retirement savings accounts can mean a loss of approximately half a consumer’s terminal retirement savings amount (Angus et al., 2007). Finally, financial numeracy should affect the amount of taxes that a consumer owes or pays in a number of ways. Due to likely correlations of business acumen as well as intelligence with financial numeracy, more financially numerate people will likely have higher incomes and pay more taxes. However, more financially numerate people probably pay less tax and fewer penalties once income is held constant. A lack of sufficient financial capacity likely will result in errors that lead to overpayment or initial underpayment with interest and penalties due upon payment of the remainder. Ability to monitor on an ongoing basis to make the most of tax law changes and the tax implications of changing personal financial circumstances will depend on a consumer’s financial capacity. Knowing how to adjust financial management behaviours based upon tax laws depends on a consumers’ financial literacy. In regard to retirement savings, for example, a consumer with greater financial literacy might know to allocate highly taxed bonds to a pension account to reduce overall taxes (Lai, 2006). Such a decision is much less likely for a consumer without prior knowledge. Thus: P21. Financial numeracy should directly impact borrowing, saving, and tax-payment behaviours, ceteris paribus. Higher-order financial consequences Financial numeracy should have an effect on higher-order financial consequences (e.g. bankruptcy, credit scores, interest rates on loans, net worth, and size of inheritance left to heirs) that can partially be explained through its impact on financial management. Consumers with insufficient financial capacity to process information provided by financial services and make utility optimizing decisions more easily fall prey to predatory financial service providers who rely on consumers’ poor financial numeracy, laziness, and time and resource poverty to make substantial profits at those consumers’ expense. In fact, consumers with poor financial numeracy who become subject to predatory lending practices are often induced to take on more debt until their total debt is beyond their ability to repay (Hill and Kozup, 2007). A high debt-to-income ratio is
linked to a consumer’s likelihood of suffering bankruptcy. Greater interest rates on loans also increase the likelihood of bankruptcy (May and Young, 2005). All savings, including retirement savings, should provide a safety net to protect consumers from bankruptcy. Creditors use credit scores to predict future financial behaviour based on past financial management decisions. Credit scores are based on a variety of measures, including dept payment consistency, debt-to-income ratio, length of credit history, savings, and number of credit applications. Thus, credit scores are indirectly impacted by a consumer’s financial numeracy through their prior borrowing and saving behaviour. One’s credit score, level of debt, and amount of savings affect the interest rates that one is charged for subsequent loans. Good credit scores provide consumers with preferential treatment and lower interest rates for subsequent loans. On the other hand, riskier borrowers pay higher interest rates. Sufficient savings can provide collateral for loans and demonstrate to lenders that a consumer is not overextended on debt. Both less debt and larger savings should be more likely for consumers with greater financial numeracy. Net worth is a function of a consumer’s borrowing, saving, and, to some degree, tax payments. Thus, net worth is also indirectly a function of financial numeracy. Although the link between savings and net worth is obvious, judicious borrowing can also increase net worth as can making wise decisions in regard to taxes. For example, many countries have accounts that allow savings and investments to grow and/or generate returns that are sheltered from taxes (e.g. Individual Savings Accounts in Britain or Registered Retirement Savings Plans in Canada). Financially numerate consumers should better know when and how to use these as well as how much to put into such accounts to realise the optimal capital gains and income tax benefits. Finally, financial numeracy should impact the likelihood of a consumer leaving a sizeable inheritance. For example, the debt and financial mismanagement (e.g. lack of sufficient health or life insurance) of a consumer with poor financial numeracy and little retirement savings likely will exhaust an estate before it can pass to heirs. The tax implications of a consumer’s financial management also may affect the inheritance size. Thus: P22. The effect of financial numeracy on higher-order financial consequences is mediated by financial management outcomes. Implications for research and practice The current article presents a conceptual model of financial numeracy and its antecedents and consequences (see Figure 1). The model creates a framework in which previous research on financial literacy, financial education, financial behaviour and financial service usage is interconnected and viewed in relation to a larger construct; namely, financial numeracy. Unlike previous research on consumer difficulties with financial information, this article differentiates between efficient use of a consumer’s capacity for acquiring financial information and prior knowledge about financial concepts to help researchers, financial service providers, public policymakers, and others interested in helping consumers develop financial numeracy. The model also develops theoretically based propositions regarding the effects of cultural and
