Only 33% of Adults Are Financially Literate – Can You Pass the World Financial Literacy Test?

This was a study conducted by Standard and Poors about a year ago. A little dated, but our previous post (“86 Percent of Americans can not answer all of these questions – can you?“) from 2012 is a post that still brings in a lot of traffic years later. So I wanted to continue the financial literacy theme with a newer study and newer questions. This study questioned 150,000 people across 140 countries.

 

How many could get 3 of the following questions correct? World wide? Just 33% could answer. Americans were slightly better, but still a dismal 57% pass rate. Here are the questions, along with a detailed explanation of the answers. How well did you do? Miss a few? No worries, at the end we explain the answers in detail to ensure you understand the topic.

Why is Financial literacy important? It means knowing how to get the best return on your savings, it means understanding risks in your investments, it means a less likelihood of being scammed. Those with lower financial literacy pay more for loans, pay higher transaction fees and have higher debt on average. In my opinion, learning the ins and outs of your own finances is one of the surest ways to save and secure your money. So understanding these basic concepts is important. Take the test below to see how you stack up to the rest of the world:

 

Question 1: Topic: RISK DIVERSIFICATION

Suppose you have some money. Is it safer to put your money into one business or investment, or to put your money into multiple businesses or investments?
(a) one business or investment;
(b) multiple businesses or investments;
(c) don’t know

 

 

Question 2: Topic: INFLATION

Suppose over the next 10 years the prices of the things you buy double. If your income also doubles, will you be able to buy less than you can buy today, the same as you can buy today, or more than you can buy today?
(a) less;
(b) the same;
(c) more;
(d) don’t know;

 

 

Question 3: Topic: INTEREST

Suppose you need to borrow 100 US dollars. Which is the lower amount to pay back:
(a) 105 US dollars;
(b) 100 US dollars plus three percent;
(c) don’t know;

 

 

Question 4: Topic: COMPOUND INTEREST

Suppose you put money in the bank for two years and the bank agrees to add 15 percent per year to your account. Will the bank add more money to your account the second year than it did the first year, or will it add the same amount of money both years?
(a) more;
(b) the same;
(c) don’t know;

 

 

Question 5: Topic: COMPOUND INTEREST

Suppose you had 100 US dollars in a savings account and the bank adds 10 percent per year to the account. How much money would you have in the account after five years if you did not remove any money from the account?
(a) more than 150 dollars;
(b) exactly 150 dollars;
(c) less than 150 dollars;
(d) don’t know;

 

 

 

Answers below:

 

 

 

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How well did you fare? The answers are in bold and underlined below:

Question 1: Topic: RISK DIVERSIFICATION

Suppose you have some money. Is it safer to put your money into one business or investment, or to put your money into multiple businesses or investments?
(a) one business or investment;
(b) multiple businesses or investments;
(c) don’t know

 

 

The answer:

This questions tests on the understanding of diversification. I’m sure you have heard the phrase “Don’t put all your eggs in one basket.” Being diversified means not having all of your investments in “one basket”, which could mean 1 single company’s stock.

If you have $10,000 to invest, and you put all of that money into company ABC and the company goes bankrupt, you lose all of your money. Whereas, if you had split your money between ABC and 9 other companies (aka diversified your investments) you would only lose 10% of your money assume no other companies failed as well. This is why it is safer to split your investments up into multiple businesses over one single business. This is why index investing has become so popular. It requires no active participation from the investor, and their investments are split up into hundreds or even thousands of companies.

 

 

Question 2: Topic: INFLATION

Suppose over the next 10 years the prices of the things you buy double. If your income also doubles, will you be able to buy less than you can buy today, the same as you can buy today, or more than you can buy today?
(a) less;
(b) the same;
(c) more;
(d) don’t know;

 

 

The answer:

This question tests on a basic understanding of inflation. As the price of things rise, your dollars effectively lose “purchasing power”, meaning they don’t buy the same amount of things as they used to. This becomes a problem when investors have large amounts of their savings in cash, earning little to no return while the price of things go up. For example, a 30 year old with $100,000 in savings today may feel content knowing they have many years worth of living expenses in the bank. But the problem is that over the decades the purchasing power of that $100,000 will decline and not last as long as this saver had hoped. Look at house prices, food prices or automobile prices from 40 years ago and you will see the importance of your savings keeping up with inflation.

The answer for the question is the same because even though your income has doubled, so has the price of everything else, meaning your purchasing power of those dollars you earned have decreased by half.

 

Question 3: Topic: INTEREST

Suppose you need to borrow 100 US dollars. Which is the lower amount to pay back:
(a) 105 US dollars;
(b) 100 US dollars plus three percent;
(c) don’t know;

 

 

The answer:

This question test your ability to do a basic interest calculation. How do we calculate what 3% of $100 is? The formula is:

$f = $i * (1+r)

Where $f = the final amount

$i = the initial amount

and r is the interest rate, in decimal form (so 3% = 0.03)

 

So $f = 100 * (1+ 0.03) = $103, which is less than $105, so the answer is b.

Question 4: Topic: COMPOUND INTEREST

Suppose you put money in the bank for two years and the bank agrees to add 15 percent per year to your account. Will the bank add more money to your account the second year than it did the first year, or will it add the same amount of money both years?
(a) more; 
(b) the same;
(c) don’t know;

 

 

The answer:

This questions tests your understanding of basic compounding interest. The idea behind compounding interest is that as you save for long periods of time, not only does your original investment earn interest, but you also earn interest on the interest earned in previous years!

Look at the calculation for this question, using our formula from the answer to question 3 and assuming the investment is $100:

For year 1:

$f = $100 * (1 + 0.15) = $115

So the bank added $15 to your account in year 1. But the bank will not only add $15 to your bank next year, they will add more because they are now going to give you interest on your $115 instead of the original $100.

$f = $115 * (1+ 0.15) = $132.50

So the bank added $17.50 to your account for year 2.

Granted, small amounts and short time frames make the effects of compounding interest seem rather small. But what happens when instead of $100 we use $10,000, and instead of 2 years we use 20? We can use our Compound Interest Calculator to find out:

compound_interest_calc

 

As you can see the chart begins to grow exponentially as the years go by. In fact for this example, the interest earned between year 19 and 20 is over $21,000! 14 times more than the interest earned during year 1. That is the long term power of compounding interest.

Question 5: Topic: COMPOUND INTEREST

Suppose you had 100 US dollars in a savings account and the bank adds 10 percent per year to the account. How much money would you have in the account after five years if you did not remove any money from the account?
(a) more than 150 dollars;
(b) exactly 150 dollars;
(c) less than 150 dollars;
(d) don’t know;

 

 

The answer:

This question is testing your understanding of the concept of question 4. For the first year, the saver earns 10% on their $100, which is $10. But that money stays in the account and now for year 2 this saver does not earn $10 in interest again, but instead earns $11 because of the interest on that added $10.  We saw in the answer for 4 that interest begins to build on previously earned interest, and the same happens here. So you would end up with more than $150 because of compounding interest. Just how much would you end up with exactly? A little over $161:compound_interest_calc_2

 

How did you do? What topics tripped you up?

 

You can read much more on the study here:  S&P Global FinLit survey

 

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