Financial Literacy

Consider the following three questions (from Lusardi and Mitchell):

1. Suppose you had $100 in a savings account and the interest rate was 2% 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% per year and
inflation was 2% per 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.’

T. F. Do not know. Refuse to answer.

Sadly, most Americans rate themselves high on financial acuity but they cannot answer all three questions correctly.

Only about a third of Americans answer all three questions correctly (and that figure is inflated somewhat due to guessing). The Germans and Swiss do significantly better (~50% all 3 correct) on very similar questions but many other countries do much worse. In New Zealand only 24% answer all 3 questions correctly and in Russia it’s less than 5%.

Some of the variation can be explained by experience. The Japanese, for example, don’t have much experience with inflation in recent decades and they perform poorly on that question. The questions, however, can hardly be considered esoteric and a large literature indicates that the ability to answer these questions correlates with the ability to intelligently make real and important financial decisions regarding mortgage refinancing, credit card borrowing, and retirement planning.

Most states now require that financial literacy be taught to high school students and there is some evidence that teaching financial literacy improves financial outcomes later in life but the evidence is not strong and most teachers still feel that they are unqualified to teach the basic concepts.

In my opinion, improving financial literacy is one of the areas in which principles of economics teachers can make a great contribution to their students. Modern Principles, my text with Tyler, contains extensive material on these topics including a chapter on stock markets and personal finance but more needs to be done.

Addendum: Take the quiz here (with a few more questions). Hat tip: PD Shaw and Tim Ogden for an added link.