Money Worries TACKLING THE UK S PERSONAL FINANCE PROBLEM

Transcription

1 Money Worries TACKLING THE UK S PERSONAL FINANCE PROBLEM

2 INTRODUCTION THE TROUBLE WITH MONEY WE HAVE A PROBLEM WITH MONEY IN THE UNITED KINGDOM. It s not just that millions are struggling to pay the bills since the financial crisis. It seems that a significant number of people in the UK don t fully understand money matters. As a society, our personal finance capabilities are sorely lacking. Many people have little or no grasp of even the most basic tasks and concepts from reading pay slips and bank statements, to the interest they pay on loans or earn on savings. People are making poor financial decisions as a result. Many take on unmanageable debt and buy (or are missold) financial products they do not understand. This lack of personal finance know-how has a number of roots: recent developments in financial services, our emotional relationship with money, a poor understanding of financial concepts like risk and the complexities of the tax system. In this report, we review these issues and examine what can be done to help make the UK more money wise. Martin Upton Director, True Potential Centre for the Public Understanding of Finance SECTION ONE THE SCALE OF THE PROBLEM Even if we are reluctant to talk about money we do worry about it. The government s Money Advice Service (MAS) found that while almost fourth fifths of us feel confident about managing our money, half are still concerned about their finances. Feeling the pinch Households are feeling the pressure to make ends meet. One in five has experienced a large drop in real income over the past three years, leaving 52% of the population struggling to pay the bills. What s more, the nation is caught in a mire of personal debt. Recent government figures show that: The average household now owes 3,200 in loans, overdrafts and credit card bills. Personal debt (excluding mortgages) has gone up 10% since the financial crisis. One in five people describe their debt as a heavy burden. Skills gaps A recent MAS survey revealed some startling gaps in basic financial skills. Many people in the UK are unable to find the balance on a bank statement, or pick out the best savings account from a choice of three. Living for today To make matters worse there is, for many in the UK, a live-for-now culture. According to MAS, nearly a fifth of people buy things they know they cannot afford. Similarly, HSBC found that when they do save, UK consumers prioritise holidays over retirement. The bank also revealed that three quarters of the population believe they are not saving enough for a comfortable retirement. In fact, a third of us have no savings plans at all. It is clear that something must change if UK households are to prevent severe financial headaches in the future. A better understanding of personal finance is urgently needed if people are to manage their money more effectively. Many people in the UK are unable to find the balance on a bank statement

3 A newly released consumer survey by True Potential LLP, examining the saving habits of 2034 respondents, found: 51% of year olds are not saving anything Only 20% contribute to a pension Almost as many would seek financial advice from the internet (33%) as would use a financial adviser (34%) whilst 26% would get their financial advice from their bank. 53% said that not having enough disposable income prevents them from saving. 73% would be more encouraged to stay with their current high street bank if they offered a higher interest rate on savings. Men seem more willing to take capital risks with their savings; 57% of males would consider investing in stocks and sharesbased products if it was quicker and easier, whereas only 37% of women would do so. Men save more; in the last 3 months the males questioned saved an average of 802, whereas females saved an average of 445 in the same timescale. SECTION TWO THE STORY SO FAR What s caused the problem? The UK s money problems have been building up over many years. Widespread confusion about personal finance can be attributed to several factors. Education Until very recently, personal finance education has been sadly lacking in the UK. It has only been part of the school curriculum in Scotland, Wales and Northern Ireland for the past few years, and will not be introduced in England until As a result, financial literacy in Britain is extremely low. Evidence in support of this came in a recent report by the Organisation for Economic Co-operation and Development (OECD) showing how England s 16 to 24-yearolds were ranked 21st for numeracy out of the 24 counties surveyed. Many people do not understand basic financial information never mind important concepts such as APR (the Annual Percentage Rate of interest), compound interest and risk. Illusion Whatever the reality, mass marketing and media create the impression that we actually know what we are talking about when it comes