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Financial literacy: a psychologist's perspective

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115

Financial literacy: A psychologists perspective on an emerging societal

problem in Australia
Gerard J. Fogarty (fogarty@usq.edu.au)
Department of Psychology
University of Southern Queensland, Toowoomba QLD 4350 Australia

Karina MacCarthy (karina_in_roma@bigpond.com)

Department of Psychology
University of Southern Queensland, Toowoomba QLD 4350 Australia

Abstract
In the past decade, researchers in New Zealand, the
United States, and the United Kingdom have devoted
considerable effort to monitoring financial literacy
among adolescents and adults and concluded that
almost half the population of those countries exhibit
serious deficiencies in their understanding of everyday
financial matters. Two recent surveys by Australian
financial institutions indicate that the situation is no
different in Australia, prompting the federal
government to call for a concerted effort from all
sections of the professional community to address this
growing societal problem. To explore the
psychological predictors of financial literacy, the
present study administered tests of numeracy, general
fluid (Gf), and general crystallised (Gc) intelligence to
a sample of 126 adults. Despite the fact that the test
was not intended to be difficult, 39% of the
participants failed to achieve a pass mark. The
demographic variables, level of education and annual
income, explained 26% of the variance in scores with
the cognitive ability measures contributing a further
15%. We conclude by outlining directions for future
research and some possible ways in which the
discipline of psychology can contribute to this
emerging societal challenge.

Introduction
In May, 2003, the ANZ Bank produced its final
report on the first national survey of adult financial
literacy in Australia. One of the clearest findings to
emerge from the study was the negative correlation
between financial literacy and socio-economic status.
Age was an important factor with 18 to 24 year olds
and those over the age of 70 showing lower levels of
financial literacy. The report also concluded that
some areas of finance, such as superannuation, were
not very well understood by any section of the
community. Understandably, these findings are of
concern to government agencies and professionals
who deal with the consequences of financial
mismanagement at the individual level. Our aims in
this paper are to raise awareness of the issue among
psychologists and to explore demographic and

psychological predictors of financial literacy. We

begin by presenting further background information
on the topic of financial literacy.
Financial literacy is defined here as the ability to
make effective decisions regarding the use and
management of money and other assets. Beal and
Delpachitra (2003) included among the behavioural
symptoms of poor financial literacy such things as
overuse of credit cards to the point where debts
cannot be met, using personal loans for consumption,
undertaking overly-optimistic home-loan obligations,
foolish commitment to get-rich-quick schemes,
making unwise high-risk investments inconsistent
with required capital stability, and entering
inappropriate
vehicle-leasing
contracts.
The
consequences of such behaviours are potentially
devastating from both a societal and an individual
point of view. Reid (2003), speaking at the ASIC
Stakeholder Forum in Sydney, highlighted the
following areas of concern: a) bankruptcies, with
youth bankruptcies increasing; b) marriage
breakdowns, where financial problems are a common
cause; c) crime pressures placed on individuals
because they are part of a consumer society; d)
personal hardship from growing consumer debt; and
e) low levels of national savings.
In the past, the affluence of many Western
economies has helped to gloss over these problems.
However, times are changing and there are
indications that higher levels of financial literacy will
be needed by all sections of society in the future. The
most obvious indicator is our increased life
expectancy and the need for careful retirement
planning. Choosing the time to retire, the amount
needed to maintain a reasonable standard of living,
and the mix of investments that will return the best
yield are all complex tasks. Towards the other end of
the age spectrum, Australian students now leave
university with a substantial debt and face a career
path that may involve contract work, changes in jobs,
and possibly some periods of unemployment. At a
more mundane level, the free market economy offers
consumers from all walks of life a bewildering array

