Think you’re financially literate? Take the world’s most famous 3-question financial literacy quiz used in over 20 countries and see how you compare!

In this episode, Mark and Shani go through the official global financial literacy test before adding their own tougher questions about bonds, mortgages and compounding, revealing the lessons every investor should know.

From inflation and diversification to saving habits and compounding, this episode is packed with insights to help you understand how small concepts can shape big financial outcomes.

You can find the transcript for the episode below:

Shani Jayamanne: Invest Your Way is a different kind of book about money. We want it to be a trusted resource for investors who have graduated from Investing 101. For investors who know what a share is and an ETF is, but are struggling to put it all together to get onto the pathway to financial independence.

Mark LaMonica: Too much financial commentary focuses on investments rather than on the people investing. We believe investors are hungry for a new perspective. The investors we talk to tell us that they are tired of aspirational messages that lack the practical steps to put a plan into action. They don’t want bewildering and unrelatable jargon and complexity. They want the focus to be on the only thing that truly matters, creating a better life for themselves and their loved ones.

Jayamanne: Invest Your Way is a guide to successful investing with actionable insights and practical applications. You’re able to purchase the book through the links in the episode notes and at major bookstores or request a copy through your local library.

Welcome to another episode of Investing Compass. Before we begin, a quick note that the information contained in this podcast is general in nature. It does not take into consideration your personal situation, circumstances or needs.

So, a couple of podcasts ago, Mark, I gave a shout out to your food Instagram.

LaMonica: Yes, it’s wildly popular.

Jayamanne: Mark’s Moveable Feast. And you got two new followers.

LaMonica: I did. So, thank you, Sean.

Jayamanne: Who was the other person?

LaMonica: It seemed like it might have been a photography business.

Jayamanne: Okay. That’s great. Maybe they want to help you with your food photography. You can ask for some tips.

LaMonica: I need them. But you know, we actually saw – I put a food thing at the bottom of my articles.

Jayamanne: Yes.

LaMonica: And the last one – so, Shani has this thing where she’s like, Oh, of course I read your articles. In the last one, I put a picture up of a meal that we had together and I made a couple of jokes about you. And of course, you did not read the article.

Jayamanne: I don’t read it immediately when it comes out.

LaMonica: So, you’re not waiting there on Friday.

Jayamanne: No. I read all of your articles. It just sometimes takes me a couple of days.

LaMonica: Okay. I published it on Friday. Today is Tuesday.

Jayamanne: Business days. Business days.

LaMonica: I read every one of your articles.

Jayamanne: It’s your job to.

LaMonica: Wow. Okay. Well, we’re going to talk today about financial literacy. So, I think we’ve talked a lot on here, Shani, about how this is one of our motivating factors for the work that we do is to try to improve financial literacy. And I will say that the Morningstar community is very financially literate. It’s a financially literate bunch. But that doesn’t mean, of course, that there isn’t all more to learn. But people definitely know the basics.

Jayamanne: That’s true. And when you spend time with financially literate people who like to discuss the nuances in the different approaches to take with your finances, you can lose sight of the facts that most people know very little.

LaMonica: And there are a lot of organizations out there that are trying to improve financial literacy. So, we’re, of course, supportive of all these organizations. But the U.S. there is an organization at Stanford University called the Global Financial Literacy Excellence Center or GFLEC.

Jayamanne: GFLEC, all right.

LaMonica: I don’t know if that’s what people actually say.

Jayamanne: That sounds like a rapper.

LaMonica: Yeah. It does. It does.

Jayamanne: One of the reasons that GFLEC is famous in the financial literacy world is because they invented a three-question financial literacy quiz that has been used in more than 20 countries. Since so many people have taken this quiz, it can be used as a benchmark.