to money matters. So, although there are far more avenues to invest money and get credit, the options have become more difficult to understand. The industry The behaviour of the financial sector has attracted criticism over recent years. It is fair to say that certain practices have contributed to a lack of understanding of personal finance. Misselling: Millions of people have been persuaded to buy products they don t need, such as payment protection insurance and credit card and identity theft cover. Lack of transparency: Firms include important terms and conditions in the small print, knowing many customers will not read them. For example, what an insurance policy does not cover: holidaymakers may find their accident claim turned down because of excessive alcohol intake, the definition of which varies widely from insurer to insurer. Misleading product names: Some financial products do not actually do what they say on the tin. For example, an insurance bond is not a conventional bond. Selective information: Providers do not make it easy for consumers to compare different investment options. For instance, can a consumer see if they would have been better off investing in, say, a cash ISA instead of a stocks and shares ISA? Are they aware of the different risks associated with such products? This is undoubtedly a positive step. Yet pension fund fees can eat heavily into the amounts people invest. Indeed, one recent investigation found that many workplace pensions do not offer value for money, in part due to high fees. Spread of wealth, debt and access Until the financial collapse, disposable incomes in the UK rose over many decades, giving many people more money to invest though the distribution of wealth became more unequal. More recently, however, real disposable incomes for much of the population have fallen since the crisis. Declining family support Much has been made in the media of the Bank of Mum and Dad. The fact is, however, family structures are changing, and people cannot necessarily rely on relatives for a financial leg-up. We are constantly surrounded by personal finance adverts and press coverage. Some of our biggest sports stars and TV celebrities feature in adverts for financial institutions, and just about every Sunday newspaper features a Money section. This gives us a sense of familiarity with a subject we do not necessarily understand. Why is it such a problem? We are living in an age that demands a greater understanding of finance than ever. Over the past few decades, consumers have been driven to make more and more financial decisions, for several reasons. A shift in responsibility We now need to take greater responsibility for our retirement. State pensions may not be enough to get by on in future and generous company pensions are becoming a thing of the past. Financial literacy in Britain is extremely low England s 16 to 24-year-olds were ranked 21st for numeracy out of the 24 counties surveyed. Complexity Over the last few decades, the number of financial products on the market has mushroomed as has their complexity. There are two main reasons for this: Deregulation and globalisation of financial markets has brought many new players and products onto the market. Technology particularly the Internet has made trading easier and has reduced transaction costs. So it is now up to the individual to work out how to save for retirement. However, the options and risks involved are extremely complex and, as we saw in section one, many people are struggling to pay their bills, let alone save for a pension. The government has tried to help with the introduction of a workplace pension scheme, which employees, employers and government all have to pay into.

4 SECTION THREE THE ROLE OF EMOTION What s the problem? Money brings out strong emotions in us all. If we are to develop a more healthy relationship with personal finance, we must address the emotions that can get in the way of decision-making. However, financial advice tends to focus on practicalities, ignoring the emotional side of money. While the government and financial advisers are good at giving out the facts, they do not always consider why people get into in debt in the first place. For instance, if someone is in financial trouble, they re told how to put together a debt management plan and consolidate their loans. That s a bit like expecting someone struggling with obesity to lose weight by telling them how to count calories. Why do we have this problem? Living for today Of course, many people have had to take on debt in order to get by and the recent recession has not helped matters. When we re struggling for money, our emotions can make matters worse. We live in a culture where people prioritise the present over their future financial security. The Money Advice Service (MAS) found that a fifth of us would choose 200 today over 400 in four months time. What is it that makes us want to buy things now, even