This post is part of a series on financial capacity assessment and teaching.
If we’re going to assess (and teach how to assess) financial capacity then we should be clear on the construct of financial capacity itself. What is it? Marson (2016) provides a good review of the literature of the various ways to understand what we might mean by the financial capacity.
Here’s my summary:
(1) Financial capacity is the degree to which an individual can manage independently
Lawton and Brody (1969) introduce the notion of ADLs and iADLs used throughout medicine to this day: the “activities of daily living” a person must execute for their physical maintenance and independence. The “ability to handle finances” is one of the instrumental activities. For an activity, an individual is either fully independent, partially dependent, or fully dependent on others. An individual who is fully dependent on others for managing their finances is deemed to be incapable of doing so. In this view, financial capacity is purely functional and purely determined by the extent to which a person can manage alone or not. There is no consideration of how why they are relying on others, how well they are managing, or any explicit assessment of the skills or thinking the individual is doing. It’s simple, and ostensibly easy to assess: you just need to look at who the person relies on for help and how much of their daily financial tasks they do on their own.
(2) Financial capacity is real-world financial performance
In a similar vein, Medicine & National Academies of Sciences (2016) propose a view of financial capacity that is also functional and intuitive. The emphasis is on “real world” function not only independence. That is, financial capacity it is the degree to which an individual is surviving and thriving financially in the real world in the face of real world problems. A financially capable person is one who is thriving and, I suppose, an incapable person is not. I haven’t looked at the source document, but from Marson (2016)’s description, this seems like a very under-determined model — it’s not clear what exactly “real-world” financial performance really means, how to measure it, or how this model accounts for other aspects of a person or their social context (e.g. disability, status, race) that might interfere with their ability to thrive.
(3) Financial capacity is having the skills required for independence
Marson et al. (2012) take a more reductionist and skills-based view. Financial capacity is decomposed into necessary and sufficient skills to manage finances and live independently. In many ways, it is an elaboration of the Lawton and Brody model, but they add the extra stipulation that there are also skills needed to live free from coercion (e.g. not susceptible to fraud and to be able to act in one’s best interests). They propose a set measurable skills, such as procedural skills (e.g. the ability for basic arithmetic, and the ability to conduct cash transactions) and higher level skills such as making wise investment decisions and detecting coercion attempts. Their model treats financial capacity as a fixed set of skills shared by everyone who is capable, and does not look at an individual’s context and adaptive functioning (e.g. despite being poor at arithmetic, can they adapt by outsourcing this skill to a calculator, computer or another person).
(4) Financial capacity is having both knowledge and skills for independence
In a slight elaboration of the above conceptualization, Marson reviews a cognitive view on financial capacity that proposes capacity is having the right financial (1) declarative, (2) procedural and (3) judgmental knowledge (i.e. have “financial situational awareness”). In a slogan, to have capacity means you have to know that, know how, and know why when it comes to your financial management. Similar to Marson et al. (201), this view neglects to assess aspects of real-world performance and adaptive function.
(5) Financial capacity is the ability to make reasoned financial decisions
Grisso and Applebaum (1998) lay out a model of decisional capacity that is very familiar to anyone in medicine and law. In their view, financial capacity is the ability to make decisions. This ability has four parts:
- Evidencing a choice (yes or no) regarding a decision (Choice)
- Understanding the decisional situation and choices (Understanding)
- Appreciating consequences to one personally of a particular choice (Appreciation)
- Reasoning about choices in the decisional situation (Reasoning)
Precisely what these aspects of capacity are and how to assess them is left as an exercise for the reader. These are all abstract ideas that require judgment calls as to their presence or absence. In practice, the skills and cognitive abilities of earlier models (e.g. arithmetic ability) are used to determine capacity (in particular of understanding). Even ‘real-world” performance can be used as a proxy for a person’s appreciation of their decisions (e.g. a person whose life is in financial disarray might speak against their claims to appreciate the consequences of their choices). Unlike some of the other models, this model tends to be used more as an aggregate threshold model: either a person has financial capacity or they do not.
However, capacity is typically individualised and specific: it ss the capacity to make the particular financial decisions in front of the individual that is in question, not some abstract idea of capacity as seen in, say, the Marson et al. (2012) model, That said, in the decisional view, one does not consider absolute performance on various skills or whether a person acts in their best interests or not (e.g. as long as the have the capacity to appreciate the consequences of their decisions, they are deemed capable). Autonomy is key.
I’ll have a lot more to say about this model because it is the model used in medicine.
(6) Financial capacity is the ability to make financial decisions with personal integrity
Litchenberg et al. (2015) propose a much more humanistic and person-centred idea of financial capacity. In their view, they look at the integrity of personal “sentinel” financial decisions to assess how well these adhere to a person’s known values and best interests across time. This model is somewhat of an extension to the decisional model but adds the requirement to assess the individual’s vulnerability to exploitation and adherence to their personal values. Like some of the other models, it seems intuitive but I wonder how easy it is to apply these abstract concepts in practice.
In summary, there are the performance models of financial capacity, such as Lawton and Brody’s capacity-as-independence, or the M&NAS’s capacity-as-real-world-performance to judge an individual’s capacity by their level of practical functioning. There are the process models of Marson et al. 2012’s capacity-as-skills or the capacity-as-a-cognitive-process that attempt to breakdown capacity into constituent skills that can be assessed in the laboratory. Finally, there are the integrative models of Grisso and Applebaum (1998) and Litcheberg at al. (2105) that look at both performance and process aspects of financial management, and elevate humanistic features of capacity such as autonomy and personal values as part of capacity.