Four Powerful Benefits of Financial Self-Awareness
Our research finds knowing one's financial condition is crucial.
Posted October 28, 2019 | Reviewed by Lybi Ma
“Knowing yourself is the beginning of all wisdom.” - Aristotle
I have written before on this blog about the value of financial knowledge in producing positive financial outcomes. Numerous statistics from social science studies attest to the poor financial knowledge of American consumers, and the significant downsides that occur from the lack of knowledge.
But what exactly does it mean to be financially knowledgable? When considering financial knowledge, many psychologists and public policymakers focus on financial literacy, defined as an understanding of basic economic principles and financial concepts such as how interest rates work, the effects of inflation on savings, the differences between individual stocks, bonds, and mutual funds, and so on. However, there is another type of financial knowledge, which is just as important, if not more so. We call this knowledge: Financial self-awareness (FSA).
What is financial self-awareness?
FSA is a specific type of knowledge about personal finances that is distinct from financial literacy. It concerns how well the person knows their financial situation. In our research (conducted with doctoral candidate Nivriti Chowdhry), we formally define FSA as the “personal knowledge about one’s current financial assets, liabilities, and spending patterns.” We developed a questionnaire to measure FSA, which includes a total of 19 questions, about everything from total net worth, monthly before and after-tax income and retirement fund to student loan debt, and benefits from a life insurance policy.
In a nutshell, we found that having a higher FSA (and raising it) is a good thing. Here are four significant benefits of FSA we found in our research.
1. Financial self-awareness is associated with higher financial self-efficacy.
Self-efficacy is an important psychological concept. Defined as the beliefs regarding one’s capabilities for a particular task or endeavor, self-efficacy has been shown to have multi-faceted benefits, from experiencing a greater interest in life activities and greater commitment in chosen goals to quicker recovery from setbacks.
In our research, we found that a higher degree of self-awareness about one’s finances translates into feedback about past successes and failures with money, lower uncertainty about the strengths and weaknesses of the current finances, and clarity regarding how to move forward. We pointed out that “once one knows their [financial] situation, they will feel confident in how to maintain and improve it.”
2. Financial self-awareness is associated with more persistence in sticking to a repayment plan and paying off more debt.
In one study, we examined the role of FSA in predicting the persistence of financially distressed individuals in debt repayment and continued participation in a Debt Management Plan over 13 months. We found that after controlling for demographic variables such as gender, age, marital status, race, and educational attainment, people who spent more time up-front in understanding their financial situation in an initial counseling session with a trained financial counselor were more likely to remain in the program, and pay more of their debt 13 months later.
3. Financial self-awareness is associated with greater financial satisfaction and more prudent spending and investing decisions.
In another study using data from the 2015 National Financial Capability Study, we found the survey participant’s FSA was positively associated with their satisfaction with their current financial situation, keeping their spending below their income, having a budget, regularly contributing towards retirement savings, and having an emergency fund enough to cover three months of expenses in case of job loss, sickness, or another emergency. Essentially, knowing one’s financial situation goes hand-in-hand with making good financial decisions and having peace of mind about money.
4. Financial self-awareness amplifies the effectiveness of financial literacy on financial outcomes.
The body of psychological research on the value of financial literacy provides a mixed picture of its value. A well-cited meta-analysis of 201 studies examining the relationship between financial literacy and downstream financial behaviors found that interventions to improve financial literacy explained just 0.1 percent of the variance in financial behaviors. In our research, we found that FSA amplified the effects of financial literacy on saving and investing behaviors of individuals. This suggested that knowing how personal finances work is not enough; it is also important to know one’s financial situation. With both types of knowledge in tandem, positive financial outcomes are more likely.
Our research findings show the value of financial self-awareness. Taking the time to fully understand how much and which financial assets and liabilities one has, plus one’s spending, saving, investing, and giving patterns, is a useful thing to do. Without knowing one’s financial situation well on an ongoing basis, it is hard to make sound financial decisions, feel financially secure, or prepare for retirement.