How financially literate are you?
Every day, we make hundreds of financial decisions. Some are in-the-moment: Where should I buy my morning coffee? Others are long term: How should I invest for retirement? We weigh economic input (the cost of a latte, the return on an investment) and try to choose wisely.
That process — using economic information to decide how to spend, save, and grow your money — is called financial literacy.
How financially literate are you? Here’s a simple quiz from two leading economist-educators, Annamaria Lusardi and Olivia S. Mitchell, that will give you an idea.1
1. Suppose you had $100 in a savings account and the interest rate was two percent per year. After five years, how much would you have in the account if you left the money to grow?
a) More than $102
b) Exactly $102
c) Less than $102
2. Imagine that the interest rate on your savings account was one percent per year and inflation was two percent per year. After one year, with the money in this account, would you be able to buy:
a) More than today
b) Exactly the same as today
c) Less than today
3. Is the following statement true or false: Buying a single company stock usually provides a safer return than a mutual fund.
How did you do? In a survey of people age 18 and over, one-quarter gave a wrong answer on interest rates and compounding (the first question), more than one-third didn’t know the effect of inflation on buying power (the second question), and over half couldn’t answer the investment question (the third question).2
These questions are valuable because they cover the basics of saving and investing — concepts you want to understand in order to take advantage of financial opportunities and avoid expensive pitfalls. And there is a lot to learn. For example, even if you answered the question on compounding interest correctly, are you aware it leads to compounding income tax — which could have a significant impact on your tax liability?
Committing to being more financially literate is more than a feel-good endeavor. Experts say financial literacy correlates strongly to success in retirement planning, investing, managing debt, and accumulating wealth.3 And research shows that the most financially confident Americans feel less stress and enjoy life more. That’s why some high schools and colleges are adding courses to teach students the basics of budgeting, managing debt, and investing.
You can boost your financial literacy at any age, using self-help books and online tutorials and articles, like you can find on Living Confidently. Talking with a financial professional is another smart move. Even if you aced the quiz today, there are plenty of ways to increase your financial literacy and confidence.
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