Tuesday 14 May 2013

How to tell if you will be fine financially in retirement

Never mind all those complicated calculators, spreadsheets, assumptions about stock returns, interest rates, asset allocation models, taxes, risk tolerance questionnaires, longevity assumptions etc etc. Nope, all you have to do is to be able to answer these three questions correctly and you will do fine in retirement!

1) If the chance of getting a disease is 10 percent, how many people out of 1,000 would be expected to get the disease?
2) If 5 people all have the winning number in the lottery and the prize is 2 million dollars, how much will each of them get?
3) 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?
Who says so? Professor Olivia S. Mitchell of the Wharton School at the University of Pennsylvania, in Implications of the Financial Crisis for Long Run Retirement Security. According to the paper "... these three financial literacy questions turn out to be incredibly good predictors of whether middle-aged people plan for retirement, save for retirement, and do well at retirement".

Those who can, do, and those who can't, don't.


Michael James said...

I like it. I've always said that people who can do math rule the world. (Or in this case, people who can do basic arithmetic will fare at last OK.)

Michael James said...

That should have been "at least OK".

Value Indexer said...

Now I'm worried that those are trick questions and I'm missing out on something :)

CanadianInvestor said...

VI, apparently they are trick questions for too many people. Only about half get Q2 correct and more than 80%! get Q3 wrong. Of course I'm not posting the answers (nor does the Prof in the paper), I'm still working on a spreadsheet to solve Q3.

MJ, "at last OK" makes perfect sense too.

Value Indexer said...

I don't even know the specific rules of any lotteries, so I could easily make a mistake on #2 based on invalid assumptions.

Anonymous said...

Dear Olivia,

I bet you do not base your own retirement well being on those questions. What are they supposed to prove? That you made it through 4 years of basic schooling?

CanadianInvestor said...

Anon, the quote makes an explicit and non-trivial assertion - people who are capable of doing what are relatively simple calculations also have the intelligence and perseverance to succeed, as proven by their success. I haven't a study to back it up but I bet that the same statement could probably be made about the kids who restrained themselves in the famous marshmallow test (like this one http://www.youtube.com/watch?v=amsqeYOk--w). The big question - to what extent can successful behaviour be taught - and what is the right method - teaching people math, or self-restraint?

Yes, I can figure out the answers and I believe I will be successful in my retirement, despite relying on my own investments (except for CPP and OAS) because I am bound and determined to do so.

I find it interesting that I do know some people who might struggle a bit with Q3 but whose people skills, and common sense lead them to know who to ask and who to trust to give them the right answers. There's always a good math grunt around to do the calculation.

Unknown said...

With perfect financial modelling, it is possible to stabilize the financial status. Its good to get professional advice like this.

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