A 2014 Gallup World Poll study of 15,000 representative adults in more than 140 economies across the globe measured basic knowledge of financial concepts: interest rates, compounding, inflation and risk diversification. This study concluded that only one in three adults are “financially literate.” Specifically, women, those in poverty and lower educated respondents are more likely to be financially illiterate.
If two of three adults around the world are financially illiterate, how much does the average adult know about more specific financial topics like investments and the stock market? To determine how financially literate Americans are in regards specifically to investing, we asked 4,000 American adults four basic questions about stocks, bonds and investments.
Overall, Americans performed poorly. If we were to grade accuracy for the four questions on a lettered scale, much like a report card, the results would be as follows:
Only half of Americans know that bonds are the least risky investment
Only 53 percent of respondents chose the correct answer ‒ United States Treasury bonds ‒ when asked about the safest investment type. These bonds are often referred to as “risk-free,” meaning there is nearly no loss possible with this type of investment. Because the Federal Reserve acts as a fail-safe for the federal government, investors can always expect to be repaid by the Treasury Department, even if the government is in debt or low on funds.
Men are 13 percent more likely to correctly identify the safest investment type. According to a 2016 report, men outperform women on most financial literacy tests. This is due, in part, to level of education, income and culture.
Surprisingly, millennials were the second largest age group to correctly identify the safest investment choice. 61 percent of respondents ages 25–34 chose bonds, just behind 63 percent of those ages 65+.
Young adults’ scores in other financial literacy studies suggest that the age group is not knowledgeable about financial basics. However, the results of our study speak plainly: Americans ages 18–24 are not necessarily the most illiterate when it comes to finance and investment, despite their general lack of real-world experience.
It is important to note that as of 2016, only 20 states were required to include economics in high school curriculum. At the collegiate level, only 3.2 percent of universities and colleges required an economics or finance class for graduation. With college debt continuing to rise, this means many young adults may not have the resources necessary to properly manage their finances and investments in the future. Though they responded to our questions with better accuracy than expected, it is critical to expand education and learning opportunities for young adults in these topics
3 out of 4 Americans don’t understand how bonds work
Though 53 percent of Americans identified bonds as the least risky investment, 75 percent do not understand how bonds work.
The relationship between bond prices and interest rates is classically inverse: as interest rates rise, bond prices fall. Though this seems illogical, the relationship functions similarly to a price war between two companies. The price of the bond adjusts to keep the bond competitive against the current interest rate.
Only 25 percent of respondents were able to correctly answer that the price of the bond would fall if interest rates rose. Instead, most respondents (50 percent) said that the price of the bond would not change at all.
Nearly half of Americans don’t understand financial markets
Understanding the difference between a bull market and a bear market is essential if you want to make a profit investing. We gauged Americans’ knowledge of financial markets by asking about the basic principle behind a bull market: the expectation of rising stock prices.
Bull markets are characteristically optimistic about the future price of stocks. This optimism is based on the perspective of investors, who pursue strong investment results in the form of stock value. Typically, a bull market is recognized after stock prices rise by 20 percent and are therefore difficult to predict beforehand.
Though you shouldn’t make rapid changes to your stock portfolio at the slightest change in markets, making small adjustments can help cushion losses and increase gains. Because bull markets are generally a period of opportunity for investors, it may be wise to take on additional risk during an economic uptick.
Once again, men outperform women on this question. Women answered with an accuracy of 47 percent compared to men’s 60 percent. Additionally, 40 percent of women believed a bull market is not characterised by optimism about future stock prices compared to men’s 24 percent.
On average, older Americans outperform their younger counterparts on this question. Across age groups, a slight increase is seen in percentage of correct responses. Respondents in the 18–24 age group respond with 38 percent accuracy in the bull market question and respondents in the 65+ age group respond with 62 percent accuracy.
Americans understand when to cut their losses
We asked respondents to imagine that a company they invested in suddenly filed for bankruptcy and then determine what would most likely happen to their stocks in that company. Overall, respondents performed better on this question than the other three, with approximately 64 percent accuracy. Both men and women achieved accuracy over 60 percent and nearly all age groups (the 25–34 age group fell just below at 58 percent).
According to Investopedia, in the event of a company’s bankruptcy, any stocks in the company become worthless. Shareholders may be entitled to liquidated assets by the company, but the stocks themselves cease to hold value.
Though incorrect, 25 percent of Americans think their stocks would be sold to a third party in the event of a company bankruptcy. Though it may be possible to receive some payment in the form of liquified assets, a bankrupt company cannot sell a shareholder’s actual stock in the company for money. Respondents who believe there is a possibility of making money on their stocks even after bankruptcy may be at risk of losing substantial funds if they do not properly prepare for the possibility of bankruptcy in their investments.
Respondents for these investment questions failed three of four questions. From this, we can conclude that financial literacy, especially as it pertains to knowledge of stocks, bonds and general investment, is lacking in the United States. Overall, the youngest respondents and women tended to perform below others.
Knowledge of these financial topics is imperative for participation in the stock market and makes a considerable impact on the country’s economy. Understanding the basic principles behind investment, savings, credit and debt are crucial for Americans and can help boost the overall health of the market as well as individuals’ wealth. Luckily, there are many resources to help you understand these topics in better detail, including investment websites, loan calculators and credit repair help.