Three basic questions of financial literacy

[MillCreek]

https://www.marketwatch.com/story/can-you-answer-all-six-of-these-simple-questions-2020-09-21

Here are these three basic questions for which the researchers report “shockingly low” levels of financial literacy. They were devised a decade ago by Lusardi and Olivia Mitchell, a professor at the Wharton School of the University of Pennsylvania, and have been so widely used since then that many researchers now refer to them as the “Big Three” of financial literacy. (The correct answers, should you have any doubt, are listed at the end of this column.)

• Suppose you had $100 in a savings account and the interest rate was 2% per year. After five 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; Don’t know; Prefer not to say]

• Imagine that the interest rate on your savings account was 1% per year and inflation was 2% per year. After 1 year, how much would you be able to buy with the money in this account? [More than today; Exactly the same; Less than today; Don’t know; Prefer not to say]

• Buying a single company’s stock usually provides a safer return than a stock mutual fund. [True; False; Don’t know; Prefer not to say]

But can you answer the following three bonus questions as well? Only 7% of older adults could answer all six questions correctly, and just 3% of millennials. These three additional questions are:

• If interest rates rise, what will typically happen to bond prices? [They will rise; They will fall; They will stay the same; There is no relationship between bond prices and the interest rate; Don’t know; Prefer not to say]

• Suppose you owe $1,000 on a loan and the interest rate you are charged is 20% per year compounded annually. If you didn’t pay anything off, at this interest rate, how many years would it take for the amount you owe to double? [Less than 2 years; At least 2 years but less than 5 years; At least 5 years but less than 10 years; At least 10 years; Don’t know; Prefer not to say]

• A 15-year mortgage typically requires higher monthly payments than a 30-year mortgage, but the total interest paid over the life of the loan will be less. [True; False; Don’t know; Prefer not to say]

[Ben]

In the world of today, I would expect low understanding of the last three questions. But the first three? Anything less than 90% getting them right is just a failure of the public education system. Especially the 16% of millennials. Or maybe the boomer percentages are worse, because that was second grade math in my day.

[Devonai]

I would love to switch my 30-year mortgage to a 15-year, so I know at least one of them already. 

[MechAg94]

I don't remember learning all the interest rate calculations in high school.  There may have been classes that taught it, but not in algebra and trigonometry.  However, we did have a Engineering Economics class in college that went through that as well as rate of return calculations.  I am very glad I learned that.  It isn't very hard math, but it is a bunch of simple calculations piled on top of each other such that it looks very complex.  Then again, a big part of mathematics is breaking down big problems into multiple simple problems.

If I had to teach it, I would suggest someone just set up a payment spreadsheet.  I figure more people could explain some of those questions given time and if they were forced to actually think about it.  Put on the spot, they would blank out.

[ConstitutionCowboy]

Welp! I discovered I don't know much about bond prices. All else was easy for me.

Woody

[Ben]

Welp! I discovered I don't know much about bond prices. All else was easy for me.

Woody

That is the one question from the list that I would not expect to be intuitive. Unless you have actually read up on finances and investing, or otherwise heard about it, there's zero reason you would know the (general) rule regarding stock and bond relationships. Just like I wouldn't expect non-gunnies to know the relationship of barrel length and velocity.

[lee n. field]

Got the first 3 right.  The one about 15 vs. 30 year mortgages I knew.  (We had a 15 year mortgage.)  The others, no.

[bedlamite]

I got all of them. I don't know why, but I know the bonds and interest rates have an inverse relationship.

[sumpnz]

Pretty easy questions.  Only one I had to think about a little was the doubling time one, and that only because I ran the "rule of 72" calculation in my head before noticing the range available in the answer.

[zxcvbob]

I would love to switch my 30-year mortgage to a 15-year, so I know at least one of them already.  

You can, just calculate the difference in the payments and send in the larger amount each month.  (make sure the overage is applied to the principal and not added to the end. But state law probably protects you there)

I wasn't sure I could commit to the payments for a 15 year loan, so I got a 20 year and vowed to myself to pay it off like a 15; but if times got tough I could fall back to the lower payments for a while.  I paid it off in 12.   ETA: That was a guaranteed 7.6% rate of return, so I wasn't putting much in my retirement accounts yet.  I caught those up later.  That example might not make sense today if your mortgage rate is low enough.

