This is where ‘financial capability’ comes in. It is a term that you might hear about every now and then, but you might be unclear as to exactly what it means.
In layman terms, ‘financial capability’ is having the knowledge and confidence to manage your day to day money matters well.
However, it does not just refer to the knowledge one has to make good financial decisions. It is a combination of financial knowledge, skills, attitudes, and confidence that one needs in order to make positive behaviours and money management decisions through day-to-day and significant life events.
Here is a quick breakdown of all of these aspects:
Financial knowledge
This is an individual’s awareness and understanding of money and financial concepts, products and services, and their own financial situation. This form of knowledge can be gained through education or being well read and familiar with financial concepts.
An example of financial knowledge is knowing and understanding something like inflation, why it happens, and how it affects the market and consumer behaviour. Financial knowledge also includes knowing where and when to get the appropriate advice and support needed to further your personal goals.
Financial skills
Unlike theoretical financial knowledge, financial skills are the practical hard and soft skills that provide individuals with the ability to use relevant knowledge to manage financial risks and opportunities.
Some of the skills you will require to have high financial capability will involve literacy, numeracy, problem-solving, communication, and critical thinking.
Through the use of such skills, individuals will have a greater ability to compare and contrast between different financial products, avoid financial pitfalls and scams, and also be able to determine which deals are the most suited to their circumstances.
Financial attitudes
This generally refers to one’s own mindset and opinions about finances. This involves an individual’s own motivation to engage and handle their finances and financial plan, their financial impulses, as well as the level of stress and tolerance associated with making financial decisions and risks.
Financial confidence
This ties in to an individual’s sense of belief in their ability to access and utilise financial products and services, make financial decisions and accomplish their financial goals without doubting themselves.
For example, being comfortable talking about money and being comfortable managing their own finances.
Positive financial behaviours
These tend to refer to the actions that individuals take to improve their financial outcomes and situations. We can more or less divide these into two broad categories: day‑to‑day money management and financial planning for the future. Some positive financial behaviours include managing debt and credit use, creating a monthly spending budget, making savings goals and tracking spending and cash flow.
All of these aspects combined makes up a person’s financial capability. Any improvement made to any one of these is an overall net gain. These aspects also tend to build upon one another. For example, improving your financial knowledge translates to improved skill, and better skills will in turn improve attitudes and confidence, ultimately leading to positive change.
Why financial capability matters
Financial capability is directly linked to improving your chances of a positive financial outcome. It equips individuals with the right skills and mindset to make the ideal financial decisions that fits their circumstances and meet their goals. While financial capability is closely tied to positive financial attitudes and positive financial wellbeing, it is important to note that the most appropriate decisions and behaviours will vary greatly depending on each individual’s unique circumstances and context.
When an individual works to improve their financial capability, they will learn how to better understand the risks involved with their financial decisions, information asymmetries and the incentives of financial providers. They will also be more financially savvy, being able to more easily spot potential scam or financial products which are not appropriate for their individual circumstances. It will also help you be more flexible with regards to changes in the financial ecosystem, be it social, economic, or technological; as you will already have a solid foundation to compare the changes against.
What drives financial capability
As you can see from the above, financial capability encompasses many things. As such, there are a whole range of factors that can influence one’s financial capability, both directly and indirectly. For example, an individual’s education, community, and access to financial support will all have an impact on their financial capability.
However, many of these same factors can also affect individual outcomes such as financial wellness and financial resilience. For instance, an individual’s education will affect their financial capability, but it will also affect their chances of finding employment, which in turn affects individual outcomes.
It is also critical to recognise how social and cultural factors affect individual financial decisions. Observations of families, peers, community norms and values all naturally shape an individual’s financial values and goals. Social, cultural, and economic factors can all influence how much access one has or is willing to have to financial education, resulting in a direct impact on a person’s ability and willingness to engage with their finances.
By having a good understanding of each specific factor that affects financial capability, you can begin to make targeted improvements to improve your overall financial standing. For example, financial knowledge is most affected by education and access to financial advice and support. On the other hand, financial attitudes may be most affected by an individual’s friends and family.
