Understanding Canadian Financial Literacy and Why It’s Important
November is financial literacy month here in Canada. Sandwiched between Halloween and Christmas, it might not be as well-known, but it’s just as important.
Talking about financial literacy in 2022 is very relevant because of rising interest rates across the country, causing mortgages and other debts to become significantly more expensive.
Combine rising interest rates with other financial hot topics like inflation, payday loans, or the decreasing stock market, and financial literacy becomes super important.
I dedicated episode 59 of The Canadian Money Roadmap podcast to financial literacy—what it is, why it’s important, and what the average Canadian’s financial literacy is. Go have a listen (and test your knowledge alongside my podcast partner, Jordan!) or read on here.
What is Financial Literacy?
Financial literacy—or fin lit, as those of us in the biz call it—is having a good understanding of how your money works and the systems that are in place around it.
Therefore, it captures basic money concepts such as:
Debt
Investing
Interest
Risk
Inflation
Financial literacy helps you understand these fundamental financial concepts so that you can make good financial decisions throughout your life.
After understanding the basics, you can keep learning and grow in your knowledge, to any level of complexity you want! But, the main thing here is that everyone should have a good, basic level of financial literacy to optimize their finances.
Why is Financial Literacy Important?
The most obvious answer here is that financial literacy is important to help you make good financial decisions. It helps you understand what to do with your money.
But beyond that, there are many reasons financial literacy is important:
Debt management: Do you know how rising interest rates impact your financial obligations? Carrying debt can be expensive, so basic financial literacy around debt and interest payments help you make the right decisions.
Retirement savings: There’s some evidence that suggests the difference between those who had enough money for retirement and those who didn’t comes down to financial literacy. Understanding money will set you up for a lifetime of good financial decisions that benefit you into retirement.
Offense and defense: Good financial literacy lets you play defense (not getting into trouble through good budgeting and debt management) and offense (getting ahead through saving, investing, and increasing your income).
Improved confidence: When you understand money and how it works, you can more confidently make better decisions. Instead of stressing out about purchases or inflation, financial literacy prepares you to confidently move forward.
Avoid unfair expenses and scams: Financial literacy helps you avoid unfair expenses, such as massively high interest on payday loans. It also reduces your exposure to scams and financial garbage that gets circulated. Again, financial literacy leads to wise decision-making.
Financial literacy is important just as reading literacy is important. It's baseline knowledge that sets you up to participate in the economy, make good decisions, prepare for the future, and decrease stress and anxiety around money.
Financial Literacy of the Average Canadian
At this point, you may be wondering what your financial literacy is like. Or, more broadly, what’s the financial literacy of the average Canadian?
In 2014, Standard and Poors (or, S&P of the S&P 500) did a global study on financial literacy. They surveyed 150,000 people in 140 countries.
Turns out, Canada fared pretty well—68% of Canadians were financially literate, compared to a global average of just around 33%. Even with that high of a rating compared to other countries, it still shows we have room for improvement.
The financial literacy test they gave participants had these five questions:
If you have some extra money, is it safer to A) put it into one business or investment or B) into multiple businesses or investments?
Suppose over the next 10 years, the price of things you buy doubles. If your income also doubles, will you be able to buy A) less than you can today, B) the same as you can buy today or C) more than you can buy today?
If you need to borrow $100.00 from the bank, what is the lower amount to pay back from these two options: A) $105.00 or B) $100.00 plus 3%?
Suppose you put money in the bank for two years and the bank agrees to add 15% interest each year. Will the bank add A) more money in the second year or B) the same amount of money both years?
If you had $100.00 in a savings account where the bank adds 10% each year, how much money would you have after five years? A) More than $150.00 or B) exactly $150.00?
Stop here and take a moment to answer them to test your own financial literacy.
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… Done?
Okay, let’s move on to the answers. They are:
Multiple businesses or investments (B). This is the concept of diversification. A single company or investment can be volatile as there are many things that can happen. Diversification—investing in multiple things at once—reduces this risk.
The same amount as you can today (B). This question touches on inflation. If the cost of living increases at the same rate as your earning power, you can buy the same amount of items.
$100.00 plus 3% (B). This is the understanding of interest rates and how they’re calculated as a percentage. So, 3% of $100.00 is $3.00, just as 8% would be $8.00, and 20% would be $20.00.
More money in the second year (A). This builds on the concept of interest and refers to compound interest. In year one, you’ll receive $15.00 on the $100.00 you put in, totaling $115.00. The next year, you earn 15% on $115.00, which is actually $17.25, or more than the first year. Compound interest helps your money grow faster the longer you leave it to accrue interest.
More than $150.00 (A). Again, this illustrates the difference between simple interest (10% on $100.00 each year) and compound interest (10% on the $100.00 plus any interest the year before). With this illustration, you would have $161.05 after 5 years with 10% compounding interest.
How did you do?
If you didn’t do as well as you’d like, it’s okay—there’s never a bad time to start improving your financial literacy.
And, if you knocked it out of the park, it might be time to focus on growing your knowledge and learning about some more complex financial concepts.
How to Improve Your Financial Literacy
No matter where you are in your financial literacy, you can always learn more.
There are many resources available if you want to boost your financial literacy. Here are some useful tools from the government of Canada:
Financial literacy quiz (more comprehensive than the S&P one)
Additional financial calculators and tools
And for further reading, here’s some information about the following topics:
And, of course, keep listening to The Canadian Money Roadmap podcast! You can check out episode 59 to dive deeper into this topic of financial literacy or go back and listen to past episodes.
The goal of this podcast is to make financial literacy and education simple for the average Canadian. If you have feedback or suggestions for what I can talk about next, email me at hello@evanneufeld.com and I’d love to work it into an episode.
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Evan Neufeld is a CERTIFIED FINANCIAL PLANNER® professional in Saskatoon, Saskatchewan and offers both investing and fee-only financial planning services.
*Disclaimer: Any numbers or rates of returns are used for illustration purposes only and should not be taken as fact. Note that the information in this article is current to the time of writing but is not guaranteed as up-to-date past then.
This article and accompanying podcast do not constitute personal financial advice. E