To successfully accumulate retirement savings and then make that money last throughout retirement, a person needs to have some basic financial knowledge. The Wharton School Pension Research Council at the University of Pennsylvania developed a three question financial literacy test to determine the level of financial literacy in various populations.
A short financial literacy test
Here are the three financial literacy questions that comprise the test:
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.”
Information to answer test questions is basic and readily available
How did you do? (The correct answers are at the end of this post.) I suspect you probably scored 100%. Why? Because if you found this blog, you must have an interest in personal financial matters; that interest motivates you expand your knowledge of the subject. The information necessary to correctly answer the three questions, the affect of compound interest on savings, the impact of inflation on purchasing power, and the need to diversify investments, is readily available to anyone with the slightest interest in personal finance. You, no doubt, encountered this basic information early in your education on personal finance matters.
Test results in United States
With so much information available on personal finance, specifically retirement saving and investing, it is surprising that Americans over 50, who should have an interest in this subject, scored so poorly when given the test: only 50% answered the first two questions correctly and only 33% answered all three questions correctly. When the test was give to a more comprehensive sample representing all Americans, the results were essentially the same. Participants with more education fared better on the test, but still the scores were disappointing: 64% of those with a post-graduate degree answered all of the questions correctly, followed by 44% of college graduates, 31% of those with some college, and 19% of high school graduates.
Lack of financial literacy is symptom of deeper problem
The results prove the need for some kind of universal basic financial education, but the problem runs deeper than a lack of financial literacy: most Americans simply aren’t interested in managing their finances. Oh, they would like to have the fruits of effective money management; they just aren’t interested in the details. Most would much rather consume. And we Americans are expert consumers. We’re so good at it that we spend more than we earn. When it comes down to a choice between consumption or saving, immediate vs deferred gratification, most Americans want it now. Until that changes, a majority of Americans will continue to be financially illiterate—all the way to the poorhouse.
Answers: 1. a, 2. c, 3. b
K. C. Knouse is the author of True Prosperity: Your Guide to a Cash-Based Lifestyle, Double-Dome Publications, 224 pages