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The financial literacy rate in India is 27% as compared to a global average of 60%, and 63% among the OECD*, a group of mostly wealthy nations.
A majority of the Indian population lacks an understanding of basic financial concepts and the corresponding risks. On average, worldwide, only 1 out of 3 adults is financially illiterate, the number for India is 3 out of 4, which is even below the world average. Due to a lack of crucial financial knowledge, they do not plan and thus, fail to make effective decisions to manage their finances. We at SSC recognize the profound role of transparent taxation and financial literacy in moderating the disparity of income and achieving common prosperity across India.
#Twittertrends2022: Our combined efforts have resulted in a 185% rise in discussions around financial literacy in India in FY 2022, as against a 62% rise in FY 2021. Still, metropolitan areas like Maharashtra, Delhi, and West Bengal have financial literacy rates of 17%, 32%, and 21%, respectively while states like Bihar, Rajasthan, Jharkhand, and Uttar Pradesh where poverty is rampant, suffer from low literacy rates. While Goa as a state has the highest literacy rate of 50 percent, Chhattisgarh is lacking financial education and has the lowest literacy rate of 4 percent.
In India, financial literacy programs are lifting families out of debt and fueling new prosperity. A study by the Asian Development Bank reports that by 2024, only 27% of Indian male adults – and 24% of women – meet the minimum level of financial literacy as defined by the Reserve Bank of India. It was also seen that women are particularly responsive to financial literacy outreach. Despite having a population of 1.44 billion people, about 73% of the adult population is yet to improve upon their understanding of basic financial concepts.
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Global overview of financial literacy
Financial literacy comprises of three components:
Financial knowledge - Financial knowledge can be considered as having a basic knowledge of financial concepts and the ability to apply numeracy skills in financial contexts. Financial knowledge allows individuals to manage their financial matters, compare financial products and services to make appropriate and well-informed financial decisions, and to react to events that could affect their financial well-being.
Financial behaviour - Individuals’ behaviours and actions affect their financial situation and well-being in both the short- and long- term. Some behaviours, such as putting off bill payments, failing to plan for future expenditures, or choosing financial products without shopping around, may negatively impact an individual’s financial situation and well-being
Financial attitudes - Even if an individual has the knowledge and ability to act in a particular way, their attitudes towards money can also influence their decisions and behaviours.
Get Involved - Financial Literacy for All
From savings to investments, creating wealth, or managing debt, good financial planning is the need of the hour. While one could manage finances personally or get a financial planner on board. Inculcating financial literacy early on is essential. The younger you are when you learn to manage money and invest and prioritize financial planning basics, the wealthier you will be.
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Shelf Help
The Missing Billionaires: A Guide to Better Financial Decisions is a 2023 book by James White and Victor Haghani. At its core is the concept of 'expected utility'.
Synopsis: Over the past century, if the wealthiest families had spent a reasonable fraction of their wealth, paid taxes, invested in the stock market, and passed their wealth down to the next generation, there would be tens of thousands of billionaire heirs to generations-old fortunes today. Many of these families didn’t choose bad investments– they sized them incorrectly– and allowed their spending decisions to amplify this mistake.
The puzzle of The Missing Billionaires is why you cannot find one such billionaire on any current rich list. There are several explanations, but this book is focused on one mistake that is of profound importance to all investors: poor risk decisions, both in investing and spending.
The Missing Billionaires book offers a simple yet powerful framework for making important lifetime financial decisions systematically and rationally. It's for readers with a baseline level of financial literacy but doesn’t require a PhD. It fills the gap between personal finance books and academic literature, bringing valuable insights into academic finance to non-specialists. The book is organized in three sections:
Part One builds the theory of optimal investment sizing from the first principles, starting with betting on biased coins.
Part Two covers lifetime financial decision-making, with emphasis on the integration of investment, saving, and spending decisions.
Part Three covers practical implementation details, including how to calibrate a personal level of risk aversion, and how to estimate the expected return and risk on a broad spectrum of investments.
The book is packed with case studies and anecdotes, including one about Victor’s investment with LTCM as a partner, and a bonus chapter on Liar’s Poker. The authors draw extensively on their own experiences as principals of Elm Wealth, a multi-billion-dollar wealth management practice, and before that on their years as arbitrage traders– Victor at Salomon Brothers and LTCM, and James at NationsBank/CRT and Citadel.
Whether you are young and building wealth, an entrepreneur invested heavily in your own business, or at a stage in life where your primary focus is investing and spending, The Missing Billionaires: A Guide to Better Financial Decisions is your must-have resource for thoughtful financial decision-making.