116

of choices, all of which require a certain amount of

financial nous. Unfortunately, the evidence suggests
that whilst the need for financial knowledge is
increasing, knowledge itself is not. In the paragraphs
that follow, we review this evidence.
A comprehensive test of adult consumer
knowledge in the US was conducted by the
Educational Testing Service in 1990. The test
included questions about banking and insurance as
well as other consumer goods and services. The
average score on the multiple choice test was a
disappointing 54%, with consumers from lower
income households performing worse than other
respondents (cited in ASIC, 2003, p. 32). Jumpstart, a
non-profit organisation set up to improve the personal
financial literacy of young adults in the US,
undertook four consecutive nationwide financial
literacy surveys of Grade 12 students in 1997, 2000,
2002, and 2004. The results indicated low levels of
financial literacy among US students, with average
scores of 57.3%, 51.9% and 50.2%, and 52.3%
respectively (JumpStart Coalition, 2004).
In the UK, similar research into levels and
consequences of financial literacy conducted by the
National Foundation for Education Research
revealed rising levels of household debt coupled
with low levels of understanding about financial
matters, particularly among lower income groups
(cited in ASIC, 2003, p.31). Closer to home, Morris
(2001) administered a 30-item multiple-choice
financial knowledge questionnaire to 804 senior
secondary students from a cross-section of New
Zealand secondary schools. The questionnaire was
based on the one used in the US Jumpstart studies and
covered a range of topics, including financial
planning, income and taxation, budgeting, insurance,
credit and borrowing, spending and banking, and
saving and investing. The average score was 55%
with significant differences emerging between New
Zealand Europeans and ethnic groups such as Maoris,
Asians, and Pacific Islanders. Students in the lowest
and highest socio-economic brackets had the poorest
success rate. There were no differences among
regions or between genders.
The evidence from these overseas studies suggests
that high school and university students do not have
enough financial knowledge to handle the array of
choices on offer in Western societies. The studies are
also consistent in their findings that demographic
factors such as age, income level, and education are
related to financial literacy. Although we lag behind
these other Western countries in addressing this
problem, the recent ASIC (2003) and ANZ (2003)
reports conclude that the Australian situation shows
the same overall trends. The ASIC recommendations
for Australia include a coordinated effort from the

financial sector, regulators and governments, the

education sector, consumer groups and the
community sector to raise standards of financial
literacy. Soon after the release of the ASIC and ANZ
reports, the Australian government announced a high
level taskforce to develop the first ever National
Strategy for Consumer and Financial Literacy.
To this point, much of the research in financial
literacy has been aimed at benchmarking levels of
financial literacy, or assessment of financial literacy
training. However, there is also a strand within this
research tradition that seeks to identify individual
differences variables that explain variation in
financial literacy scores. Along these lines, it has
been observed that there is a positive relationship
between financial literacy and level of education
completed (ANZ, 2003; Hogarth & Hilgert, 2002).
Age is a factor with younger (under age of 24 years)
and older (over 70) showing lower levels of financial
literacy (ANZ, 2003). Positive relationships have
also been found between financial literacy and level
of education and years of work experience. Income,
measured in various forms including socioeconomic
status, also shows a positive relationship with
financial literacy score. The research is consistent in
showing a lack of gender differences (Morris, 2001).
These data are helpful in compiling the profile of
people likely to be adversely affected by low levels of
financial literacy. To date, however, there are no
studies that have examined the relationship between
cognitive abilities and financial literacy. Given the
importance of cognitive abilities in scholastic
achievement (Brody, 1992) and working life (Hunter
& Hunter, 1984), this is a significant omission in this
fledgling literature. The main aim of the present study
was to explore the role of general fluid intelligence
(Gf), general crystallised intelligence (Gc), and
numeracy in financial literacy. Specifically, the
intention was to determine whether these cognitive
variables contributed incremental variance beyond
the well-established demographic factors outlined
above. Gf was chosen because of its value as a
marker for the capacity to learn, Gc because it
measures an individuals store of knowledge (which
can be acquired either formally or informally), and
numeracy, because of what seems to be an obvious
underlying need for numeracy skills in some areas of
financial literacy.

Method
Participants
The 126 participants in this study consisted of two
groups: 89 residents of the town of Roma,
Queensland, who voluntarily participated and
completed a pen and paper version of the tests; and
37 University of Southern Queensland students and

117

members of the general public who completed a

computer-based version of the tests. The majority of
the sample were older than 25 years, well educated,
possessing a degree qualification or higher, currently
employed in a professional, managerial or
administrative role, in the workforce for over 15
years, earning $30,000 to $70,000 per annum, and
living in traditional households as couples with and
without children.

