Risk literacy

1. Context
2. The study
3. Research questions and aims
4. Key findings
5. Points to consider

Context

Shifting economic policies around the world are leading individuals to take greater responsibility for their own financial well-being.  The ability to meet this increased responsibility not only has an impact at the individual level but also carries important implications at the macro-economic level.

The study

The study examines financial literacy – in particular, risk literacy – using data from the USA and several other countries.

It first reviews the questions used for measuring financial and risk literacy, with a short section looking specifically at the situation in Italy.  It then goes on to explore the link between risk literacy and behaviour, and to look at the role of financial advice - querying whether it is consistently effective for all individuals over time. The study concludes by looking at ways in which risk literacy might be improved.

Research questions and aims

The review is largely based on three specific questions created by Lusardi and Mitchell (2006, 2011) that were created for US National Financial Capability Survey, and which have been replicated across more than 20 countries. While these questions are complemented by other research inputs, the core of the review relates to the following three areas:

• Numeracy and the capacity to do calculations relating to interest rates;
• Understanding of inflation;
• Understanding of risk diversification.

In the USA's National Financial Capability Survey, 78% of individuals correctly identify the interest rate response; 65% answer the inflation question correctly; but only 53% answered the risk question correctly and 40% recorded a 'do not know' answer.

Key findings

Globally, only a very small percentage of individuals have basic knowledge of the concepts that underlie sound financial decision-making. This is true across countries with or without a well-developed support infrastructure.

Understanding of risk is the strongest deficiency, in the context of financial decision-making. Consistently, one third of respondents say they do not know the answers to the questions that measure understanding of risk. Yet risk literacy is a crucial component of financial literacy overall and has major implications for making the right decisions.

Financial literacy has an effect on both retirement planning and precautionary savings. Financially-literate individuals are more likely to save, to plan for future events and to invest in the stock market; they are also less likely to take on high cost borrowing liabilities.

Knowledge of risk is a powerful indicator of the competence with which individuals make saving and planning decisions.  The study finds that knowledge of risk diversification is the variable that matters most: those who are knowledgeable about risk are 11 percentage points more likely to plan for retirement and 5% more likely to have made provision against financial shocks.  

The review explores the role of financial advice (given that knowledge of financial risk is so low) and recognises that, while there may be barriers to its effective use, those who use financial advice have higher financial literacy (although it does not address causality). Strategies to address this issue include the use of financial education as part of the school curriculum and in the workplace, including the use of simple accessible written, video, or web-based tool interventions.

Points to consider

Methodological considerations: the core methodology uses three questions which have been shown to be robust and capable of being applied with consistent results internationally, in a range of circumstances and environments.

Full report

Risk literacy - full report