Are You Financially Literate?
Is this even the right question to be asking? Hat's off to Prof. Meir Statman of Santa Clara University (podcast here) for asks for the field to move beyond the three questions typically used to measure financial literacy. He makes the argument (that I agree with) in the Wall Street Journal [subscription] that knowing facts about how compound interest works or what diversification is provides no guarantee that good financial decisions will follow:
We do good when we promote financial literacy. We do even better when we promote financial comprehension and the financial behavior that comes out of that comprehension.
Here's a sampling of his eight questions which are focused on decision-making (he is also kind enough to let us know the cognitive biases (a.k.a. mental mistakes) that lead to sub-optimal decision-making):
Managers of “active” mutual funds are investment professionals who aim to beat the market, whereas managers of index mutual funds aim only to match the market. Active fund managers are experts, with special knowledge, skills and access to narrowly available information not available to amateur individual investors. On average, active fund managers do beat the market. Therefore, amateur individual investors do better to invest in active funds than in index funds. True or false?
Mutual-fund companies regularly include the number of “stars” awarded to mutual funds they advertise. Morningstar awards five stars to top funds in a category. This indicates that it is best to choose funds offered by a fund company advertising five-star funds. True or false?
Check out the NGPF research report: Who Has Access To Financial Education? which demonstrates one reason behind our lack of financial comprehension is lack of access to financial education.