{"id":873,"date":"2024-04-17T13:45:29","date_gmt":"2024-04-17T11:45:29","guid":{"rendered":"https:\/\/www.rivistaeco.com\/?p=873"},"modified":"2024-05-27T19:46:54","modified_gmt":"2024-05-27T17:46:54","slug":"the-unknown-finance","status":"publish","type":"post","link":"https:\/\/www.rivistaeco.com\/en\/2024\/04\/17\/the-unknown-finance\/","title":{"rendered":"The Unknown Finance"},"content":{"rendered":"

The “Understanding Finance” column is aimed at readers interested in navigating the often intricate world of finance. It offers tools and simple rules to better understand its workings and thus avoid common mistakes.<\/span><\/i><\/p>\n

To many of us, finance may seem foreign, like something distant. Impersonal numbers in the closing credits of news broadcasts or found in the specialized pages of newspapers, except on those days when a market crash demands our undivided attention. Yet, our lives continuously require us to make financial decisions: whether and how much to save each month, how to manage savings, whether to go into debt to buy a property, a car, or a washing machine. These important decisions are anything but impersonal. It is personal finance. This column will address it in a straightforward manner, with the aim of providing additional tools to help people navigate the often intricate world of finance.<\/span><\/p>\n

The Rule of 72<\/b><\/h3>\n

We dedicate this first article to a rule that helps answer an important question: how long does it take for an invested capital to double at a given interest rate? Knowing this is very useful: it helps, for example, to understand how much money we can count on if we invest our savings and do not withdraw them for a few years. Or, how much we will have to repay if we take out a loan for a certain number of years. It seems like a complicated calculation (and it is), but there is a simple way to answer the riddle: the Rule of 72. Simply divide 72 by the interest rate. For example, it takes 24 years to double a capital invested at an annual rate of 3% (72\/3). And just over 14 years if it were invested at 5% (72\/5). Obviously, there is nothing magical about the Rule of 72, as there is nothing magical about finance. It results from a mathematical approximation, long known. Fra\u2019 Luca Pacioli (1445\u20131514), the inventor of double-entry bookkeeping, mentions it in his “<\/span>Summa de arithmetica, geometria, proportioni et proportionalita<\/span><\/i>” from 1494.\u00a0<\/span><\/p>\n

\"Figure
Source: Bruegel Research Center based on a European Commission survey (2023).
Note: The measurement of financial knowledge is based on five questions. Individuals are considered financially informed if they answer at least three questions correctly.<\/figcaption><\/figure>\n

In addition to being relatively easy to use, the Rule of 72 serves as an effective educational function because it makes it clear that the value of money over time grows rapidly, particularly if invested at a good interest rate. To reach 200 euros by investing 100, at an annual interest rate of 3%, it does not take 33 years (i.e., what we would get with the formula (200-100)\/3), but much less. Compound interest is the eighth wonder of the world in action, according to a quote attributed to Albert Einstein: interest earns interest, and the invested capital grows over time. Those who know it earn; those who do not, lose, said the great physicist. And that’s precisely the point: many people are unaware of the notion of compound interest. Lack of awareness of this “principle” is widespread in society, with sometimes marked differences between countries. Not understanding compound interest can lead to counterproductive choices, such as postponing the moment in which to start saving, thus losing the advantage of time. Or not investing in financial instruments with rates of return that can grow wealth over time. Or getting into too much debt. Knowing the Rule of 72 helps limit these errors.<\/span><\/p>\n

The Tools We Lack<\/b><\/h3>\n

This installment of “Understanding Finance” addresses a broader problem: the pervasive lack of financial knowledge. Italy ranks below the European average in financial literacy, as illustrated in Figure 1 from the report “The State of Financial Knowledge in the European Union,” co-authored by Maria Demertzis, Luca L\u00e9ry Moffat, Annamaria Lusardi, and Juan Mejino Lopez. The 2018 PISA survey on the financial literacy of 15-year-olds, conducted by the OECD, doesn\u2019t offer more comforting numbers, showing more pronounced gender differences in Italy than elsewhere, persisting even after accounting for differences in mathematical knowledge amongst boys and girls. Simultaneously, the survey indicates a somewhat lower level of financial ignorance among those who use financial tools, such as checking accounts and credit cards.<\/span><\/p>\n

Is the lack of financial awareness making more complex tools like stocks or mutual funds less accessible, or does investing in more complex products reduce financial ignorance? What, ultimately, are the consequences of having little financial knowledge on households’ saving and investment choices? Research paints a clear picture: financial ignorance is widespread, and the quality of personal finance decisions worsens as it increases. Based on such evidence, financial education has entered the polical agenda. Many countries, including Italy, have developed national strategies for financial education, which has recently become a compulsory school subject.<\/span><\/p>\n

Financial education is also promoted by regulatory and supervisory authorities as a complementary consumer protection tool. The approach varies between countries due to different legal traditions, from which regulations emerge, as well as supervisory practices. The increasing digitization of personal finance has heightened regulators’ interest in the role financial knowledge can play in reducing potential online frauds and scams. Meanwhile, the digital dimension and the rapid pace of innovation in personal finance reiterate the issue of financial advice and its delivery methods, and more generally, the trust that should surround all savings decisions that involve delegation.<\/span><\/p>\n

In these areas, what can financial education contribute? And more broadly, how can financial education help improve personal finance choices, even in complex areas like retirement savings, where decisions made today impact the distant future?<\/span><\/p>\n

In our column we will discuss the answers to these questions, which aim to provide informed insights to readers interested in gaining a deeper understanding of the workings of the personal finance product market, common mistakes, and how adhering to certain behavioral rules can lead to better decisions. Looking to the best international practices, we will adopt an approach aimed at highlighting the procedures of change and the challenges brought by financial innovation. We will also discuss the ways in which financial education can contribute to improving decisions and identifying the conditions necessary for this to happen. In doing so, we will start from the premise that financial education is not a substitute for regulatory and supervisory activities, rather a useful complement that strengthens the institutions’ efforts to protect savers. We aim to promote a rigorous approach to financial decisions in line with the studies we will be discussing. Knowledge and adherence to some rules\u2014simple as the Rule of 72\u2014ultimately help us take care of our money.<\/span><\/p>\n","protected":false},"excerpt":{"rendered":"

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