if we cannot afford them? Why are we willing to go deeper into debt and sacrifice a more financially secure future? For many people, shopping is a source of instant satisfaction. The thrill of buying something new can override any concern for the consequences. Ironically, the deeper someone is in debt, the more likely they are to indulge in retail therapy, and to leave bank statements and bills unopened. Selling tactics Our live-for-now culture has gone hand in hand with rapid growth in the availability of credit. Pay-day loan companies have hit the headlines in recent years, accused by some of exploiting the financially vulnerable. Yet they are only the tip of the iceberg. Other finance providers and even high-street retailers use their understanding of consumer behaviour to help boost sales. For instance, stores regularly offer six months free credit on big ticket items such as televisions, washing machines and furniture. They know that plenty of people will miss the deadline to pay the loan back. Failure to pay one penny, by one day, will cost the customer the entire six months interest. It is there in the small print, but firms also know that most customers will not read it as they re more interested in getting their hands on their new purchase. What can be done? Financial service companies tap into consumer behaviour and emotions to persuade us to buy their products. In the same way, personal finance education needs to use such tactics to help people develop a more balanced relationship with money. Changing our financial behaviour will require a combination of factors: Government needs a better understanding of people s lives, financial habits and emotional relationship with spending. As well as targeted education campaigns, government and policymakers need to consider other ways to change behaviour for example, encouraging people to take small steps in the right direction. This so-called nudge approach is being used in public health, and now the Behavioural Insights Team (BIT), established in 2010, has been set up to advise on ways to improve the nation s financial health. The education sector needs to ensure that personal finance is taught as a life skill in schools. This means teaching more than the practicalities of personal finance and money management. It also means making people aware of the tactics financial firms use to profit from consumers lack of self-control. Financial service providers must also take some responsibility, especially if they are to restore trust and remain competitive. They might look to the Netherlands, where bankers are now obliged to make a pledge to put customers interests first, much like the Hippocratic Oath taken by doctors in Britain. SECTION FOUR THE ROLE OF REGULATION What is it? Consumer finance regulation exists to give legal protection to consumers. It sets out important rules for the financial services industry, in several areas. Sales: Firms and independent financial advisers must give out certain information when selling financial products. For instance, when a customer applies for a mortgage, the company must provide details on the annual percentage rate of interest (APR). Cancellation: Most financial products are subject to a 1- or 30-day cooling-off period, giving customers time to change their mind. Complaints: Finance providers must address customer complaints to a satisfactory standard. Compensation: Consumers can claim up to 85,000 of their money back if a high street bank goes out of business; and up to 50,000 on investments if a provider has given poor investment advice, managed funds poorly or is unable to return investments or money. Suitability: For some products, providers must compile a Suitability Report on the customer s risk profile, understanding of finance and experience of investment. How does it work? Until recently, financial services regulation was overseen by the Financial Services Authority. However the government abolished this in the fallout from the banking crisis, replacing it with two new bodies as of 1 April 2013: 1. The Prudential Regulation Authority oversees the regulation of financial institutions. 2. The Financial Conduct Authority has responsibility for protecting consumers and safeguarding financial markets. Though there may be extenuating circumstances, the root of poor financial decisions is often a lack of self-control. It s a problem in all walks of life. Had bankers thought about the risks attached to their trading activities, and not just their next bonus, might the financial crisis have been avoided? For many people, shopping is a source of instant satisfaction. The thrill of buying something new overrides any concern for the consequences. The Financial Conduct Authority has significant powers to protect consumer rights. It can impose minimum standards and rules on financial products, or even ban them; force firms to alter or withdraw misleading promotions; and investigate malpractice.

