This Is the Most Underrated Skill in Personal Finance
Financial numeracy > financial literacy
“Without mathematics, there’s nothing you can do.
Everything around you is mathematics.
Everything around you is numbers.”
— Shakuntala Devi
In a recent post, I explained why financial literacy does a poor job of helping you make better decisions with money. The fatal flaw in financial literacy is that the human brain forgets things so quickly that you’ll have forgotten most of what you learned by the time you need to use it.
In that same post, I pointed out that focusing on related skills that help you make financial decisions is more important than memorizing financial jargon.
One skill that underpins every financial decision is basic math.
Money = math.
Money and financial instruments are just numbers and formulas— which most people still struggle with, and as a result, most people struggle with money.
The numbers are getting more complex
In that post detailing the deficiencies of financial literacy, I reviewed how complexity has consistently crept into our financial lives over the past 50 years. This is particularly true for two financial issues.
Debt
Investing
You can’t navigate the modern economy without making smart decisions around debt and investing—and you can’t make smart decisions around debt and investing without basic math skills.
Understanding financial numbers are table stakes in the increasingly complex world of investing and debt management.
The two financial numbers people struggles with the most
The technical term for measuring someone’s ability to understand math is “numeracy,” which differs from “financial literacy” in that numeracy is about understanding, and financial literacy is often about memorizing terms.
Knowing what “amortization” means is an example of financial literacy.
Being able to work out that 10% of $10,000= $1,000 is financial numeracy.
A 2012 paper examined past studies of wealthy countries and came to the clear conclusion that the majority of people struggle with the math that’s involved with some of the most important financial decisions in life.1
In particular, people struggle to understand percentages and how to calculate interest.
The researchers cite the following standard question measuring financial numeracy:
“Let’s say you have 200 dollars in a savings account. The account earns 10 percent interest per year. How much would you have in the account at the end of two years?”
82% of respondents can’t answer that question.
This is a problem because percentages and interest calculations are used in nearly every important financial decision. From leaving a tip to your server at dinner to saving for retirement, these types of calculations are unavoidable.