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24/03/2023

Author: Borko Božović, Director of the Directorate for Financial Stability and Payment Systems Oversight

Personal finance management includes the activities of an individual or a household in making decisions about consumption, savings and investments to achieve the highest possible income within the given risk level. In a narrower sense, it may refer to using the financial institutions’ services – most often banks – and acting on financial markets – stock exchanges. Broadly, it can refer to an individual’s all economic decisions, including e.g. plans to buy an apartment, car or other long-term consumer goods or to start your own business. Adequate personal finances management guided by adequate knowledge, information, and understanding of the income-risk relationship leads to a higher living standard, i.e. higher quality of an individual’s life.

Inter alia, an individual who manages his finances well will prefer keeping free funds not intended to invest in a bank account to a wallet or under a “straw box” as the money in the bank is safer, earns interest, and can use it for non-cash payments, which are safer and more efficient than cash payments.

Furthermore, such an individual will invest the surplus funds in some financial markets instruments – shares or bonds – or in real estate, art, or other forms of property. In doing so, he will endeavour to diversify investments, i.e. invest in several different forms of property and invest in several different variants of one property form. For example, when investing in shares, it will invest in the shares of several and not just one issuer. Thus, he will understand the relationship between the return and the risks each form of investment carries and will generally match the investment to his life needs and plans.

Then, such an individual will budget well when purchasing an apartment, car or other durable consumer goods by taking a loan when appropriate and looking for a bank that will grant him the most favourable lending terms. Moreover, such an individual will use life or non-life insurance services when applicable to his needs. When paying in the country or abroad, such an individual will choose the form of payment and payment service providers optimal in a given situation. In a broader sense, such an individual will act financially wisely in all wider economic or life decisions and activities, such as starting their own business or making decisions about education, professional career and training.

Generally, better personal finance management will lead to society’s prosperity, as numerous studies point to a positive correlation between the general education level quality and society’s economic well-being. More specifically, inter alia, better personal finances management implies increased financial intermediation as individuals will deposit more free funds in banks, purchase insurance services, or invest in investment or pension funds. On the other hand, increased financial intermediation implies wider opportunities for lending, i.e., redirecting surplus funds to those entities that need them. Moreover, stock market investments in primary issues of bonds or shares mean direct financing of entities (companies, states) that require funds.

In addition, financially literate individuals’ actions will also stimulate market competition among financial service providers, i.e. sending market signals about which of them is more competitive than others are. In part, financially literate individuals’ actions influence the creation of more realistic prices for various forms of financial or non-financial assets compared to what would happen without them. Inter alia, this reduces the likelihood of price bubbles on the stock or real estate markets or credit booms and consequently avoids financial crises, which usually involve increased state expenditures and social unrest. However, the price bubbles or credit booms mechanism is more complex. It includes the collective action and market imperfections phenomenon, so rational individual actions lead to undesirable collective outcomes. Therefore, even good financial literacy of individuals cannot eliminate situations of price bubbles or credit booms, but their frequency, degree and duration would definitely be less extensive.

An adequate and sustainable society’s economic prosperity brings better care for environmental protection. From an economic point of view, the question of preserving the environment is mainly a question of the so-called negative externalities, i.e. situations in which economic actions of certain entities produce damage to the natural environment and thus part or the entire social community, without fully considering the damage aspect or not considering it adequately in their economic actions. For example, in their economic processes, if a manufacturer or someone engaged in service activities incidentally creates a product harmful to the living environment (a so-called detrimental by-product), e.g. smoke, tailings or grit then the entity is much less profitable than it appears depending on the degree of harm and the harmful products it generates. In the end, if everything needed to eliminate the negative impact on the environment were calculated and paid, such an entity might be a loser who should disappear from the market. Or, a hydroelectric power plant constructed without taking into account the harmful impact on the environment, or one that has started and works without adequate investments in the dam and the system stability, thus increasing the risk of dam failure and large-scale flooding, is much less profitable than it seems or is even a loser and should not exist.

However, even without the already mentioned generally positive connection between greater financial literacy and social development and environment protection, an individual can influence the environment, combining financial literacy with environmental awareness and his understanding of environment protection as economic issues at last in more direct ways. Inter alia, such an individual can buy or construct a more energy-sustainable place of residence that for example uses solar panels or whose walls and windows preserve the internal temperature well compared to the external temperature influence. Moreover, he can buy a car that uses electricity as a partial or complete power supply. Furthermore, such an individual can deposit free funds with banks that finance green projects, invest in shares of investment funds investing in entities that implement green projects, invest directly in shares of companies developing green projects, or invest in the so-called green bonds issued by companies or state entities to obtain funds investing in green projects. For example, in recent years, payment cards have been developed that invest a small portion of the money in some environmental actions, e.g. planting a tree. In all this, the individual has a personal financial benefit and positively affects the wider social community and the natural environment.