There’s a buzzy new term on the street, and that term is “financial capability.” It’s being used by governments, journalists, and international conference speakers alike. It’s similar to the concept of financial literacy, but it appears to be a new iteration that pushes the agenda for personal finance further. So how are these two terms different? Trust & Will explores this new phrase that is changing up the agenda for how we approach personal finance and creates a focus on building financial resilience.
What is financial capability?
The financial capability definition is as follows:
“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 behaviors and money management decisions that fit the circumstances of one’s life.”
This definition from the Australian government perfectly captures the essence of financial capability. Following the COVID-19 pandemic, policymakers across the globe are honing in on the need for financial resilience amongst their constituencies.
It’s painstakingly clear that the economic landscape is constantly changing, and unfortunately, that means that we will experience financial strife from time to time. Historically, we have seen that governments intervene as much as possible, but these interventions often aren’t enough.
Therefore, individuals should develop financial capability to build their resilience during tough times. Further, when things are good, they can use their capabilities to take action and achieve their financial goals.
Financial capability vs. financial literacy: what is the difference?
So why is this concept of financial capability making a splash now, and how does it differ from the term financial literacy?
Financial literacy describes a person’s education regarding personal finances, from budgeting to investing and understanding how the credit system works. Someone who is financially literate should have a foundational understanding of how money works.
The concept of financial literacy came to rise due to the general lack of personal financial education in our education system. Young adults often entered the economy without having any knowledge or know-how on how to set up a budget, how to invest, how to build wealth, or how to navigate our credit system. Our ongoing debt and credit crisis is more than enough evidence.
Financial literacy is also a social justice issue; wealthy families are more likely to pass on personal finance skills to their children, and so on and so forth. Low-income families may not be financially literate themselves, and thus unable to pass on wealth-building skills to the next generation.
While financial literacy education may not be a standard part of the curriculum in public education just yet, the demand for financial literacy education has caught on. More Americans now have access to free education and resources either by educators or private companies.
However, experts and policymakers are starting to realize that financial literacy, while important, just isn’t cutting it.
Just because a person is educated on personal finance doesn’t mean they’ll know what to do with it or put it into practice. The COVID-19 pandemic brought about economic strife for most families in the U.S., and it revealed a weak spot where Americans need more financial resilience to survive financial upsets, whether they be systemic or personal. Building a solid financial foundation is needed at minimum if we wish to begin building financial security within our own lifetimes, as well as generational wealth for the future.
For these reasons, the term financial capability is starting to become a buzzword. You’ll likely start seeing it replace financial literacy as experts begin to show a preference for it.
The 5 elements of financial capability
Now that we’ve laid the foundation for why we’re seeing an uptick in the use of the term “financial capability,” let’s dive deeper into what it means in practice.
According to the Center for Financial Inclusion, a person is financially capable if they:
See the value in proactively managing their money
Know what they need to make good money management decisions and take action
Have the skills to turn this know-how into active practice
Have the confidence that they are able to act on this desire
Have access to environment and resources that allow them to take action on this desire
In other words, having financial literacy or knowledge is just the beginning. A person should have an understanding of money concepts, but more than that, they should understand their personal financial circumstances and how to take advantage of products and services as needed. Knowledge could include, but is not limited to, concepts such as inflation, interest, credit, and risk.
In addition to this foundational knowledge, a financially capable person should have practical skills to manage their financial risks and opportunities. These skills might include mathematical calculation, problem-solving, critical thinking, and being able to communicate using financial terms and vocabulary. Examples of when these skills might be put to use include comparing financial products, or having the wherewithal to avoid financial scams.
Confidence and attitude is also important. Many Americans experience a lot of stress when it comes to money, and that’s because they don’t feel empowered. Perhaps their lack of financial capability in the past landed them in debt and therefore they associate money with negative emotions. A financially capable person should feel confident in their abilities to make good decisions and achieve their personal goals. Feeling empowered and thus positive feelings about money can help mitigate financial stress and thus improve their overall health.
Last but not least, financial capability is all about putting your money where your mouth is. A person who is financially capable takes aligned actions that will improve their financial circumstances. While a person could be financially literate, it doesn’t necessarily mean that they have good spending habits or money behaviors. Therefore, financial capability takes this a step further to underscore the importance of carrying out our education into actions and behaviors. Managing debt and saving toward personal goals are common examples.
Ways to build your financial capability
Now that we’ve established the importance of building financial capability, it’s helpful to get an understanding of how we can actually build it. Of course, every individual or entity will have a different approach to building financial capability.
For an adult who decides to get control over their own finances, this might look like hiring a money coach to learn about strategies to pay down debt and put money into investments.
For a child, this might look like a standardized curriculum in an educational setting that teaches him or her about the credit system.
According to the Consumer Financial Protection Bureau, there are three key building blocks to building financial capability:
Executive function
Financial habits and norms
Financial knowledge and decision-making skills
Executive Function
The CFPB describes executive function as “the ability to plan ahead, remember information, multitask, solve problems, and control impulses.” For young learners, this educational block should begin early and increase in complexity as they grow older. Having this type of function leads to becoming financially capable with age, such as being able to save money, set goals, and make smart decisions when it comes to money. Those who display executive function are better at controlling themselves when it comes to sticking to a budget and resisting impulsive spending.
Financial Habits and Norms
Financial habits dictate our day-to-day behaviors when it comes to money. Every person and family has their own philosophy surrounding money, which helps inform what those day-to-day activities might look like. They can also be influenced by our observations of the world, our peers around us, as well as our personal experiences with money. Someone who is financially capable will have developed healthy money habits by the time they reach adulthood.
Financial Knowledge and Decision-Making Skills
Last but not least comes financial knowledge and the skills that follow. Not all of us have all the financial information we need at once. There will be times when we need to conduct our own research and analysis when we encounter certain money situations. For instance, one person might want to study up on the latest strategies to pay down credit card debt while another person might want to research how to double their retirement savings in a decade. Because there is so much information available at hand, a financially capable person knows how to sort through this information, aggregate research that best meets their criteria, and make their own informed decision. Further, they must be able to lay out the steps needed to act on that decision and follow through with taking those actions.
It’s time to take aligned action: start your estate plan now
Financial capability is a phrase that is favored over financial literacy. The shift around money culture is happening because experts are realizing that being educated about personal finance isn’t enough. On top of that knowledge, individuals need to have financial resilience and have the confidence to take action and identify products, services, or resources as needed. Knowing good money habits isn’t cutting it; one must act.
This discussion leads to a moment of self-reflection; you likely have a lot of great financial knowledge, but what have you done with it lately? Perhaps it is time to take aligned action to get yourself closer to your goals and objectives.
A possible action plan you can set easily into motion today is to start your Estate Plan. Estate planning is an important activity that will protect your assets over the long-term, including during your lifetime and for future generations. By setting up a Will or Trust, you’ll have peace of mind knowing that your affairs are in order. Take our free quiz to see where you should get started, or compare our different estate planning and settlement options today!
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