Wednesday, July 23, 2014

Financial Literacy

As we near the switchover to Vanguard, we're getting folks coming into the office worried about losing money in the markets (which is understandable). But some of them have little idea how markets (basic math?) works. But apparently they have company:

... Annamaria Lusardi, a professor at the George Washington University School of Business, and Olivia Mitchell, a professor at the Wharton School of the University of Pennsylvania, have just published a comprehensive review of their own and others' work on financial literacy. To anyone who believes people generally understand how their debts and savings work, at least on a basic level, their article will be depressing reading.

Back in 2008, Lusardi and Mitchell designed three questions to test basic financial literacy. How basic? You be the judge:

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: [more than $102; exactly $102; less than $102; do not know; refuse to answer.]

2. Imagine that the interest rate on your savings account was 1 percent per year and inflation was 2 percent a year. After 1 year, would you be able to buy: [more than, exactly the same as, or less than today with the money in this account; do not know; refuse to answer.]

3. Do you think that the following statement is true or false? "Buying a single company stock usually provides a safer return than a stock mutual fund." [true; false; do not know; refuse to answer.]1

If you're wondering what the answers might be, they are: 1) More than $102. 2) Less than today. 3) False.

Here's how various populations around the globe did with the questions.

... The same questions have since been put to various samples of the U.S. population and to statistically representative groups in other countries. Only in Germany and Switzerland did a small majority (53.2 percent and 50.1 percent, respectively) get all three questions right. In the U.S., that figure was 30.2 percent; in Japan, 27 percent; and in Italy, 24.9 percent (which may go some way toward explaining why that country is perpetually in financial trouble).

In Russia, only 3.7 percent managed to answer all three questions correctly. ...

One of the things I've learned while doing this job is, knowing the basics of finance, investing and economics is very useful if you have a desire to make good decisions.

I've seen too many people make dumb economic decisions because they didn't have the information and knowledge necessary to make smart ones.

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