[tokugawa]

<I>" Only 7% of older adults could answer all six questions correctly, and just 3% of millennials. </I>"

 This is why we are doomed. Ignorance. Reading the stories about how majorities of new college grads think marxism is great, and never heard of the cold war or the gulags, and how slavery only ever existed in the US, and how white men stole the world, and on and on-
 
 We are doomed by the ignorance. And all reinforced by self esteem. Like  Von Hammerstein's fourth category- stupid and industrious. 
 About officers:

    I distinguish four types. There are clever, hardworking, stupid, and lazy officers. Usually two characteristics are combined. Some are clever and hardworking; their place is the General Staff. The next ones are stupid and lazy; they make up 90 percent of every army and are suited to routine duties. Anyone who is both clever and lazy is qualified for the highest leadership duties, because he possesses the mental clarity and strength of nerve necessary for difficult decisions. One must beware of anyone who is both stupid and hardworking; he must not be entrusted with any responsibility because he will always only cause damage.
 

[kgbsquirrel]

<I>" Only 7% of older adults could answer all six questions correctly, and just 3% of millennials. </I>"

 This is why we are doomed. Ignorance. Reading the stories about how majorities of new college grads think marxism is great, and never heard of the cold war or the gulags, and how slavery only ever existed in the US, and how white men stole the world, and on and on-
 
 We are doomed by the ignorance. And all reinforced by self esteem. Like  Von Hammerstein's fourth category- stupid and industrious. 
 About officers:

    I distinguish four types. There are clever, hardworking, stupid, and lazy officers. Usually two characteristics are combined. Some are clever and hardworking; their place is the General Staff. The next ones are stupid and lazy; they make up 90 percent of every army and are suited to routine duties. Anyone who is both clever and lazy is qualified for the highest leadership duties, because he possesses the mental clarity and strength of nerve necessary for difficult decisions. One must beware of anyone who is both stupid and hardworking; he must not be entrusted with any responsibility because he will always only cause damage.
 

I never knew my laziness could be considered a positive character trait.   

[Fly320s]

I went 5 for 6.  I didn't bother to figure out the time to double the money.

[Cliffh]

Took a guess on #5, got 6 out of 6.

This is why we are doomed. Ignorance. Reading the stories about how majorities of new college grads think marxism is great, and never heard of the cold war or the gulags, and how slavery only ever existed in the US, and how white men stole the world, and on and on-

So true.  Also sad.  And scary.

[K Frame]

OK, the first two questions aren't "financial literacy," they're basic math.

But. not really surprising.

A few years ago I had to explain the difference between ARP and APY to a very smart, very well educated friend. He had no real clue how the APR worked to get to the APY. I used a very simple example to show him.

Some of this stuff used to be taught in high school civics classes, but not all of it. And given the change in educational standards over the last 40 years, it's not surprising that a lot of this stuff has been removed.

But, I seriously doubt that anyone who hasn't been in the "real world" and handing their own finances for awhile to get even half of them correct. I couldn't have answered the question about individual stock vs mutual fund until I was well into my 30s because I hadn't started investing and I had little concept of how mutual funds worked.

[HankB]

Five of the six questions were trivial, the bond prices one I only knew because I'd seen the financial talking heads on TV discussing it on many occasions.

As for the majority of millennials being unable to "pass" this test . . . well, a good percentage of millennials are unable to either read or write in cursive. Which is a sad indictment of our educational system. (But at least they have plenty of self esteem.)

[Brad Johnson]

Five of the six questions were trivial, the bond prices one I only knew because I'd seen the financial talking heads on TV discussing it on many occasions.

As for the majority of millennials being unable to "pass" this test . . . well, a good percentage of millennials are unable to either read or write in cursive at all. . Which is a sad indictment of our educational system. (But at least they have plenty of self esteem.)

There, fixed it for you.

A big chunk of Millennials are barely able to string a sentence together, much less do it in cursive. They don't know basic multiplication tables, they've no concept of proper spelling or grammar, they lack basic crisis management skills, and they have absolutely no sense of perspective when it comes to problems versus inconveniences. It's appalling.

Brad