How well-equipped are young people to deal with the next financial and economic crisis -- as opposed to the current one? 

Not very, according to a study by experts in a new paper issued by the National Bureau of Economic Research: “Financial Literacy Among the Young.”

Annamaria Lusardi of Dartmouth, Olivia Mitchell of the Wharton School of the University of Pennsylvania and Vilso Curto of the NBER found only 27% of young adults -- 23 to 28 years old -- could correctly answer three questions to determine their understanding of interest rates, inflation and risk diversification.

When the answers were sorted by gender, race, ethnic background and education level, the researchers found “financial illiteracy is not only widespread, but is particularly acute among specific groups such as women, Blacks, Hispanics, and those with low educational attainment.”

The results are important, they said, because “people with low financial literacy are more likely to have problems with debt, less likely to participate in the stock market, less likely to choose mutual funds with lower fees, less likely to accumulate wealth and manage wealth effectively and less likely to plan for retirement.”

The three questions posed to the 7,138 young adults in the survey were (answers at bottom of story):

1. Suppose you had $100 in a savings account and the interest rate was 2% per year. After five years, how much do you think you would have in the account if you left the money to grow: more than $102, exactly $102, or less than $102.  
2. Imagine that the interest rate on your savings account was 1% per year and inflation was 2% per year. After one year, would you be able to buy more than, exactly the same as, or less than today with the money in this account?
3. Do you think that the following statement is true or false? “Buying a single company stock usually provides a safer return than a stock mutual fund.”

In addition to the suggested answers, respondents could also opt for “do not know” or choose to not answer.

While 80% of the respondents answered the first (interest rate) question correctly, only 54% got the second (inflation) question right and 47% knew the answer for the third (risk diversification) question.

The future implications of financial illiteracy are significant, the paper said, because young adults have high debt burdens -- between 1997 and 2007 the average undergraduate student loan debt grew from $9,250 to $19,000 -- and the debts loads are influencing other life decisions.

“These debt loads are of particular concern,” the paper said, “given recent evidence that young people may lack sufficient knowledge to successfully navigate their financial decisions.”

Equally disturbing as the percentage of respondents who did not answer correctly: the high percentage of respondents who answered “do not know” for the third question -- 38%.

“The large ‘don’t know’ response,” the authors said in the paper, “was particularly troubling as previous research has found that ‘don’t know’ answers identified respondents with very low levels of financial knowledge.

“In any case,” they added, “the low correct response rates, particularly to the inflation and risk diversification questions, indicated that many young people lack knowledge of basic financial concepts.”

The lack of knowledge appears to be cumulative: “those able to answer one of the financial literacy questions correctly were also more likely to answer the other questions correctly.

According to the researchers, the demographic characteristics too are disturbing.

“Young women are now more likely to have a college degree than men and participate actively in the labor market, yet their level of financial literacy remains very low.”

Men outscored women 82.2% to 76.7% on the first question, 60.1% to 47.8% on the second and 53.3% to 40.1% on the third.

Lusardi said in an interview the gender difference uncovered in her research actually surprised her, but she also noted another difference: “women are more likely to say ‘I don’t know’ than men.” She said because of the greater role women play in society, different programs are required to address their “illiteracy.”

The study found family circumstance have a great influence on the degree of financial literacy with children of parents with higher education levels more likely to have answered the questions correctly. But, there were other influential characteristics:

• Young people who came from homes where parents attended religious services regularly were more likely to answer the questions correctly -- particularly the inflation and risk diversification questions.
• Respondents who had never smoked had a greater percentage of correct answers.

According to Lusardi, attending religious services regularly suggests a more social family atmosphere, which would lead to a broader circle of peers and information sources.

Smokers, she said, generally give less weight to the future than non-smokers, and are less likely to save or invest.

The study suggested “researchers and policymakers alike would benefit from gathering information on financial literacy; often-used indicators thought to proxy for financial literacy, such as education, do a poor job of measuring respondents’ financial knowledge.”

According to Lusardi, the important word is “literacy, not financial” in the study.

She said there needs to be a single reputable source for financial information and suggested the central bank, is perfectly suited to fill this role.

Answers: 1.) More 2.) Less 3.) False

Mark Lieberman is the senior economist for the FOX Business Network. Prior to joining FOX, he served as first vice president and manager of economic analysis and research at Washington Mutual in New York. Before that, he served as senior vice president at Dime Savings Bank of New York (which was later acquired by Washington Mutual), where he specialized in credit and risk management. He is a member of the Executive Committee of the New York Association for Business Economics. He has a degree in Economics from the Wharton School of the University of Pennsylvania.