Instruments
Financial Literacy Financial literacy was assessed
using a 25-item multiple choice test developed by
Beal and Delpachitra (2003). The test contained five
subscales covering the core dimensions of financial
literacy. The first subscale (Basic Concepts) tapped
respondents understanding of basic concepts such as
the effect of compounding interest, the relationship
between risk and return, and the effect of early
withdrawal penalties. The second subscale
(Investments) assessed knowledge of international
currencies, historical returns of different asset classes,
what it means to act as a guarantor of a loan, and
fixed and variable interest rates. The third subscale
(Planning) assessed general issues, such as the
purpose of financial planning, and more specific
questions on strategies to assist with planning, such
as checking bank statements. The fourth subscale
(Decisions) tapped respondents ability to analyse
commonly occurring financial scenarios and to
choose an appropriate response. The last subscale
(Insurance) assessed knowledge of different types of
insurance and the levels of coverage offered by
various contracts. Each content area was assessed by
five four-option multiple choice questions. The
dependent variables were the five subscale scores
(range 1 to 5) and the total score (range 1 to 25).
General Fluid Intelligence. Fluid intelligence was
measured using a slightly modified 11-item version
of the Matrices test from the Gf/Gc Quickie Test
Battery developed by Stankov (2003). Modifications
involved the introduction of a time limit of two
minutes.
Crystallised intelligence. Crystallised intelligence
was measured using the General Knowledge test from
Stankovs (2003) Gf/Gc Quickie Test Battery. This
20-item general knowledge test was modified by
converting it from an open-ended to a four-option
multiple choice format and by setting a five minute
time limit.
Numeracy The Numeracy test used was based on a
scale used in the Adult Literacy and Lifeskills Survey
by Statistics Canada (2003). The test items require
use of computational skills in such everyday tasks as
reading a fuel gauge, converting temperatures from
Fahrenheit to Celsius, reading simple graphs,
calculating entitlement from a motor vehicle log, and

calculating percentage saved on grocery purchases.

This test was converted to multiple choice format and
a time limit of ten minutes was imposed.

Procedure
The tests were administered to groups and
individuals in a single session lasting up to forty
minutes. The 37 participants who were not from the
Roma region completed computerised versions of the
tests. To balance practice effects, the four tests were
administered in varying order. The dependent
variable for each test was the number correct.
Subscale scores were also recorded for the financial
literacy test.
The project was approved by the USQ Human
Research Ethics Committee.

Results
Table 1 sets out the descriptive statistics for the
four tests and the five subscales of Financial Literacy.
The majority of the participants in this study passed
the Financial Literacy test, with an average result of
61.7%. Scores on other variables were generally
around the mid-points of the scales.
Table 1. Descriptive statistics for all variables.
Test
Numeracy
General Knowledge
Matrices
Financial Literacy
FL Basics
FL Markets
FL Planning
FL Decisions
FL Insurance

Items
17
20
11
25
5
5
5
5
5

M
9.71
10.63
6.82
15.43
3.87
2.56
3.87
2.78
2.56

SD
3.94
3.13
1.99
3.77
1.14
1.21
.96
1.17
1.04

There were significant differences in the

performance of the participants on the five financial
literacy sub-scales and these differences are identical
to those reported by Beal and Delpachitra (2003)
where the easiest section was basic concepts,
followed by planning, markets, decisions, and
insurance. This correspondence with previous
findings lends credence to the reliability of data
gathered in the present study.
Correlations among the variables are shown in
Table 2. The pattern was pretty much what can be
expected, given what is known about these variables.
The Gf and Gc markers were moderately related (r =
.29), age was negatively correlated with Gf (r = -.27),
Numeracy had a stronger relationship with Gf (r =
.47) than with Gc (r = .19), all three cognitive
variables were related to financial literacy, and both
level of schooling and income correlated with
financial literacy. As expected, gender was not
correlated
with
financial
literacy.

118

Table 2. Correlations among demographic variables, cognitive variables, and financial literacy.
Variable
(1) Gender
(2) Age
(3) Level of Schooling
(4) Years in Workforce
(5) Income
(6) Numeracy
(7) General Knowledge
(8) Matrices
(9) Financial Literacy
Note. *p< .05, ** p< .01.

1
-.00
-.06
.03
-.07
-.08
-.13
-.20*
-.05

-.01
.76**
.29**
-.37**
.14
-.27**
.00

-.07
.40**
.24**
.39**
.21*
.40**

.36**
-.29**
.18*
-.22*
.16

-.02
.19*
-.02
.35**

.19*
.47**
.39**

.29**
.42**

.27**

Hierarchical regression was employed to assess the

contribution of the demographic variables and the
incremental variance contributed by the cognitive
variables. At the first step, after entering the
demographic variables into the equation, R2 = .26, Finc
(5,120) = 8.51, p < .01. On step two, adding the
cognitive ability variables, the prediction of financial
literacy total score was increased to R2 = .41, Finc (3,12)
= 10.2, p <.01. Thus the cognitive ability variables
made a significant additional contribution of 15%.

