3 questions that predict your financial future By Emily Brandon

3 questions that predict your financial future

 

By Emily BrandonFebruary 13, 2015 11:57 AM

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Workers increasingly need to make important retirement planning decisions, including how much to contribute to retirement accounts, how to invest their savings and how to draw down their wealth in retirement. A new report by the Pension Research Council at the University of Pennsylvania's Wharton School found that adults in many countries make these decisions with surprisingly little financial knowledge, and that those with greater financial literacy tend to make smarter retirement investment choices.

The researchers asked people in 18 countries three simple financial literacy questions about interest rates, inflation and investing. "Answering just one additional financial question correctly is associated with a 3 to 4 percentage point greater probability of planning for retirement, in Germany, the United States, Japan and Sweden," according to the report. "Financially literate individuals do plan better, save more, earn more on their investments and manage their money better in retirement."

Here are the three financial literacy questions:

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."

a. True
b. False

These questions explore basic saving and investing concepts that everyone saving for retirementneeds to know. Savers should be able to calculate how their money will grow over time and what inflation will mean for their spending power in retirement. And it's useful for investors in the stock market to know simple ways to reduce risk in their portfolio, especially as they approach retirement.

When Americans over 50 were asked these three questions, only half could answer the first two questions about compound interest and inflation correctly, and just a third knew how to answer all three questions.

Unsurprisingly, more educated people perform better on this quiz, but people of all education levels get shockingly low scores. Less than half (44 percent) of U.S. college graduates were able to correctly answer all three questions, which dropped to 31 percent of people will some college education and just 19 percent of high school graduates. "Even well-educated people are not necessarily savvy about money," according to the report. Among people with post-graduate degrees, 64 percent were able to answer all three questions correctly.

Men (38 percent) were more likely than women (23 percent) to know the answer to all three of the financial literacy questions. Men also said they felt more confident about their financial knowledge, even when they answered incorrectly. Women were more likely to admit that they did not know the answer to the question.

"More knowledgeable individuals invest in more sophisticated assets, suggesting that they can expect to earn higher returns on their retirement saving accounts with lower nonsystematic risk," write researchers Olivia Mitchell and Annamaria Lusardi in the report. "While everyone does not need an economics degree, people do require some financial knowledge to make such decisions."

Answers: 1. a, 2. c, 3. b