I hope you won’t mind me setting a little test of financial literacy. You buy a new £1,000 computer and borrow money to pay for it. You have a choice: either (a) pay 12 monthly instalments of £100; or (b) borrow money at an APR of 20 per cent, meaning you pay back £1,200 at the end of the year. Which offer is better – or are they (c) identical? (The answer is at the end of this column.)
If you don’t get it right, don’t worry: 93 per cent of Americans don’t either, according to Annamaria Lusardi, an economics professor and director of the Financial Literacy Center. (Financial illiteracy is also widespread internationally, she adds.) Far more obvious financial questions baffle the majority of people. And if you think the question is academic – and would like a hint at the answer – just ask yourself why companies are so keen to let you pay in instalments.
The sophistication of financial products has increased dramatically; the sophistication of consumers has not. “Knowledge hasn’t caught up with the real world,” says Lusardi. “The important word is ‘literacy’. You can’t live in society without being able to read and write, and now you can’t live without being able to read and write financially.”