Quick quiz: What's the Rule of 72?
You know that one, right? It's a rule of thumb that says you can work out how quickly your money will double by dividing your annual return into 72.
So, if you earn 10% a year, you'll double your money in about seven years. And it'll take you around 12 years to double your money if it's invested at 6%.
It's a cool trick. And one of the things you'll likely learn if you took a 'financial literacy' course… assuming one was available. Or learn in school, if your maths or economics teacher is so inclined.
But financial literacy isn't about the maths. Or, at least, not only about the maths. Yes, knowing a little about the power of compounding and the importance of (good) insurance is important.
Instead, real financial literacy is about the psychology of money. Or just psychology in general. Knowing how to calculate compound returns isn't the same as investing well. Knowing how to create a budget isn't the same as sticking to it. Understanding the role of financial advisers and stockbrokers isn't the same as embracing the power of incentives.
I'm a case in point. My maths teacher in high school implored us to save regularly early in our lives. A small weekly investment between the ages of 18 and 30 (and not a dollar thereafter), invested at the stockmarket's historical rate of return, would make you a millionaire in retirement. It opened my eyes. It had a lasting impact on me.
But I didn't do it.
It wasn't due to a lack of opportunity. Nor a lack of 'financial literacy'. I had all of the tools to make it a reality, but I didn't. What stopped me was a lack of understanding of the psychology of money — what the boffins call behavioural finance.
Behavioural finance explains what traditional finance never could: that the underlying assumption of economics — we're all rational actors who always do what's in our pure best interest — is broken. It's useful as a base model — a starting point — but not much more.
Don't get me wrong. We should absolutely be teaching financial literacy in schools. But more than just literacy, we should be teaching — to torture the metaphor — fluency. Nouns, verbs and split infinitives are interesting, but just knowing them doesn't make you John Keats. Which pretty much is the extent of my knowledge of the Romantic poets, so back to finance…
Knowing 'how' to do something isn't much use if you don't know 'what' to do. But only knowing 'what' to do isn't much better.
Superannuation exists because, without it, people won't invest enough to secure their financial future. In the US, we know that making retirement savings 'opt-out' is far more impactful than 'opt-in', even though the rational traditional economists would tell us it's the same decision.
What psychologists call 'precommitment' really works. So does the seduction of credit cards — it's not 'real' money, and besides, it doesn't have to be paid for a month or so. And spending today feels so much better than saving for tomorrow. Brands make us buy. So does marketing.
No, saving and investing doesn't need more information — it needs a makeover and a persuasive marketing campaign. Or, failing that, we need to help kids — and ourselves — recognise and deal with the things that will derail our success.
When you know it's not financially smart to buy that new phone, jacket, car or lotto ticket, but you do it anyway. When you know you should save, but don't. Or run up a credit card debt even though you know you won't be able to pay it back for months or years.
Yes, sometimes that's done because of a lack of information. There'll be more than a few people who are blown away by the compounding nature of credit card debt. But most of us already know how to tell sensible from silly.
Foolish takeaway
Eating bad foods and not exercising is universally understood to be a bad set of lifestyle choices, but many of us still don't take care of ourselves as we should. The same can be said of money.
The sooner we equip ourselves with the tools to overcome our inability to make good choices — even when we're fully informed — the better off we'll all be. That's what's really missing in the financial literacy debate.
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Scott Phillips is the Motley Fool's director of research. You can follow Scott on Twitter @TMFScottP. The Motley Fool's purpose is to educate, amuse and enrich investors. This article contains general investment advice only (under AFSL 400691).
