The 2020 TIAA Institute-GFLEC Personal Finance Index: Functional Knowledge
Turning to the eight functional areas that comprise the P-Fin Index, comprehending risk is where financial literacy tends to be lowest among U.S. adults. Comprehending risk involves, for example, understanding that the expected outcome in a given scenario depends on the range of possible outcomes, the financial implication associated with each outcome and the likelihood of each outcome occurring. On average, 37% of these questions were answered correctly (Figure 4).8
Understanding risk and its implications is integral to sound financial decision making since the outcomes associated with a given decision are often unknown when it is made. Risk and uncertainty are inherent across the realms of personal finances, not just investments. Individuals must be comfortable functioning in an environment of uncertainty. Responses to the following question demonstrate the difficulty many individuals have with comprehending risk.
Investment A will deliver a return of either 10% or 6%, with each outcome equally likely. Investment B will deliver a return of either 12% or 4%, with each outcome equally likely. You can expect to earn more by investing in which?
Investment A (chosen by 21% of respondents)
Investment B (chosen by 11% of respondents)
It does not matter – expected return is the same with each (correct answer; chosen by 31% of respondents)
Don’t know (chosen by 35% of respondents)
No response (1% of respondents)
Insuring, investing and go-to information sources are other functional areas where nancial literacy is below average, i.e., below the 52% average of correctly answered questions in the entire P-Fin Index survey.
Financial literacy is highest in the area of borrowing and debt management. On average, 64% of the borrowing questions were answered correctly (Figure 4). Debt tends to
be a feature of personal nance common across the lifecycle for many individuals; knowledge and understanding may emerge from confronting accumulated debt, often from the early stages of adulthood.
Saving, earning and consuming are other areas where personal nance knowledge
is above average, i.e., above the 52% average of correctly answered questions in the entire survey.
8 This finding is consistent with other research identifying risk-related concepts as the most difficult for individuals to grasp. See Coppola, et al. (2017) and Lusardi (2015).