5 What s the problem? Although the Financial Services Authority had been doing some valuable work to bolster consumer protection, it came under heavy criticism following the banking crisis. Despite the new, strengthened regime, there are still some key areas of concern. Lack of understanding Consumers are often unaware, or do not understand, their rights. The protection that regulation should give them may therefore fall short. For example: The government guarantees, as mentioned above, up to 85,000 of savings for each individual in the UK a rule that was reinforced through increasing the size of the guarantee to prevent further runs on banks after the near collapse of Northern Rock. However, many people do not realise that this is the maximum per person per institution, not per account. So if you have two accounts with the same bank you are only protected once. Millions of consumers were sold insurance for credit card and identity theft, even though the law already protected them against financial losses from these crimes. Industry practice Finance providers are obliged to make customers rights clear to them during the sales process. However firms are not always as transparent as they could be. Important information is often buried in the small print, and written in technical language that many people won t understand even if they bother to read it. Dual regulation Financial regulation sits under two bodies instead of a single umbrella. Complying with dual regulation could be more complex and more expensive a cost which firms may ultimately pass on to customers. Adviser fees The recent introduction of fees for financial advice has raised concerns. In 2012, the Financial Services Authority banned companies from paying commissions to independent financial advisers (IFAs). Instead, IFAs now charge individuals directly for the advice they give, and must make sure that fees are fair and transparent. The change is likely to have positive and negative effects for consumers. It should ensure that financial advice is truly independent, and make clear exactly what you pay for the advice you receive. However adviser fees will reduce overall returns on financial investments, with smaller investors feeling the biggest impact. This may prevent people seeking advice, and lead to them taking financial risks they don t fully understand. A report by the accountancy firm Deloitte suggested that the new rules could leave up to 5.5 million people 11% of adults in the UK in the advice gap. What can be done? Despite robust rules to protect consumers, it is clear that more needs to be achieved. Customers don t always understand their rights, and the industry doesn t promote them as wholeheartedly as it could. The solution therefore lies in a combination of: Regulation: Financial providers need to be encouraged to be more upfront and transparent about customers rights. Education: Organisations like Citizens Advice and the Money Advice Service (MAS) provide valuable support, but people tend to seek their help once they have a problem. There is a real need to boost consumers understanding of the rules that protect them in the first place. SECTION FIVE THE ROLE OF TAXATION What s the problem? The fact that the UK has an Office of Tax Simplification is a clear sign of one of the main issues about the tax system: Britain has a greater volume of tax legislation than almost anywhere else in the world. This fiscal maze creates confusion not to mention fear. When it comes to tax, people often bury their heads in the sand and hope that the problem will disappear. This inaction is putting them at risk of: Paying more tax than needed. Paying too little tax and ending up with an unexpected tax bill. Unknowingly evading tax and ending up in serious trouble with HMRC. What are the causes? As we saw in section three, there has been no formal personal finance education in the UK until recently. The majority of us have therefore left school with little or no knowledge of tax. Some might think that this is not a gap in their knowledge worth worrying about. Yet tax affects each one of us, every day of our lives: from VAT on the goods we buy and duty on fuel, alcohol and tobacco, to the tax we pay on our income. Ask yourself a question: what s that code at the bottom of your pay slip? Do you know what it s for, what it means and how it affects you? Many people don t, so would have no idea if their tax code was wrong and they were paying too much income tax. In 2010, HMRC had a backlog of 18.2 million income tax cases where the wrong amounts had been paid. Income tax is just the tip of the iceberg. There are many other, far more complicated, tax rules that have an impact on our lives. For example: Less than a third of people in the UK currently pay into a pension. Do they realise that pension contributions attract far more in tax relief than savings are likely to earn in a high-interest account or ISA? Most people know about the option to save tax free with an ISA, but what about the other tax-efficient products available? How do they weigh up whether a Junior ISA or a tax-free bank account would be best for them especially if their bank can only tell them about its own products? While inheritance tax rules can help individuals organise the passing of property from one generation to the next without tax consequences, this does require proactive planning. Often people do not realise this and end up being hit with an inheritance tax bill when advance knowledge of how inheritance tax applies to estates and life time gifts could have been to their advantage. What can be done? If you know what you re looking for, there are a multitude of helpful websites, including that of HMRC (hmrc.gov.uk). However, the volume of information is so great that it s difficult to know where to start. The only way a layman can be certain to get tax right is to seek professional advice. At what stage, though, is this necessary? The system is so complex that people are often unaware that they have strayed into the tax minefield and need help. With personal finance becoming part of the school syllabus across the UK, courses will need to include the basics of tax to create a rounded financial education. In 2010, HMRC had a backlog of 18.2 million income tax cases where the wrong amounts had been paid.