Discussion
This study had two main purposes: Firstly to see
whether previous findings regarding demographic
predictors of financial literacy could be replicated and,
secondly, to assess the relationship between financial
literacy and markers for well-known cognitive abilities.
Regarding the demographic variables, the results
partially confirmed previous findings with the results
relating to age and years in the workforce being the
exceptions. These exceptions could be due to sampling
differences. The studies by Beal and Delpachitra
(2003) and Chen and Volpe (1998) recruited university/
college students who were younger, with less work
experience and lower earnings. The Jump$tart (2004)
surveys and the Morris (2001) study focused on senior
high school students. Of the studies that targeted the
general
population
for
their
samples,
the
Commonwealth Bank study (2005), with a significantly
larger sample size of 5,000, was able to obtain a more
equal balance of males and females, and more
participants in age groupings above 45 years. Hogarth
and Hilgert (2002) reported demographics for 1000 of
their participants, with more participants in the age
groupings above 45 years, and with lower educational
levels than the participants of the current study. Despite
the sampling differences, the total proportion of
variance in financial literacy score due to the
demographic variables (26.2%) was still substantial and
not dissimilar to the proportions reported by other
researchers who used correlational techniques (e.g.,
Beal & Delpachitra, 2003).

The finding that cognitive variables can add to the

prediction of financial literacy is hardly surprising but it
does help to identify and quantify another section of the
financial literacy puzzle. Crystallised intelligence is a
reflection of the knowledge acquired through education
and acculturation. Financial skills are also learned
through formal and informal educational processes.
They can therefore be regarded as just one aspect of
crystallized intelligence. In the same vein, numeracy
ability is a reflection of mathematical knowledge and
skill acquired through education and experience. If one
looks at the items comprising the subscales of the
financial literacy scale used in this study, it is apparent
that calculation skills are important in some subscales
whereas knowledge is important in others. The section
on basic concepts, for example, contains questions that
require participants to engage in very simple interest
rate calculations. The insurance section, on the other
hand, contains mostly questions that tap knowledge of
different types of insurance contracts. On the basis of
what we know about Gc and Numeracy, the former
should correlate more highly with the Insurance section
of the financial literacy test and the latter should
correlate more highly with the Basics section. Post hoc
analyses show that the patterns of correlations support
these predictions.
We make these points to demonstrate that financial
literacy is an aggregate construct. It is an index and not
a scale (Diamantopoulos & Winklhofer, 2001). As
such, it has many psychological antecedents. Some of
these have to do with abilities, others may be attitudinal
or based such constructs as interests, values, or
personality. The demographic variables noted in
previous studies are, in all likelihood, as much
covariates as causes of financial literacy.
The task for psychologists is to apply their
psychometric skills to help define the domain now
known as financial literacy and to show how it differs
from other forms of literacy and what should be done to
improve skills in this area.
Along these lines, we note that the response in the
US, the UK, and New Zealand has been to introduce
courses in financial literacy into the high school

119

curriculum. Our data suggests that this intervention is

likely to have some benefit in that amount of schooling
is positively related to financial literacy. The benefit
should be greater if there are courses devoted to the
subject. It is also the one variable over which we have a
reasonable degree of control. These educational
interventions will need to pay particular attention to the
identified areas of weak financial knowledge:
knowledge of financial markets, financial decision
making, and insurance. Given problems with transfer of
training (Machin & Fogarty, 2004), interventions also
need to take into consideration such factors as
motivation to engage in training, opportunities to use
financial skills, and social support.
To conclude, the present study represents an initial
foray into an area that is certain to capture more
attention in the future. Financial difficulties are a fact of
life for a significant proportion of the population
already, and that proportion is likely to grow. The
introduction of a construct such as financial literacy
will be helpful only if we understand what is meant by
the term. This is familiar territory for psychologists but
we have covered just a small part of that territory here.
One of the main limitations of the current study is the
convenience sample used. In comparison to the general
population, the majority of the participants in our study
were young to early middle age, employed and highly
educated. Our conclusions are tentative given these
sampling deficiencies. There is also room for
improvement in the selection of cognitive measures,
especially the marker for Gf.
In ongoing work, we have extended the battery of
cognitive markers and added measures of personality,
which we believe will also contribute incremental
variance in the quest to explain the construct known as
financial literacy.

References
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Acknowledgements
We acknowledge the assistance provided by Diana
Beal and the helpful advice offered by Lazar Stankov.
NB: The correct APA citation for this paper is:
Fogarty, G., & MacCarthy, K. (2006). Financial
literacy: A psychologists perspective on an emerging
societal problem in Australia. In M. Katsikitis (Ed.),
Proceedings of the 2006 Joint Conference of the APS
and NZPsS, pp 115-119. Auckland, NZ, 26-30
September, 2006.