Compounding Interest.One Key Financial Principle That People Have No Idea OfBy Chris Brandt, UniversityHerald Reporter
When it comes to finances and cash management, it seems like a lot of people have no clue how to handle or manage their money. But what's more surprising is that there's one simple but key financial principle that people have no idea about: compounding interest.
Compounding interest is simply defined as an interest earning more interest as time goes by. Yet in a recent survey conducted by the Organization for Economic Co-operation and Development (OECD) on financial literacy, only 13.2 percent of the 51,650 adults who participated in 30 countries has the financial smarts. What's more surprising is that the survey was not conducted in third world countries but in developed and developing countries which are both OECD and non-OECD members.
One of the questions asked was simple, yet the researchers were surprised that a lot of people had no idea about it. The question was how much interest rate will a $100 deposit have within five years with a 2 percent compounding interest. Only 58 percent were able to guess it correctly.
Aside from that, the survey tested the financial knowledge, attitude, and behavior of each participants through a questionnaire with the possibility to earn up to a maximum score of 21 points. The result was disappointing as the total average score is only 13.7 percent. The highest country to score was France yet the score was still low at 14.9.
With regards to financial behavior, the area where most people struggle with was in the area of getting independent financial advice and planning in advance. Out of the respondents from 30 countries, only 19 percent said they shopped around and asked for financial advice while 60 percent said they maintain a budget. Those who said they set financial goals are only 30 percent.
Americans did not participate in the survey but according to Annamaria Lusardi, a professor who studies financial literacy at the George Washington University, Americans would not do any better and she is correct. In a separate survey conducted by Standard & Poor, Americans placed 14th in the world when it comes to financial literacy.