Globe and Mail Update
February 23, 2009
The recent federal budget included the establishment of an independent task force to make recommendations on financial literacy, among other issues. Our organization, the Investor Education Fund, applauds this development and looks forward to working with such a committee. In the past nine years, we have learned that the key problem this task force will face is that our education system is not providing the essential skills necessary for Canadians to understand money management. As a result, Canadian households have been buried under a mountain of household debt and have forgotten the importance of saving and asset building, lessons that boomers should have learned at their parents' knees. We are not talking about learning the specifics of investment products or understanding what a short is. It's much simpler than that. There are a few concepts central to good money management – which we seem to have lost in schools and households – that are the foundation of financial prosperity.
1. Understand the relationship between risk and return. All investment requires an understanding of the close relationship between return and risk. Every major financial decision an individual makes – whether deciding on a fixed mortgage, paying for a graduate degree or buying a used car – requires this knowledge. Further, if something seems to break these rules of risk and return, you need to be aware that it just might be fraudulent. An active understanding of risk and return is a cornerstone of effective personal finance decision making.
2. Know how compound interest works. A simple idea, but a poorly understood one. Time and the accumulation of resources go hand in hand, and the same holds true for debt. When making any kind of major investment, understanding the basic “mechanics” of how compound interest works is essential to long-term financial planning. It's surprising to see how many people think only in terms of simple interest. When investing (or borrowing) over the long term, we need to start with a clear understanding of how compound interest works and its implications.
3. Learn the basics of debt and credit. As the current state of Canadian households can attest, an effective working knowledge of good debt, bad debt, credit ratings and lending is in short supply. In recent years, Canadian household debt levels have escalated as expectations led people (and lenders) to overstep the boundaries of common sense. This will continue to perpetuate itself with the next generation of people who have no sense of how to manage debt – and what kind of debt to take on. An understanding of how debt works and its role in our lives (in funding education, housing or transportation) is especially important in times of historic levels of household debt.
4. Teach financial responsibilities in the context of an entire lifetime. The types of financial decisions that will be confronted change during one's lifetime. Young people need to understand the financial demands that come from investments in education, housing and retirement to put the previous points in the proper context. This is as important as civics and it is not something that is only learned by the numerate or business-minded. Teaching young people the reasons behind saving for retirement, or spending money for education, is the social context that makes financial management a personal issue.
5. Financial literacy needs to be ingrained throughout the school system. Society has changed: More of us need to take greater involvement in our pensions or retirement plans; we are expected to pay for the benefits that we receive from post-secondary education; and debt has become an increasingly “simple” solution to achieving life goals.
Schools in Canada have generally not reflected this change. When schools do offer financial education, it is often in the form of one superficial course and is combined with many other life issues.
It is time that we recognized that personal financial security is critical to every household and is fundamental for mental well-being and long-term success.
The topic needs to be ingrained throughout math, social science and life skills lessons in schools across this country. In the meantime, you would be doing your kids a huge favour by discussing their expectations, how those expectations will affect their income over time, and what they need to do to manage their debts without getting overwhelmed.
Tom Hamza is president of the Investor Education Fund. Paul Bates is chairman of the Investor Education Fund and Dean of the DeGroote School of Business at McMaster University.