In 2009, the Financial Industry Regulatory Authority, or FINRA, started a periodic survey of the financial capabilities of US adults, measuring the skills, judgment and resources needed to manage their financial well-being. Questions range from credit-card behavior (are you paying just the minimum due?) to home equity (do you owe more on your mortgage than your home is worth?).
The study was repeated in 2012 and 2015. Results are encouraging: resources and judgment show a steady improvement over six years. But when it comes to skills, results are disappointing. More and more adults fail to demonstrate a basic level of financial knowledge.
First, the good news. As labor conditions improve, fewer individuals spend more than they make: 20% in 2009, 19% in 2012, and 18% in 2015. The Affordable Care Act had a strong impact on reducing the number of people with overdue medical bills: 26% in 2012 versus 21% in 2015 (the question was not asked in 2009). Similarly, more people have rainy day funds (35% in 2009, 40% in 2012, and 46% in 2015) and fewer pay just the minimum on credit card balances (40% in 2009, 34% in 2012, 32% in 2015). And as home prices recovered, just 9% report having a home underwater in 2015 (i.e. with a mortgage balance higher than the value of the home) versus 14% in 2012.
The data paints a much improved picture. In fact, when asked directly if people are satisfied with their personal finances, the percentage saying “yes“ has gone up to 31% in 2015 from 24% in 2012 and 16% in 2009.
Unfortunately, the opposite is true of financial literacy. Study participants were asked five questions about basic aspects of economics and daily-life finances regarding inflation, interest rates, mortgage debt, and investment risk. In 2009 the percentage of respondents with 3 or less correct answers was 58%. This went up to 61% in 2012 and again to 63% in 2015.
This is a worrisome development because, as FINRA notes, “individuals need at least a fundamental level of financial knowledge” to make sound financial decisions.
Even more worrisome for us at Path Financial is that in 2015 Florida scored second-worst in the nation, at an average of 2.89 correct answers out of five (Texas was worst, at 2.81). You can take the five-question quiz here.
An even more worrisome fact is that, despite their poor performance in this quiz, Americans tend to see themselves as highly versed in financial matters. In 2015, 76% gave themselves a “high” assessment of their own financial knowledge. And while the proportion of “high” self-scoring went up in each of the study years, the public’s ability to answer basic questions correctly went down every time.
Furthermore, when asked to evaluate their math skills, less than two-thirds among the 79% of respondents who gave themselves a “high score” could estimate compound interest correctly in the context of debt.
The disconnect between people’s perceived and actual financial skills is alarming, because it is contributes to making bad decisions regarding savings, investments, and debt.
Understanding risk and avoiding fraud, specifically, are two key areas that are difficult to handle without basic financial knowledge. Even securing conflict-free advice can be challenging without some level of financial literacy: for example, many “seminars” aimed to the public, usually involving a free meal, are aimed more at selling products preying on financial illiteracy than on actually enlightening the public.
This does not mean that everyone who is not a financial expert is doomed to investment failure. But a basic set of skills is necessary to identify those “too good to be true” situations that we all encounter at some point.
A good place to start is an adult-education course offered by a community college, although you may not be able or willing to commit to classroom training. If you want to hire a financial advisor to help you instead, you can screen his or her record beforehand at the Investment Advisor Public Disclosure website. Watch for “disclosures,” which alert the public to client disputes or regulatory violations involving the advisor or firm you want to check out.
Another excellent resource is FINRA’s “protect your money” site. One of the links will take you to a “scam meter” that asks a few questions about investments you might be considering. See, for example, if you identify with these statements:
– I learned about an investment at a free investment seminar
– I cannot clearly articulate what the investment is
– I am not sure what license the person selling the investment has
– The investment is guaranteed
These four answers earn four red flags in the “scam meter”. This is a useful tool that will not analyze a specific investment but can alert you to potential dangers when considering one.
The bottom line is that it would be great for individuals to have better investment skills, but the numbers show little improvement on that front. Also, free tools that can help people avoid serious investment mistakes remain under-utilized. In the meantime, well-crafted investor protection regulations will have to fill the gaps.