Experience may be the best teacher in other areas of life, but not when it comes to retirement planning.
In fact, according to a recently published study, experience matters surprisingly little. When it comes to practical financial skills, those with decades of experience are only marginally better educated than those in their 20s. Those with the most experience can still barely answer half of a few dozen basic financial literacy questions.
That’s according to a new study by the TIAA Institute and George Washington University’s Global Financial Literacy Excellence Center (GFLEC). The authors of the study are Paul Yakoboski, senior economist at the TIAA Institute; Annamaria Lusardi, Professor of Economics and Accounting at GWU and Founder and Director of GFLEC; and Andrea Hasler, Professor of Financial Literacy at GFLEC.
Take MarketWatch’s financial literacy quiz — Do you get 10/10?
The survey they conducted this year marks the sixth consecutive year the researchers have measured the financial literacy of US adults. They did this by sending respondents a detailed 28-question survey that tested their practical knowledge of common financial situations – from topics ranging from saving, investing and borrowing to insurance and understanding risk. The researchers distilled the answers into a single index — which they call the P-Fin Index — that reflects the average percentage of questions answered correctly.
Read: This man has made it his mission to offer personal finance courses in all high schools. Here’s the #1 lesson he says everyone should know
The latest P-Fin Index is 50%, meaning that, on average, US adults were only able to correctly answer 50% of the index questions. The P-Fin Index has remained remarkably stable since 2017 when it was 49%. In 2020 it was even 52%. In an interview, Professor Hasler said that these fluctuations in the annual values of the P-Fin Index were not statistically significant, meaning that the average level of financial literacy today is indistinguishable from where it was in 2017.
Can it really be that our financial literacy hasn’t improved in the last six years?
Experience a bad teacher
While this depressing result points to the poor job that experience does in teaching financial literacy, another finding by the researchers supports this conclusion even more. When they calculated the average P-Fin index scores for each generation, they found that the oldest adults performed only slightly better than the youngest.
These results are summarized in the attached table. On average, members of Generation Z had P-Fin Index scores of 42%. This number increases with each older generation, but is still only 54% for the oldest generation. Those with the most experience were still unable to answer nearly half of the financial literacy questions.
In other words, a lifetime of learning from financial missteps increases the number of correct answers on the test by an average of just three — from 12 to 15. And note that even if the oldest generation were able to answer all 28 financial questions to literacy, it’s still not clear if this would make a big difference to their financial security in retirement. That’s because they needed this education earliest in their careers.
If experience is such a bad and inappropriate teacher, what is the solution?
Professor Hasler says there is no getting around financial education. In fact, she and her colleagues view their findings as a loud and clear “call to action.”
Understand risk and uncertainty
The need for financial literacy is particularly acute when it comes to properly assessing risk and uncertainty, she added. Such understanding is critical to making wise decisions that affect your lifelong financial security — and your retirement in particular. But the researchers found that not only was this the subject in which the average US adult had the least financial literacy, but that their education has declined in recent years.
In the 2017 P-Fin Index survey, US adults correctly answered just 39% of risk understanding questions on average. In this latest survey, it had fallen to 36% – a statistically significant drop, Professor Hasler said.
(The survey questions are proprietary, but at the end of this column I’m reproducing a risk and uncertainty question that the authors included in the 2021 survey. I’m sure all readers of this column will get the right answer.)
Although the researchers didn’t collect data on what might have caused this decline in already low levels of financial literacy in terms of risk and uncertainty, I suspect a big culprit was the strength of financial markets in the wake of the COVID-19 pandemic. It would hardly have been surprising if this pandemic and the associated economic lockdowns had caused the stock market to enter an extended and punishing bear market. However, far from causing this, the stock market experienced one of its strongest bull runs in history.
No wonder investors are more confused than ever about risk!
The bottom line? educate yourself If necessary, consult a qualified financial planner. Assume you don’t know all the answers because you probably don’t.
Example of a risk and uncertainty question asked in the P-Fin Index survey
Which of the following statements indicates the highest probability of developing a specific disease?
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The chance of contracting the disease is one in twenty
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2% of the population will get the disease
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25 out of 1,000 people will get the disease
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I do not know
The answer, of course, is the first option. However, according to the researchers, only 28% of respondents were correct. This is sobering: if we can’t answer this simple question correctly, it’s hard to imagine how we can make sensible and wise financial decisions that impact our lifelong financial security.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at [email protected]
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