Are You Financial Literate? (Financial Literacy Test)

It wouldn’t surprise you that poor countries show low ratings of financial literacy. But that only 57% of people in the richest country on earth pass a relative simple test may cause some raised eyebrows. The United States ranks at the 14th place of the Financially Literate with a score only 3% higher than Bhutan, which ranks 130th in the list of GDP per capita. Fortunately, the US is at par with bankers country Switzerland. The most financial literate, which means how well one understands the way money works in the world, live in Scandinavia. Norway, Denmark and Sweden show a score of 71%. Yemen is at the bottom with only 13% passing the test.

The Standard & Poor’s Ratings Services Global Financial Literacy Survey contained a test to probe the concepts numeracy, risk diversification, inflation and compound interest. Albert Einstein once famously said “Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.” According to the test-scores, the world may be in a pretty bad shape. No wonder we had a couple of severe financial crises in this millennium! But let’s take a look at the questions and see if you can pass the test (answers, if needed, at the end of the article, including topical reference):

1. Question: 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?
2. Question: 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?
3. Question: Suppose you need to borrow $100. Which is the lower amount to pay back: $105 or $100 plus three percent?
4. Question: 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?
5. Question: Suppose you had $100 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? Less than $150, exactly $150 or more than $150?

The scores come from a survey of 150,000 adults in 148 countries. In conducting the survey, S&P’s Ratings Services partnered with the Gallup World Poll, the World Bank and the Global Financial Literacy Excellence Center at George Washington University. The partnership was founded since the organizations see financial literacy as ‘a critical barrier to financial inclusion, or access to financial services”. A lack of knowledge about finance may restrict many people, especially the poor, the undereducated and unfortunately in many underdeveloped countries women, to access banking and financial services. According to the partnership, this limits financial and economic well-being and thus the overall health of a countries economy. Simply put: people are not able to make the right financial decisions which affects their lives in a negative way.

Therefore, it doesn’t come as a surprise that most poor countries can be found at the bottom of the list. However, the scores are shockingly low for rich and/or educated countries as well. Only 25 countries have a score of above 50%. Japan ranks 38th with 43% passing, Italy finds itself at place 63 with a score of 37%. A large number of African countries are in between. Men score better than women: 35% vs 30% passed the test. This may be explained by the lower level of education for women in many underdeveloped countries. It’s difficult to say if there’s hope for the world. In some countries, such as Canada and the United Kingdom, younger generations didn’t score better than their (grand) parents. However, in Asia, the youth scored significantly better than the elder generation. Nevertheless, the survey makes clear that there’s a long road to go before citizens become financial savvy.

Answers to the questions:

1. Risk Diversification: To put your money into multiple businesses or investments is certainly wiser. Never put all eggs in one basket! This is the rule of thumb for many financial advisors and portfolio managers. However, there’s a limit in the effectiveness of diversification
2. Inflation: You can buy the same as today, since wage and price inflation are in this case the same, they even out
3. Numeracy and Comparison (Debt): $100 plus three percent is the lower amount (totals $103)
4. Interest Compounding (Saving): The bank will add more money in the account. This is the miracle of compound interest
5. Interest Compounding (Saving and Numeracy): More than $150. Again, the miracle of compound interest