This Is the Most Underrated Skill in Personal Finance

Financial numeracy > financial literacy

Photo by Immo Wegmann on Unsplash

“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.

1. Debt

2. 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.

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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.

Importance of numeracy in financial decision making

Research has shown that the inability to work out simple formulas leads many households to rely on rules of thumb to make important financial decisions.²

‌As I covered in my two-part series on financial rules of thumb, relying on shortcuts rather than doing the math yourself leads to poor financial decisions.

An example I used was the “Rule of 110,” which states the amount of your portfolio you allocate to stocks should equal 110 minus your age. So 30-year-olds would allocate 80% of their portfolio to stocks and 20% to bonds. While this simplifies the asset allocation decision, it oversimplifies it. It ignores critical factors like when you need to use the money, your risk tolerance, and how reliable your paycheck is.

Financial rules of thumb are a good place to start understanding complex topics but should never be relied on to make financial decisions.

Another study showed that people who can’t work out simple interest calculations are less likely to save for retirement and accumulate less wealth than those who can.³

Other studies have shown this to be true not only in the U.S but around the world.

The less you understand financial calculations, the less wealth you’ll accumulate.

The ways in which financial numeracy matters range from decisions as fundamental as whether to save at all to more complex issues like selecting an investment fund with the lowest possible fees.

Those with low numeracy levels are also less likely to participate in workplace retirement plans, invest in stocks, or even own a home, all of which are classic pillars of wealth creation.

These are all examples of the opportunity cost of low numeracy; it’s the potential wealth creation you forego for not understanding basic calculations.

More painful is the wealth that is destroyed by a lack of numeracy.

One study found that those with low numeracy levels were more likely to miss their mortgage payments and have their house foreclosed on by the bank.⁴ Those who understand interest calculations are more likely to make their mortgage payments.

How to improve numeracy

I have some good news and bad news.

The bad news is that there is no easy fix to instantly become better with math and financial calculations—You will need to dedicate yourself to learning this skill.

The good news is that you don’t need to become an economist or financial pro—you need to learn some basic calculations. You absolutely can learn to understand these numbers.

A 2020 study reviewing how adults can learn numeracy later in life outlines the three forms of adult education.⁵

1. Formal: In a classroom, often being taught by a teacher within a formal institution and results in a diploma or certificate.

2. Non-Formal: Planned education that does not involve a credential. Think of a workplace seminar on retirement planning.

3. Informal: Spontaneous and non-structured learning that is part of our daily routines. The post you are currently reading is an example of informal education.

In future posts, I will review resources and exercises to increase your financial numeracy.

Financial Numeracy Pop Quiz*

The following questions are standard measures of financial numeracy that I found in a 2012 paper titled "Numeracy, financial literacy, and financial decision-making."⁶

Test out your financial numeracy, and see the bottom of this post for the answers.

Okay, ready for the answers?

Q1: More than $102

Q2: Less than last year

Q3: False

How’d you do?

1. Lusardi, A. (2012, February 1). Numeracy, financial literacy, and financial decision-making. National Bureau of Economic Research. https://www.nber.org/papers/w17821

2. Douglas Bernheim, B. (n.d.). ScholarlyCommons ScholarlyCommons Financial Illiteracy, Education, and Retirement Saving Financial Illiteracy, Education, and Retirement Saving. Retrieved October 24, 2022, from https://core.ac.uk/download/pdf/287648316.pdf

3. Mitchell, O. S., & Lusardi, A. (2011). Financial Literacy and Retirement Planning in the United States. SSRN Electronic Journal. https://doi.org/10.2139/ssrn.1810550

4. Gerardi, K. S., Goette, L. F., & Meier, S. (2010). Financial Literacy and Subprime Mortgage Delinquency: Evidence from a Survey Matched to Administrative Data. SSRN Electronic Journal. https://doi.org/10.2139/ssrn.1600905

5. Gal, I., Grotlüschen, A., Tout, D., & Kaiser, G. (2020). Numeracy, adult education, and vulnerable adults: a critical view of a neglected field. ZDM, 52(3), 377–394. https://doi.org/10.1007/s11858-020-01155-9

6. Lusardi, A. (2012, February 1). Numeracy, financial literacy, and financial decision-making. National Bureau of Economic Research. https://www.nber.org/papers/w17821

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This article is for informational purposes only. It should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any significant financial decisions.