Here’s an article on financial literacy that is making my day: People flunked this money test because the questions were dumb.

The article is referring to an undertaking by McGraw Hill, the World Bank and Standard & Poors. They commissioned Gallup to pose five questions in a financial literacy survey to 150,000 people in more than 140 countries. You had to get three of the questions right in order to demonstrate financial literacy.

The big drama: only about a third of people were able to do that.

The Financial Literacy Questions

Here they are:

  1. Suppose you have some money. Is it safer to put your money into one business or investment, or to put your money into multiple businesses or investments?
  2. Suppose over the next 10 years the prices of the things you buy double. If your income also doubles, will you be able to buy less than you can buy today, the same as you can buy today, or more than you can buy today?
  3. Suppose you need to borrow 100 US dollars. Which is the lower amount to pay back: 105 US dollars or 100 US dollars plus three percent?
  4. Suppose you put money in the bank for two years and the bank agrees to add 15 percent per year to your account. Will the bank add more money to your account the second year than it did the first year, or will it add the same amount of money both years?
  5. Suppose you had 100 US dollars in a savings account and the bank adds 10 percent per year to the account. How much money would you have in the account after five years if you did not remove any money from the account?

I answered the questions on this Quartz article. Here’s that first question on Risk Diversification again:

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<insert sarcasm> Oh yes… That’s what poor people do. They take their spare rupees and throw them into single stocks on the stock market. <end sarcasm>

Um, how about no. Clearly, this question is a financial literacy question for this rich. Also – if you’re entrepreneurial (which most poor people are), isn’t it more sensible to put money into your own business, instead of trying to spread it around?

Here’s the next one on Compound Interest:

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Counter-question: if you don’t use banks, because you don’t meet eligibility criteria, is it really a statement of your financial ‘illiteracy’ that you don’t quite understand compound interest?

I think not.

Then for Numeracy:

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…same counter-question.

Inflation:

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Perhaps not all that surprising that real world experience might interfere with that inflation question?

Finally:

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And we’re back to that same counter-question.

What Felix Salmon Thinks

Here’s a sample of Felix Salmon’s derision from that making-my-day article:

This is completely bonkers: nothing useful can be learned by going up to poor workers in, say, Afghanistan (to take the very first country on the list), and asking them this question. They don’t have banks, and if they do have banks they don’t have savings accounts, and if they do have savings accounts they don’t hold on to them for five years, and if they do hold on to them for five years they’ll probably end up with nothing at all, since the bank will probably have been looted, or gone bust, or else they will have no way of proving their ownership of the account. On top of that, there’s no reason to believe that they have any idea what “10 percent” means, because that’s a mathematical concept they are very unlikely to have been taught at school.

Afghans, like everybody else, can be very smart and shrewd about their finances, and, like everybody else, sometimes they can be stupid too. But if they’re smart, and they’re faced with a question like this one, the only sensible response is some kind of WTF eyeroll.

The Financial Literacy of the Poor Entrepreneur

The only other thing that I wanted to say is that the poor are often capable of generating returns that are absolutely astronomical by normal investment return standards.

Consider this:

  1. A poor Indian mother has no money.
  2. So she borrows, say, $5 to be repaid by the end of the day.
  3. It has to be repaid at $6 including interest.
  4. By the end of most days, she has enough money to cover her family’s food (let’s say that she spends $3 on food).
  5. She repays her loan with interest.
  6. The next day, she starts again with no money.

So: she has to make $4 a day in margin ($3 for food, $1 for interest) off $5 in borrowed money (and her own sweat).

That is a Return on Investment of 80% – in a day.

Sure, in absolute terms, it’s not very much at all. But almost no company can claim to be making that kind of ROI.

I realise that there are some flaws in that calculation, but I did a more expanded version of that in this post: “How can I spend my $35 to get the best return on investment?” And the point is: this is financial literacy. It just might not be the kind of financial literacy that the rich use in their day-to-day financial decision-making.

And, I guess, the rich have that kind of financial literacy because they are rich – and they are not rich simply because they have that kind of financial literacy.

If you want to see more of the results, here’s a youtube clip.

Rolling Alpha posts about finance, economics, and sometimes stuff that is only quite loosely related. Follow me on Twitter @RollingAlpha, or like my page on Facebook at www.facebook.com/rollingalpha. Or both.