Synopsis: Making better decisions is not a zero-sum game
Sound financial decision making, consistent with your individual preferences, will not only increase your and your family's expected happiness, but will dramatically increase the welfare of our entire society. Good decisions will take account of your personal circumstances, financial preferences, and your considered views on the risks and expected returns of available investments. …You will likely get the most out of this book if you have already accumulated a decent amount of financial capital or if you are young with a healthy measure of human capital. …
The book is written from the perspective of an individual or family…” Based on their many years of wealth management experience and portfolio systems development, they conclude that:
Page 36: “The optimal bet size [such as allocation to stocks], expressed as a fraction of wealth, is directly proportional to the gamble’s expected return, and inversely proportional to its variance [square of the standard deviation] and to your personal degree of risk-aversion.” Goldilocks Bet Sizing - Constant fractional betting: Proposition that sizing decision, often an afterthought, is actually the most critical part of investing. We've experienced first-hand the impact of getting the “how much” decision wrong, losing the majority of our personal wealth in the process. A 10% (safer) to 20% (risky) bet-size seems pretty good. Returning to betting on 25 flips of a 60/40 coin with no profit cap, we've found that a 20% bet size is what maximizes your median profit. We're not claiming it's exactly optimal, for anyone or everyone, but we think for many people it's a reasoned and reasonable choice for a good bet size in this particular situation. As bet size increases, both lift and drag increase, but the drag increases faster.
Pages 52, 54, 60: “If we want to use earnings yield and expected real returns to decide how much to invest in the stock market, to be consistent we also need to evaluate alternatives to stocks in terms of their long-term real return. It seems natural to turn to US Treasury inflation-protected securities (TIPS) as the relevant low-risk alternative to stocks, since the yield on TIPS is a measure of their expected real return… [During 1900-2022,] the excess earnings yield dynamic strategy did a lot better than a static strategy… Momentum can be effectively used in combination with earnings yield by increasing the equity allocation when momentum is positive and reducing it when momentum is negative.”
Pages 76-77, 79, 82, 83: “The empirical finding that we see similar levels of risk-aversion for people at quite different wealth supports use of CRRA [Constant Relative Risk-aversion] utility as a reasonable fit for most people… Each curve with positive risk-aversion goes up more slowly as wealth increases, and this effect is more dramatic for higher levels of risk-aversion. …our Base Case individual has CRRA utility with risk-aversion 2,…within the range of risk-aversion expressed by respondents to our survey… The Certainty-equivalent Return (CER) of a risky investment is the return of a risk-free, certain investment that generates utility identical to the Expected Utility of the risky investment… CER takes in all the information known about the investment’s return distribution, and in combination with the investor’s utility function, transforms it into one number that can be used to compare across very different investments.”
Pages 132, 138, 144: “Using Expected Lifetime Utility [sum of the utility from each period’s spending, all discounted back to the present] to guide family investment and spending decisions…involves three main steps:
1) Simulate asset prices, wealth, and spending based on a given investment and spending policy over time.
2) Calculate the Expected Lifetime Utility of the spending that arises from each policy choice, including that from the wealth left over for legacy bequests.
3) Search over many investing and spending rules to find that which gives the best result.”
it is important to realize that as circumstances evolve with the passage of time, a new plan should be created to reflect updated conditions.”Page 191: “The Expected Utility Framework won’t tell you how to balance personal consumption, intergenerational giving, and philanthropy because your relative preferences are an input to the framework. What it will do is provide a good rule for how to spend and invest in light of these preferences and all the different sources of complexity and uncertainty we throw into the mix–taxes, inflation, volatile asset returns, uncertain longevity, uncertain family dynamics…”
Pages 194-195: “The Expected Utility Framework concept is valuable in weighing the pros and cons of different career paths, by focusing attention on the risk-adjusted value of human capital. Different vocations will vary dramatically in terms of the uncertainty of outcomes, from those with high expected values but with payoffs similar to those of a lottery ticket to others that resemble the payouts of an inflation-indexed government bond… If your human capital is equity-like, you may want your investment portfolio to have less equity risk.”
Page 203: “To cut through all the complexity, we find ourselves always coming back to these three related hypotheses:
- The efficient markets hypothesis: The markets, especially large and liquid ones, are fairly efficient.
- The cost matter hypothesis: Costs matter.
- The average investor hypothesis: The market portfolio is the only investment that everybody can own at the same time.
Given these beliefs, the headline message is that individual investors should avail themselves of the low hanging fruit of high diversification, low fees, and tax efficiency. Such an approach will generally preclude concentrated, high-fee, tax-inefficient investments in hedge funds, structured products, and other complex alternative investments.”Page 264: “…under the right conditions and with due care, options can modestly increase investor welfare as a substitute for portfolio rebalancing, as portfolio protection, or as a source of limited liability leverage. The benefits tend to be greatest for investors who are some combination of risk tolerant, optimistic, or young. But we have also seen that a number of popular option strategies, such as buying out-of-the-money options to speculate on individual stocks , or shorting equity market volatility, are more likely to harm an investor’s welfare.”