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psychographic variables that likely will affect financial numeracy and its consequences. The model and propositions create many opportunities for future research, and the discussion focuses on several specific areas. First, although some support for the model can be indirectly gleaned from prior research on variables related to the model, a formal test of the relationships among the constructs within the model is needed. The model presented in this manuscript is comprehensive; thus, tests may need to focus on a few specific constructs or observable measures of the constructs. Second, as pointed out in the discussion of antecedents to financial numeracy, many opportunities exist for increased understanding of psychographic influences in financial numeracy. Much previous literature related to financial numeracy is based on secondary datasets that primarily include financial service usage and demographic information. Although previous research has made important contributions, new insights may be found by investigating how psychographic constructs impact financial numeracy and its consequences. For example, future studies could investigate: . differences in consumers based on degree of deal proneness in switching behaviour (e.g. signing up with a different financial service provider due to a promotion); . the degree to which deal proneness can overcome inertia in switching behaviour, termed the “hassle factor” by Panther and Farquhar (2004); or . differences in attitudes toward promotions, because consumers with poor financial numeracy should be less aware of the consequences of deal-prone switching behaviour. A case in point is that both new credit card applications and too much available credit can trigger universal default policies and raise interest rates on all credit cards held by a consumer. Thus, one might expect consumers with poor financial numeracy to have more favourable attitudes toward financial service promotions. Third, future research should develop and validate a formative measure of financial numeracy and its two components: financial capacity and financial literacy. Such a measure of financial numeracy would help researchers understand the effects on consumers of marketing communications for financial products (e.g. insurance, mutual funds, and credit cards). Useful sources for item development for this measure include the UK’s Financial Services Authority and Basic Skills Agency’s Adult Financial Capability Framework (online at www.bba.org.uk/pdf/58072.pdf), the Day and Brandt (1974) interview results, the Elliehausen et al. (2007) work on borrower behaviour and financial education, the Fox et al. (2005) work on financial education effectiveness, and the Hilgert and Hogarth (2003) work on the link between financial construct knowledge and financial management behaviours. In addition to the value of such a measure for academic research, it could serve practitioners as a screen for entrance into financial education courses and to evaluate whether financial education materials improve financial numeracy. Also, such a measure could help consumers self-assess their financial numeracy. The relationship between the financial services industry and its publics could be improved if the industry made a financial numeracy measure and personal finance material readily available on a self-help web ite.
Fourth, the model may be extended to research the financial numeracy of those in the financial service industry. Although the current model focused on consumer financial numeracy, the financial numeracy of professionals may also warrant investigation given the recent suboptimal outcomes experienced by many large insurers, banks, and others responsible for investing and managing capital resources. Finally, marketing researchers need to investigate further how consumers search for and process information contained in financial services advertising, websites, and direct mail solicitations. In a marketing context, search effort has been defined as the attention and processing effort directed at obtaining information related to a prospective purchase or adoption decision (Beatty and Smith, 1987). Processing of the rational (rather than emotional or image-oriented) information about financial constructs (e.g. interest rates, contact information, or management fees) at work in advertisements, web sites, or direct mail solicitations should increase as a consumers’ involvement with the product grows (Celsi and Olson, 1988). Financial products can represent a significant risk, but do consumers actually perceive financial products’ marketing communications as highly involving? The general lack of readership of financial product documentation (Day and Brandt, 1974) and modest information search for financial products (Lee and Hogarth, 2000) suggests that they do not. Consumers’ financial capacity may explain why attention to and search for financial product information is so low. Whereas many critics of advertising hold that more information is better (Abernethy and Franke, 1998; Pollay, 1986), the concept of financial capacity suggests that more financial information is of value to a consumer only until it reaches the processing limit of one’s financial capacity. This is consistent with the idea that more information in marketing communication can discourage consumers from reading the information (Franke et al., 2004). Unfortunately, the information load in marketing communications for financial services is much greater than that for tangible goods due to the complex presentation and the lack of full disclosure of important details (Chang and Hanna, 1992; Hill and Kozup, 2007; Huhmann and Bhattacharyya, 2005). Financial industry marketing communications provide a great deal of information that largely is required by regulations (e.g. mutual fund advertisements, credit card solicitations, securities prospecti), but is difficult to comprehend by consumers with poor financial numeracy. Financial capacity differs across individuals, but could be used as a segmenting variable by financial product marketers, who could provide a succinct and simplified version of critical information, perhaps in the form of a simple standardized table to aid comparisons across product choices. The growing use of the internet as a search tool in financial decisions makes it possible for financial product marketers to satisfy consumers with greater financial numeracy who want full information disclosure and those with poor financial numeracy who prefer a brief overview of the pertinent points. The model has additional implications for the financial services industry and public policy makers. First, focusing efforts on consumers with the least financial numeracy should have the largest impact on reducing negative consequences and make the most efficient use of limited financial education resources. Second, implications also arise from examining psychographic variables. For example, consumers with myopic self-control should be more likely to relax their self-control and select immediate rather than delayed gratification when they have a compelling justification. Public policy
