Financial vulnerability has been described as the inability to recover from sudden financial shock, such as an unexpected loss of income or uncontrollable increase in expenditure.
Whether noticing walking down city streets, or feeling the impact closer to home, financial vulnerability can affect most of us at some point in our lives. It may be temporary, sporadic or even permanent. Rather than either being financially vulnerable or not, our vulnerability is more like a rating. It is fluid rather than static. Just as our credit rating changes based on our income, how we handle money, when we borrow, make a late payment etc., our level of financial vulnerability as consumers also changes over time.
It is heartening that ASIC is taking initiatives toward developing a better understanding of vulnerability. But what can be done to reduce financial vulnerability?
Why it is important to identify financial vulnerability
Nationally, high financial vulnerability and high levels of debt are often precursors for financial crisis.
Australian’s are not ready for a rainy day. According to a recent CoreData survey, close to a quarter of us have no financial back-up plan for dealing with a period of unemployment or time away from work. More than one in four (26.6 per cent) said they either did not save anything in a normal pay cycle or spent more than they earned. Thirty per cent said they struggled to cover their personal debt comfortably, at least some of the time. As such we are more susceptible to the negative impacts of financial vulnerability.
Higher levels of income do not guarantee exemption from financial vulnerability. A recent Italian study examined two leading indicators of financial vulnerability, the first where household debt-to-income ratio exceeds 30 per cent and income is less than median income, and the second where the sum of household income and liquid financial assets is not sufficient to cover debt payments and basic living costs for four months. These correlating factors were still unable to identify 35% of mostly higher income at risk individuals, who went on to experience high financial vulnerability.
Factors contributing to financial vulnerability
Financial vulnerability can be influenced by demographic factors including income level, marital status, age, and level of education. Within each household, a child is more vulnerable than their parents, and the primary income provider less vulnerable than other household members. The most financially vulnerable are youth with lower education levels, whose financial behaviour leads to poor money management.
Demographic influences aside, based on published research, factors contributing to our financial vulnerability can be either psychological or behavioural.
- More consistent and higher levels of anxiety about their financial situation
- Lack of financial knowledge. Financially vulnerable individuals tend to have lower levels of financial literacy. Not knowing your current financial position (irrespective of the actual financial position) is also associated with negative financial behaviour.
- Feelings of fear, frustration, and hopelessness, which can have negative impacts on their health
- Living pay to pay increases the feelings of uncertainty about the future. This uncertainty can lead to risky behaviour in other areas such as taking drugs.
- Low or inconsistent income. People of any income level can be financially vulnerable. However, most at risk are those with income consistently below the poverty line, or income that fluctuates wildly month to month.
- High level of debt to income.
- Irregular employment. Employment which varies frequently, or a stable job with fluctuating hours, introduces instability and increases vulnerability.
- Lack of emergency funds.An emergency fund of 3-6 months’ income can provide a cushion against financial shocks and reduces financial stress and anxiety.
- Lack of social support. Even if things go pear-shaped, people who have family or close friends who will provide them financial support are financially resilient. Their social circle will help them bounce back. People with this social network feel better protected and tend to make more confident financial decisions.
What can I do?
A high level of financial vulnerability is a sign that your financial situation is unstable, with little safety margin. Understanding the factors influencing your financial vulnerability and learning that at least some of them are within your control is the first step towards reducing financial vulnerability. You can take steps to better understand your own financial position, avoid taking on bad debt, build your emergency fund, strengthen your social network, and increase your financial literacy through programs such as Money101 Financial Wellbeing.
Money101 have been delivering product-free, jargon-free online financial education since 2004. Our Financial Wellbeing program is designed to empower Australians to make better financial decisions, a workplace solution delivered online, anytime on any device.