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Readers Challenge Answers To Financial Literacy Survey Questions

My February 21, 2020 column, “Are you likely to save for retirement?” mentioned financial literacy quizzes that originally appeared in the 2017 Quarterly Journal of Finance paper, "How Ordinary Consumers Make Complex Economic Decisions: Financial Literacy and Retirement Readiness."

If you were not able to take these surveys, there is a link to them on my website (www.juliejason.com).

Readers reached out about two questions. Spoiler alert: we are going to discuss the answers, so if you want to take the quiz, do so first before reading further. 

First question: Suppose that in the year [2025], your income has doubled and prices of all goods have doubled too. In [2025], how much will you be able to buy with your income? (i) More than today; (ii) The same; (iii) Less than today; (iv) Do not know; (v) Refuse.

  1. 3.7% answered, “More than today.”
  2. 86.2% answered, “The same.”
  3. 9.43% answered, “Less than today.”
  4. 0.67% answered, “Do not know.”
  5. 0.0% answered, “Refusal.”

The “correct” answer is “The same.” But is that true? Some of you objected. 

One reader, K.R. wrote “I disagree with one of the questions on the basics quiz. If your salary doubles you pay a higher rate of taxes at the higher salary. If you start at $150k and double to $300k, your tax rate goes from around 20% to around 25%, so you lose roughly $45k to taxes. That decreases your buying power.” 

G.K. also challenged the answer, “[This question] regarding doubling your income is incorrect. In most cases If your income doubles your income tax rate will increase thus you will have less than double your take home pay to pay for goods that have doubled. This question should be rewritten to say: and your effective income tax rate stays the same.”

Another reader, R.R. wrote, "If my income doubled, and prices doubled, I could buy LESS because of the progressive income tax. It did not say tax rate stayed the same. I think the Financial Quiz 2 answer is wrong."

I reached out to Annamaria Lusardi at The George Washington University School of Business. who created the question. Here is her response: “these comments are well taken, but one should not make assumptions that are not listed in the questions (it is ceteris paribus, or everything else stays the same).”

There are real-life variables that may change in the future, including inflation, changes to the tax code and changes to your expenses.

Second Question: “Assume a friend inherits $10,000 today and his sibling inherits $10,000 3 years from now. Who is richer because of the inheritance?”

Answer options (i) My friend; (ii) His sibling; (iii) They are equally rich; (iv) Do not know; (v) Refusal.

  1. 79.4% answered, “My friend.”
  2. 4.4% answered, “His sibling.”
  3. 9.1% answered, “They are equally rich.”
  4. 6.8% answered, “Do not know.”
  5. 0.3% answered, “Refusal.”

The correct answer is “My friend.” But why? 

One reader, C.C. asked, “How can [this question] be answered with any certainty because there is no information about interest, etc in the intervening years between the inheritances?” 

Another reader, K.K. responded, “the way the question is stated makes no mention of receiving any interest or other return on the money for recipient #1. If recipient #2 also receives $10,000 (years later), on the date of receipt both parties have exactly $10,000 no more or less. Assuming recipient #1 had received some return which is not stated in the question is not a proper way of forming the question.”

A third reader, E.F. wrote, “I just took the financial literacy quizzes. One question says that your friend inherits $10,000, and then his sibling inherits $10,000 3 years later and asks who is richer. I said neither, because it doesn’t say what your friend does with the $10,000 between when he inherits it and when his sibling inherits it, so I have to assume that the friend has done nothing with it and, at that point, they both have $10,000. I know you didn’t write the questions, but it puzzles me: if we knew that the friend had invested the money, or even put it in an interest-bearing checking account or savings account, then in three years he would have more money than his sibling.  But it doesn’t say that, so I am apparently missing the point. I’m wondering whether the question should’ve been “your friend inherits $10,000 today and his sibling is scheduled to inherit $10,000 3 years from now; Who is wealthier today?” But that’s not what it asks. So: what am I missing?”

* * *

Response: This question is testing knowledge of opportunity cost. $10,000 received today is worth more than $10,000 received three years from now because of your capacity to do something with it. Your friend could put it in the bank and earn interest, invest it, spend it, put it in a mattress, or give it away. 

According to Lusardi and Mitchell “planning for retirement is a complex undertaking, requiring consumers to gather and process data on compound interest, risk diversification, and inflation, and make assumptions about future asset market performance…financial literacy is a key determinant of retirement planning, and that respondent financial literacy is higher when consumers were exposed to economics in school and in employer-sponsored programs."