- Americans struggle to comprehend risk more than any other financial concept, according to the latest results of an annual study from TIAA Institute and the Global Financial Literacy Excellence Center (GFLEC) at George Washington University.
- Even after more than a decade since the financial crisis, Americans still receive a “failing grade” on overall financial knowledge, says one study author, with the average number of questions answered correctly barely above 50%.
- The study shows that many Americans are stuck in paycheck-to-paycheck survival mode and have debt that keeps other financial goals out of reach.
Americans are still receiving a failing grade at personal finance, according to the latest results from an annual study. And it could not come at a worse time, with the coronavirus pandemic causing massive market volatility, job and income losses compiling at an unprecedented clip, and a level of financial stress for Americans not experienced since 2008.
Just take one question that seems copied out of a maddening college entrance exam math section but can help explain our biggest personal finance weakness.
Can you answer it?
Investment A will deliver a return of either 10% or 6%, with each outcome equally likely. Investment B will deliver a return of either 12% or 4%, with each outcome equally likely. You can expect to earn more by investing in which?
There’s only one right answer: It does not matter which investment you choose, because the expected return of each investment is the same, at 8%. If you got it right, that places you in the minority. Only 31% of Americans did in the latest annual financial literacy survey conducted by the TIAA Institute and the George Washington University School of Business Global Financial Literacy Excellence Center (GFLEC).
The concept behind this question — expected return — can lead you into the weeds of corporate finance. But understanding the basic lesson has never been more important: Most Americans are still not very good at comprehending risk. The survey has found this to be Americans’ biggest financial blind spot each year it has been conducted since 2017.
“We’re not measuring how smart people are. We are not measuring how much people understand math. We want to understand basic concepts that allow us to make good decisions,” said Annamaria Lusardi, Denit Trust Chair of Economics and Accountancy at the George Washington University School of Business and a co-author of the study.
“People only think about the stock market, but we face risk in every part of our life: What is the probability a car breaks down? Risk and risk management is not just about investing but unexpected things,” said Lusardi, who is a member of the CNBC Invest in You Financial Wellness Council. “We are in the middle of a pandemic now, and we face an even more uncertain future, and here is when knowledge of risk can be particularly important.”
Ted Jenkin, CEO and founder of oXYGen Financial, a financial advisory and wealth management firm specializing in Generations X and Y, and a member of the CNBC Financial Advisor Council, said many people do struggle with basic risk concepts. “People can say they will invest more when the market is down 20%, but in real life they don’t do it,” he said.
“Everyone understands rewards, but hardly anyone understands risk. We should be trying to get back to basic financial literacy about risk and time,” Jenkin said. “The stock market is a long-term investment. People without five years or more to be in it shouldn’t be in it. There is just not enough education on risk,” he said, and that is always compounded after a period of time during which the market seemed to only go up.
Among eight key financial knowledge areas surveyed by TIAA Institute and and GFLEC — which also include earnings, saving, investing, borrowing, consuming and insuring — risk was the one where Americans know the least. “No wonder we’re all frantic,” Lusardi said.
Americans are still failing at finance
The survey was conducted among more than 1,000 American adults throughout the month of January. Lusardi said that is key, because the U.S. market was still booming at the time, unemployment was low, and that means more recent events reinforce the importance of the failings exposed in the data. And the question on risk was far from the only one Americans struggled to answer.
On average, adults answered 52% of the survey questions correctly. There was close to a 50/50 split between those who correctly answered over one-half of the index questions (53%) and those who correctly answered one-half or less (47%).