Imagine that you have a savings account with an interest rate of 1% per year, while inflation annually is running at 2%. After one year, with the money in this account, would you be able to buy more than you could today, less or exactly the same?
If you guessed that your money would be worth less than it did a year ago, you join the 64 % of Americans who answered this question correctly. This information emerged out of a pioneering study — designed by economists Annamaria Lusardi and Olivia Mitchell — measuring financial literacy levels in the United States in 2018. These economists discovered that only 30% of Americans were able to correctly answer all three of their questions. Low levels of financial literacy were also prevalent in developed markets like Germany, the Netherlands, Sweden, Italy, Japan, and New Zealand.
In South Africa last year, researchers, who have developed their own index, found that below-average financial literacy is common among women, young adults, high-school dropouts, the unemployed, and people living in rural areas.
So, what is financial literacy and why is it so important? Lusardi and Mitchell define it as knowledge about a few but fundamental financial concepts, while the Organisation for Economic Co-operation and Development (OECD) says financial literacy also requires having the skills and motivation to make effective decisions.
The inflation scenario, mentioned in the beginning, is one of the “Big Three” questions used to measure financial literacy in more than twenty countries. Once economists had developed a way to gauge financial literacy, they were able to investigate whether knowledge actually influences behaviour.