Financial literacy is not just knowledge about money. It is a practical life skill. It helps people have more productive conversations and make better decisions about saving, borrowing, investing, KiwiSaver and retirement. The benefit is rarely dramatic in a single year, but over time it can compound into very different outcomes.
Most people think of financial literacy as knowing the answer to a few money questions. What is compound interest? How does inflation work? Why diversify? Those questions matter, but they are only the starting point.
The bigger point is that financial literacy influences hundreds of ordinary decisions over many years. It affects whether someone increases their KiwiSaver contribution, understands the trade-off between cash and growth assets, pays down expensive debt, stays invested through a market fall, or asks for help before a major financial decision. None of those choices may feel life-changing on the day. But consistently smart, small decisions can compound in a big way.
New research published by Dr Bart Frijns of Auckland University of Technology gives useful weight to this idea. His Netherlands-based study measured financial literacy in 2011, then looked at the income and savings of the same households in 2019. That eight-year gap is important because it helps answer a key question: does financial literacy contribute to better outcomes, or do people simply become more financially literate after they have more money?
A smarter way to look at the question
For years, researchers have observed that financially literate people tend to be wealthier. That may sound obvious, but it does not prove that literacy created wealth. Instead, it’s possible that wealthier households may have more reason to learn about tax, investments, pensions and estate planning. So literacy increases with wealth rather than because of it.
Dr Frijns’ study is helpful because it looks forward. Researchers used data from households in the Netherlands and compared what people knew financially in 2011 with where they ended up eight years later. ‘What people knew financially’ was measured by their answers to four practical questions covering compound interest, inflation, diversification and the relationship between interest rates and bond prices.
Although the study is observational and limited to 475 households, its design is stronger than a simple one-off survey on financial literacy because it can measure change over time. While a financial literacy score in 2011 doesn’t guarantee a particular level of wealth in 2019, it does provide insight into the relationship between the two over time.
The finding investors should not ignore
The headline result was simple. Each additional correct answer on the four-question financial literacy test in 2011 was associated with €4,644 higher annual income and €12,540 more savings in 2019. In New Zealand dollar terms, the researchers described the figures as approximately $7,900 higher income and $21,000 higher savings.
This is a striking result. The researchers found that one extra point on the literacy scale was associated with roughly a 12% increase in income and a 25% increase in savings.
The implication is that people who understand money a little better make decisions that, over eight years, add up to significantly better financial outcomes.
Now let’s look more closely at the concepts tested. The four questions covered compound interest, inflation, diversification and the relationship between interest rates and bond prices.
Almost everyone understood compound interest and inflation. The weaker areas were diversification and bond pricing. Only 64% of respondents correctly understood diversification, and only 30% correctly understood the relationship between bond prices and interest rates. That is telling because understanding diversification and how interest rates affect bonds (debt) sits at the heart of everyday investment and borrowing decisions.
Why this matters for New Zealand families
The study was conducted in the Netherlands, and while the answers of New Zealanders may have been slightly different, the underlying lessons are no less relevant. New Zealand households face the same kinds of compounding decisions throughout their lives: how much to contribute to KiwiSaver, which fund type to use, how much debt to carry, whether to diversify or concentrate an investment and how to prepare for retirement.
The point is not that every investor needs to become an expert. Most do not. The point is that sound financial decisions are often cumulative. A slightly better choice made early, repeated consistently and supported by good advice, can create a very different outcome from a slightly poor choice left unchecked.
Advice may be the key
Financial literacy is valuable, but knowledge alone is not always enough. People can understand the idea of compounding and still delay saving. They can know diversification is sensible and still become uncomfortable when markets fall. They can know debt is expensive and still struggle to change behaviour. This is where advice has a practical role.
The purpose of good advice can be boiled down to helping someone make financial decisions they are proud of and helping them avoid decisions they regret. The best decision is not always the one that produces the greatest financial return. It may be a deliberate choice to use wealth to support the life someone wants to live, rather than continuing to save it. What makes it a good decision is that the trade-offs are understood and the choice is aligned with what matters most to that person.
The best advice often looks simple from the outside. Increase contributions. Diversify properly. Avoid panic selling. Repay high-interest debt. Keep an emergency reserve. Review insurance. Build an estate plan. And perhaps most important, understand what you really value (what’s more important than money) and ensure your decisions align with those values. But simple does not mean easy. These are the quiet decisions that shape long-term financial wellbeing.
The big takeaway
Dr Frijns’ study shows something we’ve intuitively thought about for a while. We believe the most useful way to think about financial literacy is as a form of human capital. We invest in education, training, qualifications and careers because those skills improve our prospects and ability to earn more over time. Financial literacy deserves a place beside them because it does the exact same thing.
The evidence from this study is not that financial literacy guarantees wealth. It does not. Income, opportunity, health, family circumstances, housing, employment and luck all matter. The more balanced conclusion is that financial literacy appears to be an often overlooked ingredient that can improve financial outcomes over time.
That should be encouraging rather than intimidating. Financial wellbeing is not the result of a single perfect decision. It is built through a series of reasonable decisions, made with better understanding, and repeated over many years. The gains may feel modest at first. Then, much like investment returns, the effect becomes clearer in hindsight.
In that sense, financial literacy behaves much like compounding. Small improvements in understanding can lead to better decisions. Better decisions can lead to better behaviour. Better behaviour, given enough time, can change a family’s financial future.
If you have friends or family members who you think could benefit from reading this article, please feel free to share it with them. We would love to help all New Zealanders make better financial decisions, so we are happy for this information to be shared.
Our aim is not to turn everyone into an investment expert. Instead, our aim is to help people build confidence with money and make sound decisions early, before those decisions have years to compound.
