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The price of financial ignorance

Do you know more about finance than the average American?

If not, you may be in big trouble. You see, the average American would get a failing grade on even a simple test of financial knowledge. According to FINRA, the Financial Industry Regulatory Authority, when given a quiz of five basic financial questions, some Americans cannot get even three out of the five answers right.

Failing a financial quiz could mean failing finances overall

The national average for correct answers on the quiz -- based on compound interest, the relationship between interest rates and bond prices and more -- is a little less than three correct answers. That would be a failing grade by most standards.

If you can't do better than some of these test takers, it will probably cost you money throughout your lifetime.

Furthermore, the test is pretty simple. You can take it yourself on the FINRA website. While the questions deal with basic financial issues, real-world decisions are usually much more complicated than the questions on this quiz. In other words, if most people are failing on this quiz, their actual financial decisions are probably pretty poor.

Gender gap in financial literacy

Unfortunately, women did particularly poorly on the Financial Literacy Quiz. Across all age groups, a higher percentage of women than men failed to answer at least three of five financial questions correctly.

Disturbingly, the gender gap actually widens over time. The quiz results indicate that financial knowledge improves with age for both men and women, but it improves more slowly in women. One interpretation is that being pigeon-holed into traditional gender roles is a culprit -- if men typically take the lead on financial decisions within a household, women will have less opportunity to learn about what goes into those decisions.

Expensive money lessons for young adults

As mentioned above, financial literacy scores generally improve with age. Among adults, they are at their worst among 18- to 24-year-olds. They peak between ages of 65 and 69, before falling off a little in later years.

This improvement with age is a mixed blessing. It's good that financial literacy improves with experience, but when it comes to your finances, keep in mind that experience is a very expensive way to learn. Perhaps the real problem is that financial literacy starts at such a low level among young adults -- less than 50 percent of men and less than 40 percent of women got at least three out of five answers right on the FINRA quiz. By the time people are in their late 60s, more than 80 percent of men and more than 70 percent of women were able to get at least three out of five questions right.

This suggests that for many people, financial learning does not occur in the classroom but only through experience. Often, that method of learning about finance means paying for your mistakes along the way.

Financial literacy and overconfidence

The low level of financial literacy is bad enough, but what makes it especially dangerous is that it is often coupled with a false sense of security. A high percentage of those who scored poorly on the Financial Literacy Quiz actually expressed confidence in their financial knowledge. This overconfidence is especially prevalent in young adults.

Complacency about financial competence can compound the problem. It can make people feel they can make financial decisions they are not really prepared for, and it can reduce the likelihood that they will ask for help or try to improve their knowledge.

How to grow your financial knowledge

Admittedly, a five-question quiz is a crude tool for measuring financial knowledge, but it does reveal that a surprising number of people cannot clear even a low hurdle of financial literacy. Here are four tips for avoiding getting hurt by your lack of financial knowledge - or by your complacency about that knowledge:

  1. Take the time to research your decisions. As a bonus, doing some research will also give you more time to think, and make you less likely to act impulsively.
  2. Stay informed. Doing research when faced with a decision helps, but what is even more valuable is following financial conditions regularly, so you are always up to speed.
  3. Don't be shy about asking for help. Asking a question is less a sign of ignorance than failing to ask one.
  4. Be skeptical of professionals. When asking for professional financial help, always be mindful of the incentives your advisers have, and how these might affect their advice.

People often think there is some secret to investment strategy, a special way of gaining an extra edge. The truth is that the best way you can give yourself an advantage is nothing particularly exotic. The best returns will probably come from investing in your financial knowledge.

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