Page 273: “When we bring taxes into the mix, the optimal asset allocation depends on many other variables, and the investment horizon in particular becomes a critical input.”
In summary, individual investors will likely The Missing Billionaires an interesting life cycle investing and spending model, but perhaps will view the uncertainties of life as demotivating a detailed model implementation.
Cautions regarding conclusions include:
Implementation of the model requires, in addition to estimation of asset returns and variabilities, quantification of arguably squishy individual risk- aversion.
The track record of economic theories suggests that hand waving is insufficient justification for implementation. How have individuals who have followed the model fared versus control groups?
How to avoid a common investment mistake
Think less about what to buy, and more about how much
If you ever hear a professional investor talk about a trade that taught them a lot, prick up your ears. Usually, this is code for “a time I lost an absolutely colossal amount of money”, and you are in for one of the better stories about how finance works at the coalface.
On this front, Victor Haghani is a man to whom it is worth listening. He spent the mid-1990s as a partner and superstar bond trader at the hottest hedge fund on Wall Street. In its first four years, Long-Term Capital Management (ltcm) made its initial backers average returns of more than 30% a year and never lost money two months in a row. Moreover, its partners had been trading the capital of Salomon Brothers, an investment bank, for the preceding 20 years, with similar results. But in 1998 the wheels came off in spectacular fashion. ltcm lost 90% of its capital at a stroke. Despite a $3.6bn bail-out from a group of its trading counterparties, the fund was liquidated and its partners’ personal investments wiped out. Mr Haghani writes that he took “a nine-figure hit”.
Now, along with his present-day colleague James White, he has written a book that aims to spare other investors his mistakes. Fortunately, “The Missing Billionaires” is not a discussion of the minutiae of ltcm’s bond-arbitrage trades. Instead, it examines what its authors argue is a much more important—and neglected—question than picking the right investments to buy or sell: not “what” but “how much”.
People tend to answer this question badly. To show this, the book describes an experiment in which 61 youngsters (college students of finance and economics, plus some young professional financiers) were given $25 and asked to bet on a rigged coin at even odds. Each flip, they were told, had a 60% chance of coming up heads. They had time for about 300 tosses, could choose each bet’s size and would keep their winnings up to a cap of $250. This was an exceptionally good deal: simply betting 10% of the remaining pot on each toss had a 94% chance of yielding the maximum payout and none of going bust. Yet the players’ average payout was just $91, only a fifth of them hit the cap and 28% managed to lose everything.
A list of the coin-flippers’ mistakes reads like a parable of how not to invest in the stockmarket. Rather than picking a strategy and sticking to it, subjects bet erratically. Nearly a third wagered their entire pot on a single flip and, amazingly, some did so on the 40% chance of getting tails. Many doubled down on losses, even though doing so is a reliable way of making mild ones catastrophic. Others made small bets fixed in dollar amounts, avoiding ruin but also giving up the lion’s share of their potential returns. Few considered the optimal, lucrative strategy of betting a constant fraction of their wealth on an attractive opportunity.
The rest of the book offers a corrective to these wealth-sapping instincts. Most important is to devise rules for spending, saving and allocating investments, expressed as fractions of your total wealth. Then you must stick to them, avoiding the temptation to chase hot assets or spend too much in the face of losses.
The authors’ great success is in offering a consistent and explicit framework within which to do all this. At its core is the concept of “expected utility”, or the pleasure derived from a given level of wealth. This accounts for the fact that most people are averse to risking large chunks of their capital. A happy consequence is that sizing investments to maximise expected utility, rather than wealth, can sharply reduce your chances of intolerable losses while keeping enough risk for a shot at decent returns.
In practical terms, the book’s crowning achievement is its explanation of the “Merton share”. This is a simple rule of thumb for determining asset allocation, which says that allocations should rise in proportion to expected returns, fall in proportion to the investor’s risk aversion and fall a lot in proportion to volatility (specifically, to its square).
This is not to suggest the book makes for light reading. The authors prescribe calculations that will appeal to only the most dogged investors, ideally with access to a Bloomberg terminal. Most will conclude that they need a wealth-management firm to help them; conveniently enough, Messrs Haghani and White run one. Yet for those investing in their own business—or, indeed, a hotshot hedge fund—it is worth reading simply for Mr Haghani’s reflection on how much he ought to have ploughed into ltcm all those years ago. Spoiler alert: it was rather less than he did. ■
* Figures quoted from the Standard & Poor's Ratings Services Global Financial Literacy Survey 2021, the world’s largest, most comprehensive global measurement of financial literacy.
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