What Is Financial Illiteracy?

What Is Financial Illiteracy?

The lack of financial culture carries significant costs, both in people and in communities outside this type of knowledge. This is one of the conclusions reached by a report prepared by Standard & Poor’s Ratings Services based on data from 150,000 people around the world.

In today’s column, we will try to financially evangelize our readers.

To do this, we will use the 5 questions that the survey consultant asked to determine if a person has a financial culture or lacks it. We will answer each question and develop key concepts of the subject.

Thinking of those who want to evaluate their knowledge before moving on to our explanation, we will first place the questions with the corresponding options and then, below, the answers we have developed. According to the study, the level of a financial lawyer is reached when at least 3 questions are answered correctly.

Questionnaire to assess your degree of financial Knowledge:

1) Suppose you have money saved, is it safer to allocate that money to a single investment or business, or several investments and businesses?

2) Assume that during the next 10 years the prices of the things you usually buy every month double. If your income also doubles in that period, will your purchasing power have increased, decreased or will it be the same?

3) Suppose you need to borrow 100 dollars. Which of these two options would you choose to return less money: pay $ 105 or $ 100 plus 3%?

4) Suppose you have deposited money in an account for two years and the bank offers to pay you 15% per year in interest. Assuming that you did not make any partial withdrawal, in the second year will the bank pay you more interest than the one you paid at the end of the first year or will you pay the same amount?

5) Suppose you have 100 dollars deposited in a bank that pays you 10% per year for 5 years: how much money will you have at the end of that period if you do not make any partial withdrawal? More than 150 dollars, exactly 150 dollars or less than 150 dollars?

Our answers

1) It is safer to allocate money to various businesses or investments. One of the most well-known phrases in finance indicates that “it is not convenient to put all the eggs in the same basket”. Distributing capital in different financial assets or the so-called real economy is what is known as diversification. This behavior allows us to reduce the risk of our total investment, given that, if we have problems with investment, another business unit may well compensate for this momentary loss.

A well-diversified portfolio of investments must have assets or businesses with a low degree of correlation. This means that the march of one should not affect the march of another. For example: if we buy shares of Grupo Financiero Galicia (GGAL), Banco Macro (BMA) and BBVA (BBAR) we will be dividing our investment, but not diversifying it, in the strict sense of the term, since in general the roles of the financial system experience similar variations in the Stock Exchange. Different would be to invest a little in banks, the same in the energy sector and a third in companies linked to agricultural activity, for example.

2) My purchasing power will be the same.

This question is intended for citizens of countries not accustomed to inflation. To the Argentineans, reality teaches us by force how to live with the persistent depreciation of our currency. Therefore, it is difficult for us to fail in this response. In fact, in the study we use for this column, the consultant highlights Argentina as a country where knowledge about inflation is very high: more than 60% of local respondents answered this question well. The difference between the general increase in prices and that of income determines the changes in people’s purchasing power. If both rise in the same proportion, the purchasing power will remain constant, something that does not happen at the moment.

3) 3% of 100 is 3.

Therefore, I choose to pay 100 dollars plus 3% interest. The result is less than 105 that is also proposed.

4) In the second year, the bank will pay me more money for interest.

Assuming that I have deposited 10,000 pesos, the interest of the first year will be 1500 pesos (15%). For the second year, and always under the assumption that I did not make partial withdrawals, 15% of interest will be calculated on an updated basis of 11,500 pesos ($ 10,000 plus the $ 1500 received at the end of the first year), whereby the interest payment will amount to 1725 pesos, an amount higher than the previous period. This is called capitalizing interest or making investments with compound interest: the interest obtained is added to the original capital to charge future interest for our investment. This type of operation allows our capital to grow exponentially rather than linear.

5) I will have more than 150 dollars.

It is for the compound interest that we mentioned in the previous answer. After the first year, I will have $ 110, at the end of the second my capital will have grown to the US $ 121 (110 x 1.10) and so on until five years when I will have $ 161.05. In this link, you can make your calculations with compound interest. For the given example, complete with 100 “Initial amount”, with 5 “time” and with 10 “annual interest rate”. The rest of the fields must be blank. Press “calculate interest” and you will see the result.

Conclusion

On a global level, the results of the questionnaire show a clear correlation between the most developed countries and the degree of financial knowledge of the population. The countries with the most approved were Germany, Israel, Holland, Norway, Sweden, and England (all above 65%). On the other hand, in the so-called BRIC (Brazil, Russia, India, and South Africa), the number of correct answers averaged just 28%, a result similar to that of Argentina.

At the level of people, financial illiteracy creates great risks; more in a world where the financial system, in alliance with science and technology, grows by leaps and bounds, with fintech as the main exponents of new developments.

Not knowing the new concepts and tools can place us in the least desirable place in the new interconnected world, where debtors are.

In an economy like ours, with interest rates in the clouds, believe me, that it is convenient to leap to the other side of the counter. Starting to devote energy to our finance training is the best investment for compound interest to become a friend of our pocket and give us free time to enjoy life.

Share

Leave a Reply

Your email address will not be published. Required fields are marked *

Solve : *
15 ⁄ 5 =