To date we’ve covered the impact of personality and irrational influence on making sound money decisions. Now it is time to ask what impact your money sense is having on your dollars. What do you know about finance? What have you read? Who have you talked to? How deep is your knowledge and how firm is your grasp of things monetary?
I decided to test the financial literacy of my 61 lawyer interviewees, not by being overly technical, but by examining their knowledge of basic financial concepts.
Before discussing the results, let’s be sure we understand the term financial literacy. Basically, it is the ability to make informed judgements and effective decisions regarding the use and management of money. In other words, combining financial knowledge with the understanding, confidence and motivation to make sound financial judgements and decisions. I felt it important to test lawyers for financial literacy, since it contributes at all stages of their lives to smart saving, borrowing and investment decisions.
Interest, inflation and diversification.
I asked three questions, relating, in particular, to interest on a savings account over a five-year period (avoiding the concept of compounding interest by asking whether, after five years, the amount was above, the same or below the original amount plus one year’s interest); the effects of inflation versus interest on real money (in my question the inflation rate was higher than the interest rate and therefore eroded the value of money); and the concept of diversification in an equities context (which is more risky – a portfolio of shares or a single share?).
An impressive 86% (more than three times the New Zealand average) answered all three questions correctly. Only 14% answered at least one of the questions incorrectly. Interestingly, almost half the lawyers who made one or more mistakes were Generation Y (in their 20s), perhaps explained by the fact that such lawyers have had little personal interaction with banks by not yet borrowing to buy a house or making a major investment. Their main experience with borrowing money is through the Government’s student loan scheme, which is structured very differently from a bank loan.
Financial literacy is important because people with a lower degree of understanding of financial concepts tend to borrow more, accumulate less wealth and pay more in fees related to financial products. They are also less likely to invest, more likely to experience difficulty with debt and less likely to know the terms of their mortgage.
The costs of financial ignorance are high, resulting in bad financial decisions, late payments, overspending and perhaps most importantly no retirement planning. Speaking of which…
Introduced by the Government in 2007, this predominantly work-based, voluntary pension scheme encourages New Zealanders to save for their retirement.
Do lawyers contribute to KiwiSaver? 61% Yes, 39% No.
A total of 61% of the sample of 61 lawyers, contributed to KiwiSaver. A few who had worked overseas had also contributed to an offshore pension scheme. Some hadn’t realised they could transfer these contributions to their KiwiSaver scheme.
The balance of 39% did not contribute to KiwiSaver. However, a couple of lawyers mentioned that although they didn’t contribute themselves, they had set up KiwiSaver accounts for their children and were contributing on their behalf. Non-contributing lawyers often thought the scheme was not designed for them, for example, equity partners not actually employed by the firm. Although, interestingly, they knew that as employers of lawyers, they contributed to KiwiSaver on their behalf.
I pointed out that the scheme was set up to include the self-employed, allowing them to determine their own contribution level either through lump-sum or regular payments. The self-employed also receive the Government’s member tax credits.
Member contributions have risen steadily since 2007, totaling more than $2 billion in 2015 with around $30 billion in assets invested.
What lawyers know
Let’s review the key benefits of KiwiSaver, since these don’t appear to be well understood. First, the Government pays an annual member tax credit of up to $521, provided your contributions are at least double this amount. The second benefit – one of the most well-known if you are employed – is the provision that your employer has to contribute at least 3% of your gross salary into your KiwiSaver account.
The percentage of compulsory employer contributions has gradually increased from the initial 1%. This is on top of your own employee contributions (which can be topped up with voluntary contributions). Some employers also elect to contribute more than the required minimum rate as a further employee benefit. It is on record that judges enjoy much higher contributions from their employer, the Crown. One participant described the judicial scheme as “KiwiSaver on steroids”.
Despite the obvious benefits for both employees and the self-employed, testing revealed that 41% of interviewees enrolled in KiwiSaver were unaware of the member tax credits and 27% were unsure of their balance, specific fund and contribution rate.