6 SECTION SIX A LEVEL PLAYING FIELD It is clear that UK consumers need help managing their money and making wiser investment and borrowing decisions. Improving our personal finance capability calls for a collective effort from the industry, regulators and the education sector. As recent misselling scandals show, the financial services industry must be fairer and more transparent in its dealings with the public. More robust regulation is also needed. Despite the good work regulators do and have done to protect consumers, the playing field for players in the financial services industry is still far from level. This brings us to education. Personal finance education in the UK needs a significant boost. People need a working knowledge of basic concepts such as interest and risk; the kinds of financial products on offer; the sales strategies firms use; consumer rights and their emotional responses to financial matters. The introduction of personal finance to the school curriculum is a major step in the right direction, but that can only help current and future generations of schoolchildren. The fact remains that the vast majority of the UK population has received no formal financial education. Besides which, creating lessons to help pupils manage their money day-to-day and plan for their future will be a challenge. With an already packed syllabus, there is far more to personal finance than schools can realistically be expected to teach. If we fail to plug the UK s financial capability gap, millions more people risk being dragged into money worries. The vast majority of the UK population has received no formal financial education. CONCLUSION THE MISSION OF THE TRUE POTENTIAL CENTRE FOR THE PUBLIC UNDERSTANDING OF FINANCE (PUFIN) All the evidence above sets out a compelling case for a new educational centre to promote the understanding of personal finance. It is, therefore, great news that the resources to enable us to establish such a centre have been kindly committed by True Potential LLP, with the initiative being led by Managing Partner, David Harrison. Being based within the Open University Business School the True Potential Centre for the Public Understanding of Finance is ideally placed to lead in this work. The Open University (OU) is the largest university in the UK with more than 240,000 students. The outstanding quality of the OU s educational materials is renowned. In student satisfaction surveys the OU has always been within the top five of all UK universities. The Centre will: Conduct and disseminate high quality research on public finance and on how to improve public financial literacy Develop links within the financial services industry including regulatory bodies - and the academic community to support and promote the Centre s work Provide free and open access to the public to develop their personal finance skills through a number of short courses which provide interactive feedback Publicise and debate contemporary issues in personal finance through news streams and blogs The OU has a sustained record, reaching back to its establishment in 1969, of educating the UK population. The True Potential Centre for the Public Understanding of Finance is the next stage of this mission as we set about enhancing personal finance skills in this country. Martin Upton Director, True Potential Centre for the Public Understanding of Finance

7 About The Open University Business School The Open University Business School is a leader in modern flexible learning and the pioneer of teaching methods that enable people to change their life goals, studying at times and in places convenient to them. The Open University Business School is one of a select group of schools worldwide accredited by the three leading international accrediting bodies AACSB, AMBA, EQUIS. It is the only triple-accredited business school that specialises in flexible learning and is home to more than 24,000 MBA graduates in over 100 countries. Its MBA programme offers residential schools and face-to-face and collaborative learning options. Thanks We would like to thank the Board of True Potential LLP for their support in the Centre s development. I would also like to thank Professors Fenton-O Creevy, Frecknall-Hughes and Rutterford, for their contribution to this document. Contacts For further information on The True Potential Centre for the Public Understanding of Finance, or to request information about our courses, please contact: Martin Upton, Director of the True Potential Centre for the Public Understanding of Finance: martin.upton@open.ac.uk For more information, please visit The Open University Business School, Walton Hall, Milton Keynes MK7 6AA The Open University is incorporated by Royal Charter (RC ), an exempt charity in England and Wales and a charity registered in Scotland (SC ). While we have done everything possible to make sure the information in this publication is accurate, it may change due to regulations or policy, or because of financial or other reasons. Copyright 2013 The Open University, all rights reserved.