A new report testing American’s financial literacy proves how badly we’re in need of education on the subject.
In a new study conducted by the Teachers Insurance and Annuity Association of America Institute and the Global Financial Literacy Excellence Center called the New Measure of Financial Literacy, 1,043 Americans were asked questions testing their financial literacy. The test covered eight main areas of personal finance: earning, consuming, saving, investing, borrowing/managing debt, comprehending risk, insuring and go-to resources.
The results aren’t pretty.
We could do better
Only 16 percent answered at least 75 percent of the questions correctly, while 20 percent of respondents got 75 percent of the questions wrong. Folks above the age of 40 didn’t come out completely clueless. Those aged 44 to 59 answered 21 percent of the questions with “I don’t know” and 47 percent weren’t able to answer more than half of the questions correctly.
Millennials, however, did worse.
Of those aged 18–44, only 10 percent answered more than 75 percent of the questions correctly. Thirty percent couldn’t even get a quarter of the questions correct!
A whopping 35 percent of respondents only answered 25 to 50 percent of the questions correctly.
The “tough” questions
Where people had the most trouble was in comprehending risk. Only 39 percent of respondents answered questions in this field correctly. For example, one question looked like this:
There’s a 50/50 chance that Malik’s car will need engine repairs within the next six months which would cost $1,000. At the same time there is a 10% chance that he will need to replace the air conditioning unit in his house, which would cost $4,000. Which poses the greater financial risk for Malik?
Just a mere 41 percent of the respondents got this question right (the car repair). Nineteen percent answered incorrectly, and another 19 percent answered, “there’s no way to tell in advance.” Twenty percent answered, “I don’t know.”
The younger the respondent, the more difficulty they had understanding questions involving compounding interest. Here’s another question:
Anna saves $500 each year for 10 years and then stops saving additional money. At the same time, Charlie saves nothing for 10 years but then receives a $5,000 gift, which he decides to save. If both Anna and Charlie earn a 5% return each year, who will have more money in savings after 20 years?
Barely 44 percent of millennials answered accurately — Anna — while 27 percent answered, “I don’t know.” Come on, y’all!
More financial literacy = less financial fragility
Predictably, the report notes that having higher levels of proficiency in these areas of personal finance translate into:
1. Being less financially fragile by being more confident in raising $2,000 for an unexpected need
2. Having emergency savings
3. Having investments aside from retirement accounts
4. Being better prepared for retirement
5. Paying debts faster and being on-time with credit card and loan payments
To be fair, these results are kind of biased and hard to translate to the real world. What’s more is that risk is subjective. Honestly, if Malik would just save for the air conditioning unit, he would be saving for the car repairs at the same time. Money is fungible, meaning it can be used for a bunch of things, right?
Nonetheless, more education in personal finance results in a substantial improvement in financial literacy. Yet only a minority of schools in the U.S. mandate a personal finance class. Our education system cares more about kids taking geometry than learning how to balance a checkbook.
We should be well-versed in how money works early on in our lives considering the level of stress caused by financial realities.
Even Albert Einstein was humbled by the importance of financial literacy. He famously said, “Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.”
We need to stop treating personal finance as an elective in our lives and make it a priority. Honing our financial literacy and acting on it will undoubtedly yield a fat return.
Previously posted at GenFKD.