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makers and financial service providers who want to increase consumer financial numeracy should conduct campaigns aimed at undermining such justifications for spending rather than saving. Finally, the model has implications for consumers interested in improving their financial numeracy and avoiding the negative consequences of poor financial numeracy. First, consumers must seek clarification if their lack of financial capacity or prior knowledge prevents them from comprehending the financial service terms. Second, if parents possess sufficient financial numeracy, they should instruct their children about how stocks, mutual funds, loans, and interest work. Early exposure to financial information should help avoid the negative consequences of poor financial numeracy, because prior knowledge aids comprehension and integration of new knowledge into memory. Parents could also increase financial numeracy by providing experience through parentally-supervised financial activity, such as encouraging children to have a parentally-monitored savings or checking account or credit card. Financial numeracy can be improved if one is sufficiently motivated; the rewards in terms of better financial consequences are worth the effort. Limitations The current model uses a theoretical basis in consumer psychology concepts (e.g. cognitive capacity, prior knowledge, need for cognition, self-control) to generate insights on differences between consumers in their motivation and ability to process, comprehend, and use financial information and knowledge. Other theoretical domains might provide different insights into how consumers process, acquire and use financial knowledge to optimize financial management behaviours. One such domain is the theoretically rich field of knowledge management (e.g. Alavi and Leidner, 2001; Spender, 2008) with its emphasis on and ability to distinguish forms of knowledge: tactic versus explicit; individual versus social; declarative, procedural, pragmatic, etc. Another theoretical domain that might help researchers make and test predictions in this area is Prospect Theory, which explains the inclination to over- or underweight certain information or risks during decision making (Kahneman and Tversky, 1979). Researchers may develop competing models that apply these or other domains. In fact, some competing models are present in the literature. The Personal Finance Research Centre (2005) has developed a model with three dimensions: (1) knowledge and understanding; (2) skills; and (3) confidence and attitudes. However, the theoretical basis of other models is not always clear. For example, Willis (2008) presents a model in which financial education leads to financial literacy, which leads to good financial decisions and behaviour. The underlying reason for this sequence is unaddressed. One strength of the current model is its basis in cognitive capacity and prior knowledge as well as its focus on cultural and psychographic factors that account for differences in processing motivation for individuals who may have been exposed to similar personal finance materials and different outcomes for consumers with a similar degree of financial numeracy. The current model attempted to develop as many propositions as possible to further theory-based research in this area. Thus, depth of coverage for each proposition is
limited. Each proposition could likely be tested in its own study. Also, additional constructs may play a role. This is an initial, not an exhaustive, model; however, it should encourage more controlled investigations of psychological and cultural influences on financial numeracy and its effects on financial management behaviours that will supplement existing research derived from the analysis of secondary data from government or industry sources.
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Conclusion Consumers’ difficulty with understanding and managing their finances is well documented, yet the lack of a theoretical framework has hampered researchers, public policy advocates, and financial service firms in helping consumers. Therefore, this article develops a model of financial numeracy based in the broader theoretical constructs of cognitive capacity and consumer knowledge, and demonstrates how the findings of prior research on consumers’ financial difficulties may be incorporated into this model. Financial numeracy, or proficiency in comprehending and using financial information, arises from two interrelated constructs: financial capacity (i.e. ability to process financial information) and financial literacy (i.e. prior knowledge of financial concepts, services, and products). Previously, terms such as “financial literacy” or “financial capability” were confounded with definitions that would encompass the domains of some or all of the following: cognitive capacity, prior knowledge, expertise, financial management outcomes, and financial education programmes. Part of the reason prior research has combined cognitive, knowledge and behavioural constructs under a single term like “financial literacy” is the readily available secondary data on and relative ease in measuring financial behaviour outcomes, compared to the internal cognitive resources and skills of financial numeracy. Our model, however, delineates financial capacity from financial literacy knowledge to aid efforts in understanding the internal psychological processes and how to improve them for the benefit of consumers and society. Rather than criticising financial institutions or individual consumers for growing financial problems, the model should help identify areas in which improvements can be made or further research can expand understanding of the processes at work. For public policy makers, implications can be drawn from the model to assist in creating fair and equitable parameters for financial product marketing that deter unethical firms from engaging in predatory credit, lending, and investment procedures that target consumers with poor financial numeracy. In an age of growing complexity in financial products and increasing consumer responsibility for retirement security, healthcare costs and debt management, public policy makers no longer can turn a blind eye to unethical and predatory practices or to the poor financial numeracy that makes such practices profitable. The accounting scandals, mutual fund market timing scandals, and sub-prime housing loan fiascos of recent years are evidence of the need for the insights provided by the current model. References Abernethy, A.M. and Franke, G.R. (1998), “FTC regulatory activity and the information content of advertising”, Journal of Public Policy & Marketing, Vol. 17 No. 2, pp. 239-56.
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[email protected] Shaun McQuitty (PhD, University of Alberta) is professor of marketing at the School of Business, Athabasca University, Canada. His research interests include services, consumer behaviour, societal marketing, measurement, and applied statistical analysis.
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