Marin Community Foundation
Flunking Finance
Research

Financial Literacy Is Still Abysmal Everywhere

Originally published by Wall Street Journal [link] on October 12, 2016

John Maynard Keynes advocated setting policies assuming people suffered from “money illusion”—confusing changes in their nominal income with changes in their buying power when prices were rising or falling.

A brilliant mathematician himself, Keynes was too optimistic. The bigger problem for policy makers, today at least, appears to be money confusion: the inability of most people to perform basic financial calculations or understand basic investment principles.

A new OECD survey of over 25 countries reveals very few people understand simple investment rules.

Barely more than 40% of the almost 52,000 adult respondents across 30 countries knew whether a $100 savings account compounding at an interest rate of 2% a year would grow to more or less than $110 over five years. Only 60% had any sort of budget, half bothered setting financial goals and trying to achieve them, while only 44% shopped around when selecting a financial product.

Out of a maximum score of 21—made up of scores for financial knowledge, attitudes and behavior—the average was 13.2, barely more than a pass. Among the big countries participating, France, Finland and Norway were at the top, with scores near 15, while the Brazilians, Russians and Poles scored around 12 or below.

Not surprisingly, the OECD has recommended schools put more emphasis on financial education, and at an earlier age, and try to foster good habits and attitudes. “It is essential that people have a strong foundation in basic calculations such as simple percentages, and rules of thumb that they can apply confidently to help them with financial decisions requiring higher-order mathematics skills such as compound interest,” it said.

“The results are always dreadful,” said professor Annamaria Lusardi, of George Washington University’s Global Financial Literacy Excellence Center, pointing to a two-year-old survey that found less than 60% of adults in the U.S. were financially literate.

“If the U.S. had participated, they would not have scored in the top 10. Because you’re born in a country with high GDP per capita, you don’t acquire financial literacy by breathing in the air,” Ms. Lusardi told The Wall Street Journal. Indeed, the United Kingdom, renowned for its financial expertise, scored below the average of all 30 countries. Just 38% of Britons, and 25% of South Africans, understood the impact of inflation on savings.

Only the Dutch, Norwegians and Hong Kong Chinese could answer the question on compound interest correctly more than half the time.  Men tended to score better than women, and respondents in developed countries tended to score better than those in poorer countries.

“The gender differences are also in line with our research—though what the study doesn’t mention is that women are more likely to get the questions wrong, but they are also willing to admit they don’t know, whereas men are very confident even when they are quite wrong,” said Olivia Mitchell, finance professor at Wharton Business School.

“Self-assessed financial knowledge was, surprisingly, relatively realistic,” the OECD found, notwithstanding a “worrying level of overconfidence” in Brazil, Poland, South Africa and Thailand.

The results present challenges for policy makers wishing to privatize pension savings, given only around two-thirds of people understood a more diverse portfolio of investments reduced risks. Almost 20% of respondents didn’t associate a high return investment with higher risk.

The OECD, which made financial literacy a component of a triennial global testing of 15 year old in 2012, deserved credit for championing the need to improve financial literacy, Ms Lusardi said. “In a capitalistic society we need to start everyone on the same level.”