Individuals who have more financial knowledge have a greater likelihood of planning for retirement, according to a new National Bureau of Economic Research study. The telephone survey of 1,488 adults asked respondents three financial literacy questions and found that those with all correct answers are likely to be the most prepared for retirement.
The questions involved simple calculations about interest compounding, inflation, and risk diversification. The researchers found that survey respondents who answered all three financial literacy questions correctly were almost 10 percentage points more likely to have a plan for retirement. Those who knew the answer to at least one question were four percentage points more likely to be planners.
Here are the three questions the researchers used to assess financial literacy:
1. Suppose you had $100 in a savings account and the interest rate was 2 percent per year. After 5 years, how much do you think you would 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 1 percent per year and inflation was 2 percent per year. After 1 year, how much would you be able to buy with the money in this account?
a. More than today
b. Exactly the same
c. Less than today
3. Please tell me whether this statement is true or false. “Buying a single company’s stock usually provides a safer return than a stock mutual fund.”
Fewer than a third (30 percent) of those surveyed got all three questions correct and under half (46 percent) were able to correctly answer both the interest rate and inflation questions. The third question about risk diversification gave respondents the most difficulty, with only about half (52 percent) of this representative sample of the U.S. population getting the answer right, compared to 65 percent and 64 percent respectively for the first two questions. “In view of the complex financial decisions that individuals confront in the current economic environment, these are discouragingly low success rates,” write researchers Annamaria Lusardi and Olivia Mitchell in the report.
Financial literacy was found to be lowest among people under age 35 and women displayed less financially literacy than men. The prevalence of correct answers rises with education, with those who lack a high school degree performing the worst. Those not employed showed lower levels of financial knowledge than workers or the self-employed. African-American and Hispanic respondents answered fewer questions correctly than White and Asian respondents. But despite the poor performance, almost 70 percent of respondents say they believe they are above-median with regard to financial knowledge.
Less than half (43 percent) of the respondents say they have tried to figure out how much they should save for retirement. Younger respondents were the least likely to have a plan, but only 57 percent of those ages 50 to 65 have attempted to figure out how much they need to save for retirement. “Many respondents lack key knowledge of financial concepts and fail to plan for retirement, even when retirement is close at hand, only 5-10 years off,” according to the NBER report. “This is important since being able to develop and implement retirement plans is key to retirement security: Those who do not plan reach retirement with half the wealth of those who do.”
Answers: 1.a 2.c 3.b