LaMonica: So, we’re going to go through this quiz. And we’ll see if listeners can answer the questions. So, I’ll do the first question. Suppose you had $100 in a savings account and the interest rate was 2% per year. After five years, how much do you think you would have in the account if you left the money to grow? Would you have A, more than $102; B, exactly $102; C, less than $102; and D, you do not know, or you refuse to answer? And that is the language from the actual test. I like the to refuse to answer.

Jayamanne: Yes.

LaMonica: I know the answer. I’m just not going to tell you.

Jayamanne: Yeah, but I don’t want to answer it. No. We will get to the answers after we go through each question. The next question is, imagine that the interest rate on your savings account was 1% per year and inflation was 2% per year. After one year, how much would you be able to buy with the money in this account? A, more than today; B, exactly the same; C, less than today; and D, do not know or refuse to answer.

LaMonica: All right. The last question is, please tell me whether the statement is true or false. Buying a single company stock usually provides a safer return than a stock mutual fund. So that’s a managed fund in Australia. A, true; B, false; C, do not know, refuse to answer.

Jayamanne: All right. So, let’s go for the answers now. The first question is meant to measure knowledge about interest. This is obviously a pretty important concept for both choosing even a simple bank account savings product, but also understanding the impact of debt. The answer to the question is more than $102. The kicker here is at the annual interest rate over a five-year period. There were lots of ways they could have framed the answers to this question, but they chose a pretty easy one because you don’t even need to understand the impact of compounding.

LaMonica: Exactly. The second question is measuring knowledge about the impact of inflation. This is also critical to understand because if you don’t understand inflation, you don’t understand why it’s important to save and earn a return on your savings. The answer is less than today. It was 2% was inflation and the bank account was offering 1%.

Jayamanne: The last question measures knowledge about diversification. The answer is false. Buying a single share is not safer than buying a diversified mutual fund or managed fund, as we call them in Australia. It also tests to know if someone knows what a mutual managed fund is because that’s a key part of the question.

LaMonica: Okay. So, as we said, this has been given a lot. So, let’s go through the results. For Americans who took this three-question quiz, only 29% got all three questions right. So, I don’t know if that surprises you. It doesn’t surprise you. What do you think? You have a pretty low opinion of Americans. So, did this seem like a high percentage for you?

Jayamanne: No comment.

LaMonica: Okay. 69% of people got the first question right. 53% got the second question right. And 42% got the last question right. And I want to be shocked, but I’m just not.

Jayamanne: But of course, when we cut the data in different ways, we can see how different demographics performed. Young people are less financially literate than older people. If we divide ages up between 18 and 35, 36 and 50, 51 to 65 and 66 and above, the overall results and the results for each question followed the same pattern. Each older cohort had a higher percentage of people that got each question right and all the questions.

LaMonica: So not good for young people. For the 18 to 35-year-old group, things were really not great. 14%, only 14% answered all three questions correctly. And I think this illustrates the simple fact that financial literacy is not taught in school. So, people obviously need to take the initiative and learn this on their own once they are ejected into the real world from school.

Jayamanne: And also, something that is particularly upsetting is that there is a sizable gender gap. So, only 20% of women answered all three questions correctly and 38% of men. What was interesting and also upsetting is that women were far more likely to answer, they don’t know, to the questions, which indicates a lack of confidence. Confidence can be – or they could have just refused to answer. Maybe they’re really confident.

LaMonica: Yeah, I guess that’s the most confident.

Jayamanne: Yes.

LaMonica: That I’m not answering your stupid quiz.

Jayamanne: Yes. Confidence can be an issue in investing as overconfident investors trade too much, but having no confidence means many women don’t get started. And this matches other results that we’ve seen in different studies.

LaMonica: They also measured success by education level in what I’m sure won’t surprise anyone, the more educated you are, the better off you did on this. So, for people who didn’t complete high school, only 14% got all three questions right. And 51% of all people with a graduate degree got all three questions right, which still seems low to me. So, they did it by wealth. Rich people did better than poor people. So, all this is fairly predictable. But today we want to spend some time updating those questions a bit. Not because we don’t think that they serve the purpose they were designed to serve, but because we want to do something different.

