More Depressing Information

As if my perception of the financial ability of the average American wasn't bad enough, now comes this piece from US News. They cite a National Bureau of Economic Research study where 1,488 adults were asked three questions to assess their financial literacy. The questions:

1. Suppose you had $100 in a savings account and the interest rate was 2 percent per year. After 5 years, how much do you think you would have in the account if you left the money to grow?

a. More than $102

b. Exactly $102

c. Less than $102

2. Imagine that the interest rate on your savings account was 1 percent per year and inflation was 2 percent per year. After 1 year, how much would you be able to buy with the money in this account?

a. More than today

b. Exactly the same

c. Less than today

3. Please tell me whether this statement is true or false. “Buying a single company’s stock usually provides a safer return than a stock mutual fund.”

a. True

b. False

The correct answers are at the end of this post.

Now here's the depressing part -- the results:

Fewer than a third (30 percent) of those surveyed got all three questions correct and under half (46 percent) were able to correctly answer both the interest rate and inflation questions. The third question about risk diversification gave respondents the most difficulty, with only about half (52 percent) of this representative sample of the U.S. population getting the answer right, compared to 65 percent and 64 percent respectively for the first two questions. “In view of the complex financial decisions that individuals confront in the current economic environment, these are discouragingly low success rates,” write researchers Annamaria Lusardi and Olivia Mitchell in the report.

And the kicker:

But despite the poor performance, almost 70 percent of respondents say they believe they are above-median with regard to financial knowledge.

In case you're wondering, yes, it's impossible for 70% of the people to be above the median in anything. So again we have the same signs when it comes to Americans and financial ability: on average they don't know much but they think they're doing better than most. Ugh.

Now look at those questions again. They are not hard at all. In fact, they are pretty easy. And yet only 30% got all three correct and not even half answered the first two (the easiest two questions) correctly. Is it just me or does anyone else think that Americans need a big dose of financial education?

Answers: 1.a 2.c 3.b

Comments

[STRONGside]

I completely agree with you. Granted, your statement at the end that these questions are "pretty easy" is relative as you proved in your article, however for us readers here on Free Money Finance, I would assume that the answers to all three of these questions seem fairly basic. I work in a large public university in the student financial office, and I don't have encouraging news for our next generation of college grads either. I have been promoting our financial literacy program for a long time now, and it really is depressing to see the level (or complete lack therof) financial knowledge among college students. I've long pushed for a financial literacy or personal finance class to be added as a requirement for graduation with no luck, but I am still hopeful and would love to hear if anyone else has ever considered this.

[thehouseflipguy]

Interesting test. Of course the first 2 could be termed as math type questions as much as finance, however, they should still be easily answered.

It does seem as if we need to educate ourselves more because the dynamics of this country are changing. I think people are fooling themselves if they believe they will have the same standards of living in retirement if they do not make some tough decisions now.

[Paul]

Fifth graders should be able to answer these. Sheesh.

[FMF]

Paul --

So I guess most people aren't smarter than a fifth grader, huh? ;-)

[Morten]

While the first two questions are math questions and has a definite answer, the answer to the third question is actually "it depends". If you know what you're doing, your money is both safer and will provide a higher return in a single company than in mutual funds. That's how Warren Buffet made his fortune.

[The Poker Meister]

Good post. The engineer in me wants to point out the following, though:
"yes, it's impossible for 70% of the people to be above the median in anything"
It's completely possible when the total amount of people surveyed is less than the total amount of all people.

Therefore, it is possible to achieve 100% above median, so long as those surveyed are a smaller subset of the overall population; i.e. 2 surveyed out of a population of 100, where the 2 surveyed happen to be in the 75th percentile.

[FMF]

Poker Meister --

I was referring to the total population when I made that comment...

[Sunil from The Extra Money Blog]

mind boggling. i need to become a financial planner i guess - i'd be a millionaire. now if i can only convince everyone to hire me

[The Poker Meister]

While surprising that most respondents (70%) got at least one question wrong (we have a sad state of financial education in this country), the bigger statement is that most people overvalue their own expertise. I'm not sure whether it's a product of our "everyone is special" upbringing, but I can't believe that 70% of people "believe they are above-median with regard to financial knowledge".

For all I know, perhaps there is some truth in that statement; didn't I read somewhere that around 30% of lottery players believe that the lottery is a valid form of securing their retirements?

[Face palm]

[themillionairerecruit]

This is proof positive why the vast majority of Americans have no business managing their retirement money. It could be perceived as an argument for defined-BENEFIT pension plans except that the "professional" investors running many of those plans are just as inept.

It is also hopeless to try and teach personal financial management at the high school level because students just can't relate to the lessons and forget them or simply do not value what is being taught because it is not yet relevant to them.

We have no one to count on but ourselves to become financially literate and we are letting ourselves down!

[cashflowmantra]

These are the "greater fools" that allow bubbles to happen.

[MC]

I'm not surprised that most people are bad at math.

And every single man I've ever met thinks he is way smarter financially than most people. Even if he is broke, in debt, bankrupt, whatever--they all think they're financial geniuses. Human nature, I guess.

[Bad_Brad]

I totally agree with STRONGside's idea. I think basic skills like balancing a checkbook, creating and adhering to a family budget, understanding debt and interest rates, etc should be taught at the high school level as part of home economics. It seems like these are basic skills that every American should have (or should at least be taught) but clearly every American does not have (and is not taught).

Then, in college, cover concepts like risk and return, inflation, asset allocation, investment management, etc. These will be critical for college graudates that have any significant amount of money to invest.

[JM]

This is just plain depressing to read.

[Matt]

Stupis is as stupid does.

[Funny about Money]

Morten's right in saying these are actually very easy arithmetic questions. It's not so much financial education as math education that's lacking. If a person doesn't understand basic arithmetic, no amount of teaching him or her to balance checkbooks, construct budgets, and think about debt and interest rates is going to promote understanding of personal finance.

It's sad.

Viewed from this point of view, y'know...we could infer that the late, great real estate bubble resulted not from greed but from plug-poor public education. As a nation, we're reaping what we sowed.

[Mike - Saving Money Today]

Truly sad. Those are really basic questions that everyone should know.

[Tina Gold]

It is shocking how little some people understand about basic math but it is scary that these people are expected to understand complicated financial products and make the right choices.
Finance companies take advantage of this ignorance all the time though they would never admit to such a thing.