18  Financial wellbeing

At the beginning of this book I examined the classical economic foundations to some financial activities. There I assumed the consumer’s objective was maximisation of their expected utility.

Expected utility maximisation is typically not a practicable framework for assessing whether someone is achieving their financial objectives. The dominant approach in assessing financial outcomes in applied settings is financial wellbeing. How can we improve our customers’ or the population’s financial wellbeing?

In attempting to improve financial wellbeing, financial services providers, regulators and NGOs target a number of intermediate objectives, such as financial literacy and financial capability. I will define each of these below, together with financial wellbeing. These definitions are often debated - you don’t need to get into the semantics - but you should be able to distinguish between them.

18.1 Financial literacy

I discussed financial literacy in Chapter 5.

There is a high correlation between financial literacy and financial outcomes. But this does not mean that measures intended to target financial literacy are valuable. One study by Fernandes et al. (2014) found that interventions to improve financial literacy explain 0.1% of the variance in behaviours studied, although some recent arguments are more positive (e.g. Kaiser et al. (2021)). We will discuss this in further detail in Chapter 23.

18.2 Financial capability

Like financial literacy, financial capability has many definitions.

The Australian Government the Treasury (2022) defines financial capability as:

Financial capability refers not only to the knowledge needed to make sound financial decisions, but to a combination of financial knowledge, skills, attitudes, and confidence that leads to positive financial behaviours and money management decisions that fit the circumstances of one’s life.

Muir et al. (2017) define financial capability as:

the combination of knowledge, skills, attitudes and behaviours necessary to make sound financial decisions, based on personal circumstances, to improve financial wellbeing.

Financial capability includes financial literacy, but extends to capture attitudes and behaviours.

Many organisations with a historic remit to improve financial literacy have broadened their scope to financial capability. This was in part a recognition that literacy was an overly narrow approach to improving financial wellbeing.

18.3 Financial wellbeing

Muir et al. (2017) define financial wellbeing as when a person is able to meet expenses and has some money left over, is in control of their finances and feels financially secure, now and in the future. Financial wellbeing is an outcome metric. It is what interventions relating to the other concepts are trying to achieve.

The Consumer Financial Protection Bureau (2015) defines financial wellbeing as:

“a state of being wherein you:

  • Have control over day-to-day, month-to-month finances;

  • Have the capacity to absorb a financial shock;

  • Are on track to meet your financial goals; and

  • Have the financial freedom to make the choices that allow you to enjoy life.”

Financial wellbeing is also essentially a subjective measure (once basic needs are met), but objective outcomes are major determinants of subjective wellbeing. It is generally wise to consider both.

As an example of the types of questions in a financial wellbeing survey, the following are drawn from the Consumer Financial Protection Bureau (2017) Financial Wellbeing Scale:

This statement describes me (completely, very well, somewhat, very little, not at all):

  1. I could handle a major unexpected expense

  2. I am securing my financial future

  3. Because of my money situation, I feel like I will never have the things I want in life

  4. I can enjoy life because of the way I’m managing my money

  5. I am just getting by financially

  6. I am concerned that the money I have or will save won’t last