Jayamanne: And we want to up the game a bit. But first, we want to acknowledge some of the findings when you look at the study results outside of the US. There were differences in the scores across countries. But in every country the test was given, there were low levels of financial illiteracy. So, it’s not just a problem in the US, Mark.

LaMonica: Despite what Shani would like to believe and thinks.

Jayamanne: Although on TikTok they have this trend where they go around and show Americans a map of the world and ask them to, like, name any country, like any country on there. And a lot of them can’t. So maybe it’s not just financial literacy that’s not being taught in schools.

LaMonica: Yes, there you have it. Nothing is being taught in schools. But now that we’re renaming everything, the Gulf of America and whatnot, it should be easier for Americans to understand geography.

Jayamanne: Yes.

LaMonica: Especially once we take over Canada and Greenland, then less countries to know.

Jayamanne: Exactly.

LaMonica: But we’re going to get back to differences in other countries. So, there are differences. So, when countries where students score high on maths and science, so they do well on these global standardized tests, they tend to do better on the first question, which does require some numeric proficiency. So, examples of countries that do well, Sweden and the Netherlands.

Jayamanne: What do they not do well in?

LaMonica: Well, I don’t know. We’re trying to be positive here.

Jayamanne: Oh, no, I mean, that is positive. They do very well.

LaMonica: The Dutch and the Swedes are learning maths and science, so they can answer the first fairly basic question in the financial literacy test.

Jayamanne: And what you have experienced personally does matter. So, people in countries that experienced inflation, they did better on that question. So, for example, Italians were able to answer the inflation question at a much higher level of success than the Japanese who have been dealing with deflation. The same thing occurred with the diversification question. So, in countries that switched from a defined benefit pension scheme to a defined contribution pension scheme, like super, people understood diversification more.

LaMonica: And so, I think we can draw some lessons here. So, one, and we say this a lot, the maths matter. So, you don’t have to be some sort of maths genius to invest successfully. But you do have to be numerically literate. And remember, you don’t have to calculate anything. I think in school, the focus is still on answering maths problems, but there are computers and there are calculators. So that’s not the part that’s important. Being numerically literate is understanding what compounding is and how it works. It is understanding conceptually the influence of time and different drivers on amassing wealth.

Jayamanne: The second big lesson is that because your personal experiences have such a large influence on the things that you know, it is important to be aware of blind spots you may have. So, few of us in Australia have experienced inflation for a long time. So, what happened after 2020 was something that was new for people. Personally, I haven’t experienced a long crushing bear market. People my age and younger are in the same boat. That is certainly going to make it more challenging for us when it does come and it will come in our lifetimes.

LaMonica: We said we were going to add some questions to the Mark and Shani Financial Literacy Quiz. And to do that, we are going to augment something that is called the Big Five Questions.

Jayamanne: Like when you go on safari?

LaMonica: Like when you go on safari. Although there are parts of safari that are disappointing. Members of the Big Five.

Jayamanne: Okay. Which members?

LaMonica: The Cape Buffalo.

Jayamanne: Okay. It’s just a buffalo, I’m guessing.

LaMonica: It’s just a buffalo. Like it’s cool because there can be thousands of them.

Jayamanne: Right.

LaMonica: But you’re also just kind of like – so it’s a water buffalo that’s a little bigger with some friends, right?

Jayamanne: Okay.

LaMonica: So maybe listeners out there are more impressed with the Cape Buffalo, but I’m sure they’ll write and let me know. But the Big Five, that is the augmented Big Three. So, the Big Three is the questions that we just went through.

So, they, of course, added these. So, one of these questions is on bonds, which I think is a good one. So, see if you can answer this one. If interest rates rise, what will typically happen to bond prices? A, they will rise; B, they will fall; C, they’ll stay the same; D, there is no relationship between bond prices and interest rates; and E, don’t know, refuse to answer.

