FINRA stands for Financial Industry Regulatory Authority. It’s the self-regulatory body for brokerage firms and exchanges. Its educational arm FINRA Investor Education Foundation, together with Department of Treasury developed and conducted a National Financial Capability Study.
Part of the study included a 5-question financial literacy quiz. The 25,000 participants in the study scored an average 2.88. State-by-state, Utah scored the highest at 3.23, Mississippi the lowest 2.53. I will call it a 3.
Before people jump up and down saying how poor the general public is in terms of financial literacy, we need to look at the questions first.
1. Suppose you have $100 in a savings account earning 2 percent interest a year. After five years, how much would you have?
A) More than $102
B) Exactly $102
C) Less than $102
D) Don’t know
This one is easy. If people answered wrong, it’s because they didn’t read the question carefully. It’s asking after five years, not after one year. The question is measuring whether people are paying attention, not whether they understand interest rate.
2. Imagine that the interest rate on your savings account is 1 percent a year and inflation is 2 percent a year. After one year, would the money in the account buy more than it does today, exactly the same or less than today?
Fair question. Easy.
3. If interest rates rise, what will typically happen to bond prices? Rise, fall, stay the same, or is there no relationship?
This question doesn’t belong here. The finance types love this question but it has nothing to do with day-to-day financial life. You can be fully financial literate without knowing the answer. If we have to go there, the right answer must be "don’t know" because there isn’t enough information to answer the question. What interest rates rise? Student loan interest rates? What bond prices? My I Bonds?
4. True or false: A 15-year mortgage typically requires higher monthly payments than a 30-year mortgage but the total interest over the life of the loan will be less.
Another ambiguous question. It doesn’t say anything about the interest rate or what the life of the loan is. A typical 5/1 ARM is a 30-year mortgage. Its interest rate is usually lower than a 15-year fixed. If you sell the home in 5 years — the life of the loan ends — the total interest over the life of the loan will be less on the 5/1 ARM. The right answer should be "false" because you only need one example to invalidate the statement.
5. True or false: Buying a single company’s stock usually provides a safer return than a stock mutual fund.
OK. Easy enough.
Among five questions we have two ambiguous ones and one tricky question that can easily slip if you didn’t read the question carefully. The 25,000 participants scored an average 3. That’s pretty good. I would get a 3 if I answer the question truthfully rather than trying to answer what they want me to answer. Any conclusion drawn on these five questions isn’t that reliable. These are the best five questions for financial literacy smart people at FINRA came up with "in consultation with the U.S. Department of the Treasury, other federal agencies and President Obama’s Advisory Council on Financial Capability"? What a shame.