KiwiSaver funds on offer in the market differ according to asset class and risk exposure. There are five main KiwiSaver fund choices.
- cash (low risk) – bank deposits and other fixed-interest securities;
- conservative (low to medium risk) – high proportion in fixed-interest securities and bank deposits, with a smaller proportion in growth assets;
- balanced (medium risk) – more equal split between higher-risk growth assets, such as shares or property, and more stable assets, such as fixed-interest and bank deposits;
- growth (medium to high risk) – high amount in shares and property with a smaller amount in deposits and fixed interest; and
- aggressive (high risk) – Mainly shares.
New members who do not choose a KiwiSaver provider or fund are automatically allocated to conservative schemes run by Government-appointed default providers. The default schemes have been popular, as have conservative schemes.
Columnist Janine Starks aptly referred to default KiwiSaver schemes as a “dinghy with one oar”, commenting that default funds “were only designed as a temporary holding tank; a nice safe place to bob around in a life jacket. You are unlikely to sink and you won’t get far. We are then supposed to find a suitable boat and sail away with our choice of V-shaped hull, outboard motor, hydrofoils or international cruise liner. However, vast numbers of us have been bobbing around the marina for years. We either don’t realise there’s a boat to catch, or we need some help choosing one.”
Do lawyers keep abreast?
Next up was my quest to discover how financial news ranked on the radar for interviewees. I chose the Official Cash Rate (OCR) as a means of testing such awareness. The interest rate set by the Reserve Bank to meet inflation targets influences the price of borrowing money in New Zealand and provides the Reserve Bank with a means of influencing the level of economic activity and inflation. Eight times a year, the OCR review is well covered in the media. I therefore thought a question about the current OCR level would provide a good measure as to whether lawyers keep up to date with financial news.
What is the current OCR? 15% correct, 85% incorrect or not known.
These figures are revealing as just 15% gave the correct rate. Many of the remaining 85% acknowledged their answers were at best an educated guess. Most of those who answered correctly were property and banking lawyers, for whom the rate had a bearing on their work or clients. Only two answered the question correctly without hesitation – one, a retired judge, and the other, a Kiwi lawyer visiting from London.
Many professed to know what the OCR was, but couldn’t specify its current level. However, they often knew the general trend of either going up or being on hold. The OCR, and monetary policy in general, are clearly not directly relevant to lawyers, yet many seemed to know how it affected them.
Noticeably, Generation Y lawyers had no idea what the rate was, with a few sheepishly asking what it stood for. One senior property lawyer, with advanced financial literacy skills, managed to calculate the OCR backwards in less than a minute from his knowledge of the floating mortgage rate and average lending margins.
So, what did I learn about the ability of lawyers to make sound and informed financial decisions? My prediction that lawyers are smart, and not just legally smart, was certainly justified. If I hadn’t conducted face-to-face interviews and allowed clarification of the questions, the outcome may have been slightly different. However, leniency is appropriate here, in view of the fact that lawyers like to analyse.
The lack of KiwiSaver contributions (especially by partners in firms and other self-employed lawyers) and a corresponding lack of knowledge of the scheme (even from active members) were disappointing. Of course, this doesn’t mean lawyers have missed the boat on retirement saving. It may simply mean that for them the benefits are immaterial, especially in view of the absence of compulsory employer contributions. Lack of access to the funds before the age of 65 may also be constraining.
An awareness of current financial affairs, as measured by knowledge of the current OCR, highlights a lack of time or interest for lawyers to stay abreast of news in areas not immediately relevant.
The question remains whether this mixed bag of results sufficiently equips lawyers to make rational and informed decisions about money and their financial futures. Which is why in my next article I will discuss lawyers’ wealth-creating strategies.
Laetitia Peterson is a personal wealth adviser and is married to competition barrister Andrew Peterson. She is now the CEO (and founder) of The Private Office, helping successful lawyers achieve the financial goals important to them and their families.