As part of the 2004 Health and Retirement Study, there was a survey for Financial Intelligence. How much do people really know about the most basic financial principles? That’s what Annamaria Lusardi, in collaboration with the economist Olivia Mitchell, set out to learn. They came up with three survey questions. The results realized roughly 70 percent of Americans are financially illiterate.
Let’s see how YOU do!
1. Question one is about compound interest and assessing numeracy“Suppose you have $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
D) I don’t know
The correct answer is: A) “More than $102”. Because 2 percent interest on $100 in a year is $2, so after year 1 you have $102 — and then over the remaining four years, the interest grows on that $102, and so on. And that is why compound interest has been called “the eighth wonder of the world.
2. Question two is about inflation: “Imagine that the interest rate on your savings account was 1 percent per year and inflation was 2 percent per year. After one year, how much would you be able to buy with the money in this account?”
A) More than today
B) Exactly the same as today
C) Less than today
D) I don’t know
The answer is: A) “Less than today” because if inflation is 2 percent, prices go up 2 percent. But if you only earned 1 percent in your savings account, you basically can buy less.
3. Question three has to do about risk diversification: “Do you think the following statement is true or false: Buying a single company stock usually provides a safer return than a stock mutual fund.”
Do not know
The correct answer is False: Buying a single stock is NOT safer than buying a mutual fund, because a single company is a lot riskier than a basket of stocks. Don’t put all of your eggs in one basket!
Okay, how you’d do? Did you get all three right? If so, that would put you in a distinct minority.
That’s right: Lusardi found that only around 30 percent of the respondents got all three questions right. The numbers are pretty similar around the world, even in other rich countries. In the U.S., financial literacy has some distinct demographic differences: “those facing most challenges,” Lusardi and Mitchell wrote, “are the young and the old, women, African-Americans, Hispanics, the least educated, and those living in rural areas.”
Text taken from Stephen Dubner’s Freakonomics podcast ~ “Everything You Always Wanted to Know About Money (But Were Afraid to Ask)” Listen to the whole podcast.