Jayamanne: The other question that was added is one on mortgages. A 15-year mortgage typically requires higher monthly payments than a 30-year mortgage, but the total interest paid over the life of the loan will be less. Is this true, false, or don’t know, refuse to answer?

LaMonica: Yeah. The answer to the first question is they will fall. So, bonds move inversely to interest rates. So, if interest rates go up, bond prices will go down. The second question is true because a mortgage is an amortizing loan where principal and interests are paid with each payment. So, the shorter the term of the loan, the less interest there is.

Jayamanne: So, what do you think is missing from this, Mark?

LaMonica: Well, I think we mentioned it earlier, but I think one of the topics that’s missing is on compounding. So, in my view, I don’t know about yours, Shani, but compounding and understanding compounding is critical because it not only helps investors make decisions, but it also encourages good behavior like starting early.

Jayamanne: So, what’s your question?

LaMonica: Okay. So, I’m going to use one from an article that I wrote earlier this year. And my question is a little more complicated.

An investor is saving and investing $10,000 a year for a 40-year period and earns a 7% return. In scenario one, an investor saves for the first 20 years and then stops, just earns returns for those last 20 years. In the next scenario, an investor doesn’t save for the first 20 years and then saves and invests for the next 20 years. What percentage of wealth did each of these investors generate compared to investor that saved all 40 years? So, remember, in each of these two scenarios, the investor saved half as much as the one with 40 years of savings. But for the investor that starts saving for the first 20 years, they still generate 80% of the total wealth. The investor that starts saving for the last 20 years only generates 20% of the total wealth. Now, obviously, I didn’t go through all the – I just gave the answer.

Jayamanne: Yes.

LaMonica: I didn’t go through all the A, B, C, D, refuse to answer. But…

Jayamanne: So, what do you think an investor gets out of knowing this?

LaMonica: Well, I think the simple lesson is that when you’re young, the most important thing is saving money. When you are older, the most important thing is the returns you earn. So, I think that helps people figure out their priorities a little bit.

Jayamanne: And I think what reinforces this is another question that we could come up from the same article. Let’s take this same 40-year scenario of saving and investing $10,000. Let’s say the average return was the same over the 40-year period. So still 7% average return a year. But in scenario one, over the first 20 years, the return was 4% a year and a 10% return a year over the last 20. In scenario two, the opposite happens. So, 10% over the first 20 years and 4% over the last 20. So, which would you prefer?

LaMonica: Well, I wrote the article, so I know the answer. But why don’t you let people know how this turns out?

Jayamanne: All right. So, the answer is the scenario one, where the returns are higher over the last 20 years. So, you would generate 27% more wealth. Once again, returns matter more later in life.

LaMonica: Okay. So those are our extra questions. And we certainly understand why these financial literacy tests are designed the way they are. But we want people to not just understand the basics, but also prosper. And that is why we think compounding is so important as a way to encourage good investor behavior.

We also want to know your questions. So, you can leave a comment on YouTube, hopefully a nice one, or Spotify, if there’s any questions you think need to be added to this, or if there’s any concepts that you think are missing. So, we’ll see if we get any comments that do not involve saying, Shani is dressed like she’s going to a cocktail party, which was a particular favorite. But thank you guys very much for listening and watching. We really appreciate it.

Invest Your Way

A message from Mark and Shani

For the past five years, we’ve released a weekly podcast and written on morningstar.com.au to arm you with the tools to invest successfully. We’ve always strived to provide independent, thoughtful analysis, backed by the work of hundreds of researchers and professionals at Morningstar.

We’ve shared our journeys with you, and you’ve shared back. We’ve listened to what you’re after and created a companion for your investing journey – Invest Your Way. Invest Your Way is a book that focuses on the investor, instead of the investments. It is a guide to successful investing, with actionable insights and practical applications.

If anyone would like to support this project you can buy the book now. Thanks in advance!

Purchase from Amazon

Purchase from Booktopia