What does it mean to be financially literate?
According to the newly released Standard & Poor’s Ratings Services Global Financial Literacy Survey, it’s about having a basic understanding of some key financial concepts: inflation, interest rates, compound interest, and risk diversification. The survey was conducted in 2014 as part of the Gallup World Poll, with research support from the World Bank Development Research Group and the Global Financial Literacy Excellence Center at George Washington University.
Five questions were asked to 150,000 adults in more than 140 countries, including the following:
Suppose you need to borrow $100. Which is the lower amount to pay back: $105 or $100 plus three percent?
Think you know the answer?
Well, 40 percent of U.S. adults got that question wrong (or said they didn’t know). The right answer, of course, is $100 plus three percent.
Globally, two-thirds of adults were not considered financially literate according to the survey – defined as getting the questions on three of the four concepts correct. As expected, literacy rates in high income countries are higher (55 percent of adults in the G7 countries overall “passed” the test). In most countries, women scored worse than men – overall about 5 percent worse. A number of other predictable gaps are evident: more educated, higher income, and more financially included people score higher than the less educated, poorer, and financially excluded. But there are many, many people out there who are using formal financial products without being able to pass this simple test.
These results are clearly disappointing. But what are they telling us?
It is hard to believe that people who are economically active are as functionally financially illiterate as these results suggest. The millions (or billions) of low income people who diversify their income sources are practicing risk diversification, even if a question about safe investing doesn’t resonate. The millions (or billions) of people who borrow may not understand interest rates, but they know how much they have to pay and when. And it is no surprise that countries that have experienced high inflation rates generally show high understanding of inflation, even if these countries score generally low on the other measures.
This data points to the power of “teachable moments.” Difficult, abstract concepts like inflation or compound interest, are much easier to grasp when they connect to real world matters. Incorporating financial capability building into product design, so that users can strengthen their knowledge about savings and loans while they’re actually saving and borrowing, can make the most of teachable moments.
More generally, the data suggests that financial service providers need to be aware of the limited financial literacy of their customers and in response they need to simplify their products and explain them in the same terms and language that customers use to understand them.
There is a lot more to learn about financial literacy and the related concept of financial capability. Researchers may decide to measure financial literacy in very different ways. But for now, the Global Financial Literacy Survey is an important step toward getting a handle on this challenging topic.
For the full findings, read the paper here.
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