October 23, 2004

A Fool and His Money ...

WE WERE INTRIGUED to learn this morning that The Independent, a quality British newspaper, has done some fine reporting on a rather disturbing thing: namely, many Britons are absolutely clueless about personal finance. And when we say absolutely clueless, we very much mean it.

The newspaper reports:

Nearly four out of five people do not know that APR refers to the interest and other costs of a loan, four in ten admit they do not understand mortgages or ISAs, and a third lack confidence in their financial affairs.

These are some of the results of a survey conducted by Mori for the Institute of Financial Services (IFS), the rebranded name for the Chartered Institute of Bankers, which says it is shocked by what it discovered about financial illiteracy in Britain. Gavin Shreeve, the IFS chief executive, said: "We are already becoming aware of the consequences of large sections of the population not saving enough now for the future. This report quantifies the financial literacy gap that exists in the UK. Unless tackled, this will lead to an over-reliance on the state in old age, as people continue to be unable or unwilling to determine the right solutions to their own needs."

The survey of 1,920 adults found that just over a quarter did not know that a financial adviser was someone who is supposed to offer clients appropriate guidance on money matters in line with their own circumstances.

One in five did not understand the concept of inflation. Nearly a third did not know that insurance products are designed to protect their owners from unforeseen events. Shockingly, says the IFS, only 30 per cent could calculate four per cent interest on 2,000 over two years (it's 160).

We have to admit we're really surprised at The Independent's report. That four out of five people haven't any clue what an APR is -- that's just astounding. That two out of five do not understand their mortgages is downright alarming. We are less surprised that two out of five don't understand ISAs (Individual Savings Accounts -- Britain's equivalent of a Roth IRA), as the rules governing ISAs are pretty complex. However, even allowing for our unusual interest in such things, we still think that's incredible. With Google's help, we grasped the basic concepts surrounding ISAs in about fifteen minutes. So even if a Briton knew very little about financial matters, he or she should still be able to pick up the ball and run with it after a bit of study.

What especially got to us, though, was that a good many Britons hadn't a clue about things like inflation and interest calculations. For we realized that if things were this bad in Britain, they were probably as bad here in the United States. That's really bothersome, as if people don't understand these basic things, they're prone to making a lot of poor money decisions, and prone to having unscrupulous types take advantage of them, and so on. To say nothing of how emasculating not having that knowledge would be. So, we hope that folks here in the United States will take a keen look at beefing up personal-finance education -- for like Britain, we could probably use it.


AS AN ASIDE to our remaining readers from the UK (those whom we have not mightily offended with our recent jingoistic sniping) we would ask the following: has there been any real discussion about reforming the UK's pension system?

We're just wondering. You see, we were surfing The Pension Service's Web site -- yes, we know, we're pathetic -- and it seems like you guys are getting a raw deal. Here in America, we have what are called 401(k)s, which have contribution rules similar to your Additional State/Occupational Pension schemes, except we can invest our contributions in the market. Plus, we own the accounts, so if we kick off we don't lose out. Has anyone brought up the idea of reforming the UK's pension schemes to look more like 401(k)s?

Posted by Benjamin Kepple at October 23, 2004 02:17 AM | TrackBack

To answer your last question, yes, there's been a lot of talk. There already exists a product known as a 'stakeholder pension', which I believe is similar to the 401(k). Those who hold such a pension pay in a monthly amount from their gross salary, which they can indeed invest in the market. The problem is that the management charges are capped at 1% a year, which gives the financial services industry little incentive to market them. The uptake has been very disappointing to those who introduced them. (Though I have one.)

Most companies also offer pensions for their employees, who contribute their monthly payments (gross of tax) to a fund run by the company. These schemes come in two forms: defined benefit, and defined contribution. Under the first, employees pay a set proportion of their salary and at the end of their working life receive a pension whose size depends on their final salary and length of employment. Under the second, the size of the pension is determined by the current value of all the monthly contributions made to the company scheme.

As I understand it, the UK's pension system is in better shape than many in the developed world (though of course that's not saying much). It was doing a lot better a few years ago, before: the dotcom/telecoms bubble and crash, a new tax on pension funds' dividend income, and new capital requirements for insurance companies that forced them to sell a lot of their riskier assets, like shares. Some pension funds have fallen sharply in value over the last four years.

I think the main problem with pensions is that those who do not wish to reduce their present consumption to provide for their old age assume that they can count on the frugal and the young to pay for them when they retire. Given that the retired population is only going to get more politically powerful as time goes on (as the population as a whole ages), I'm not sure they're wrong, unfortunately.

I can't say I was too offended by your jingoistic sniping. I know that you have your fair share of antisemites and moonbats on the other side of the pond.

Posted by: Jon Barnard at October 25, 2004 12:19 PM

Hi Jon,

Thanks for your informative and helpful reply; it sheds a lot of light on this topic for me.

Posted by: Benjamin Kepple at October 25, 2004 05:30 PM

No problem; I was quite surprised by how much I could find to say about this subject off the top of my head. Thanks for your blog, which has been much more informative and entertaining to me than my reply could ever be to you!

Posted by: Jon Barnard at October 25, 2004 08:56 PM


Good Lord, that's a fine compliment. Thank you for reading! I just wish my schedule allowed me to post more often.

Posted by: Benjamin Kepple at October 25, 2004 10:39 PM