What does not interest you can hurt you

Can hurt you1Two very good business schools, namely Wharton School of Business of University of Pennsylvania, and McDonough School of Business of Georgetown University, recently designed a short test to monitor the financial acuity of the general public in America. It only comprised three questions. I restate them as follows:

1. You put $100 in a savings account in a bank. It pays 2% interest a year. In 10 years you will have

a) $120
b) Less than $120
c) More than $120

2. You put $100 in a savings account in a bank. It pays 1% interest a year. Inflation is at 2% for the next 12 months. Comparing to what you can buy today with $100, in 12 months when you close the savings account and collect the principal and interest, you can buy

a) The same amount of goods as today
b) More than today
c) Less than today

3. You are thinking of investing in stocks. You are trying to decide whether to put your money in individual stocks or in a mutual fund. Which of the following statements is true?

a) Individual stocks always make more money than mutual funds long term
b) Mutual funds always make more money than individual stocks long term
c) Mutual funds usually carry fewer risks than individual stocks

I like this test because of its relative simplicity. Most American families do encounter these issues in their daily life. So there is a practicalCan hurt you2
aspect to it.

I was surprised – more like horrified – that about half of the people surveyed did not answer all the questions correctly. (I have to confess that I don’t know how large the sample was. Given the fact that it was conducted by two renowned schools, I assume that the test-takers must be a few thousand strong to make it statistically reliable.) My take is that if you don’t understand how simple and compound interests work, and you don’t have a conceptual idea of mutual funds versus individual stocks, you really don’t have much incentive to save and invest. That ignorance may partially explain why the personal savings rate in this county is so low. Right now it is a little shy of 6%, according to Bloomberg Service. By comparison, according to Forbes magazine, China’s population is saving 30% of its income — and the average Chinese citizen makes a whole lot less than her American counterpart.

By the way, all the correct choices are “c.” I hope you scored 100%. If you missed one or two of the questions, I’d suggest that you seek help from friends to improve your math quotient to 8th grade. I would recommend that you test these questions on your children and grand-children as well. It’s time to let young people know that we learn basic math for a reason. It’s especially handy when you try to talk them out of buying a fancy car with a loan. Joseph Wharton and Robert McDonough would be proud of you even if you don’t send your children to their schools.

*** The End ***

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