This test is very flawed, or at least the reporting of it is flawed.
The only thing it tells us about the sample is that the people questioned were 55 years or older.
Based on this information, the following might be true: four people were asked these questions. All of them were over 85-years-old. Three of them had Alzheimers and were unable to understand the questions. The fourth had only 4 years of primary education and was unable to read the questions.
Without more information, the results of this test are completely useless for forming any opinion of the financial literacy of American people.
Those three questions are the ones that Lusardi, along with Olivia Mitchell of Penn, have been inserting in a variety of major U.S. surveys. In a new working paper titled “Financial Literacy: An Essential Tool for Informed Consumer Choice?” (abstract here, download here), Lusardi writes that among respondents age 50 and older, only half of them got the first two answers right and only one-third of them got all three answers right.
Because Lusardi, Mitchell, and many other economists focus on retirement behavior, it is pretty horrible news to learn that so many older people are ill-equipped in the basics of saving and investing. With most U.S. companies doing away with big employee pensions (see Roger Lowenstein‘s new book While America Aged), more and more people have to plan their own retirements.
You can't really tell, given the author couldn't even be bothered to name the two economists, much less provide a link to the original publication.
A little googling indicates a possible source as this 2009 paper, by Annamaria Lusardi and Olivia S. Mitchell.
The Health and Retirement Study (HRS), a nationally representative longitudinal dataset of Americans over the age of 50, has been designed to address some of these questions by tracking health, assets, liabilities, and patterns of wellbeing in older households.Beginning in 1992, a 90-minute core questionnaire has been administered every two years to age-eligible respondents and their spouses. In addition, a random sample of respondents has also been subjected to very short experimental modules in each wave, aimed at helping researchers assess additional topics of substantive interest. For the 2004 HRS wave, we designed and administered a special module on financial literacy and retirement planning, seeking to assess respondents’ level of financial literacy along with their efforts to budget, calculate, and develop retirement saving plans, in relatively few questions (Lusardi and Mitchell, 2006).
The three questions on financial literacy we designed, which have by now become standard in assessing economic literacy and are included in many other surveys in the United States and abroad, are as follows:
- Suppose you had $100 in a savings account and the interest rate was 2% per year. After 5 years, how much do you think you would have in the account if you left the money to grow: more than $102, exactly $102, or less than $102?
- Imagine that the interest rate on your savings account was 1% per year and inflation was 2% per year. After 1 year, would you be able to buy more than, exactly the same as, or less than today with the money in this account?
- Do you think that the following statement is true or false? “Buying a single company stock usually provides a safer return than a stock mutual fund.”
The first two items indicate whether respondents are aware of compound interest and inflation, fundamental concepts required for making saving decisions. The third evaluates respondents’ knowledge of risk diversification, also crucial for making informed decisions.
We found strikingly low performance on these basic financial literacy questions. For instance, one-fourth responded incorrectly to the first question. The accuracy rate for the second question was higher (75% correct), but only slightly over half (56%) got both answers correct, indicating a very poor level of basic knowledge in this older population. Moreover, only half (52%) of the respondents correctly answered the risk diversification question, and one-third (34%) said they did not know (Lusardi and Mitchell, 2006). These are important findings since correct responses to these simple questions are strongly associated with successful retirement planning: those who cannot do a simple interest calculation, do not know about inflation and risk diversification are also much less likely to calculate how much they need to save for retirement (Lusardi and Mitchell, 2006, 2008).