The Financial Capability Gap: Who Overestimate Their Ability to Manage Finances?

Background

In recent years, social work scholars have focused on financial capability and asset building approaches to help individuals and families experiencing increasing disparities in wealth and income. Financial capability combines perceived ability, subjective knowledge, and objective knowledge among other components (Sherraden, 2013; Xiao, Chen, & Chen, 2014). Several studies (Lusardi, 2011; Bucher-Koenen & Lusardi, 2011; Lusardi, 2011; Lusardi & Tufano, 2009; van Rooij, Lusardi, & Alessie, 2012) claimed that there is a sharp disconnect between self-reported knowledge and objective financial knowledge. This study investigates the gap between perceived ability and objective measures of financial capability by addressing the following: (a) To what extent do Canadians overestimate/underestimate their financial capability? (b) How are demographic and socioeconomic characteristics associated with overestimation/underestimation of financial capability?

Method

Data came from the nationally representative 2009 Canadian Financial Capability Survey (CFCS) that included 15,519 adult Canadians. We used factor analysis to construct a latent measure of perceived ability derived from five items scored along a four-point scale. A single objective knowledge factor was generated from the tetrachoric correlations of 14 dichotomous items answered as correct or incorrect. Both factor scores were rescaled to a range from 0 to 100. A gap score was created as the difference between the perceived ability and objective knowledge scores which ranged from -93.97 to 100 (positive gap score suggests an overestimate of financial capability; negative values suggest an underestimate). A dichotomous ‘overestimate’ variable was created for gap scores greater than zero. Bivariate analyses (t-test and ANOVA) and multivariate regression were used to identify the demographic and socioeconomic characteristics associated with the gap.

Results

Overall, Canadians underestimate their financial capability (M= -11.55). Bivariate significant gap scores were found across groups: age [F (7, 13309) = 122.64, p < .001]; level of education [F (3, 13297) = 165.14, p < .001]; employment status [F (4, 13281) = 167.29, p < .001], and immigration status [F (1, 13170) = 76.98, p < .001]. Logistic regressions showed that older people aged 65 years and above (OR=1.31, p<0.05), female (OR=1.11, p<0.01), and immigrants (OR=1.55, p<0.001) were more likely to overestimate their financial capability. Full regression results including predicted probabilities and plots are discussed in the full paper.

Conclusion

This paper adds knowledge to the current discourse on financial capability. Specifically, for the first time in the literature we document the disconnect between perceived ability and objectively measured knowledge; i.e., the financial capability gap. Findings suggest that people with old age, females, and immigrants overestimate their financial capability, which might lead them to risky and undesirable financial practices. Groups that overestimate their financial capability might be prone to predatory financial exploitation. Policy makers and social work practitioners can apply knowledge about the gap in designing and implementing effective interventions for high-risk groups including suitable financial products. Future social work research is needed to understand the causes and consequences of overestimation of financial capability.