Numeracy makes for better investors

Many years ago, I read a book by John Allen Paulos, an American teacher of mathematics. Paulos recounted some examples from a test he conducted for potential employees of an organisation he was consulting with. One of the questions was whether if a quantity grows from 50 to 100, has it increased by 50%, 100%, or 200%? The answers that the candidates gave were all over the place, indicating that many of them were just guessing. It's notable that getting the answer correct requires no great competence in calculations - it's entirely a question of understanding the underlying concept.

There was another question where the test takers were asked about the population of the United States, which was about 220 million at the time. This was not a multiple-choice question and the test-takers had to actually write down the answer. Perhaps half the test-takers got it right. However, what was actually more interesting were the wrong ones. The wrong answers were not randomly spread, nor were they clustered around the correct answer. Instead, there was a cluster of answers around 20 million, another around 2 billion and a handful at 20 billion. Clearly, there were many people who, when seeing a number, do not think of and absorb its scale - how much it actually is. Instead, they just notice the starting digits.

So what does all this have to do with investments and personal finance? To understand the connection, think of what you need to be successful at personal finance, whether it be choosing a loan or mutual fund investing, or perhaps even equity investing. Conventionally, the answers are about what information or analyses you have access to, or what methodology you follow while making your choices. Certainly, most personal finance advice is about giving you information and instructions about what to do. Certainly, much of what I write here falls into this category. What salespeople of various financial products do is also the same, but of course with a different motive.

Nevertheless, based on what I have observed, investing successfully seems to arise from an investor's own capabilities. A lot of this is temperament, which is a different story. However, of the actual functional competencies that are needed, basic arithmetic skills are the most important. Unfortunately, they are also not very common. What's worse is that one doesn't see investors appreciate this as a problem, or make any attempt to rectify it.

In the same book, Paulos points out there seems to be no social stigma attached to not being able to deal with numbers. People who are hugely embarrassed at making the smallest grammar or punctuation mistake, happily, even proudly, declare themselves unable to understand or make even the simplest calculations.

It's not my brief to speculate on why this is so, although the underlying social factors are pretty clear. I'm just here to say that if you want to manage your money well, then don't do this. You owe it to your financial well-being to understand the basic arithmetic of investments. No one is going to do this for you. In fact, there will be plenty of people who will take advantage of savers who are innumerate.

And it's not hard - like everything else, there are a lot of resources on the internet, with Khan Academy obviously among the best. One needs only basic stuff, not much more than a refresher of some parts of 10th standard maths. And if you are curious about what else we get wrong because of the widespread lack of numeracy, then you can get hold of Paulos' books. They are, Innumeracy: Mathematical Illiteracy and its Consequences, and A Mathematician Reads the Newspaper, both available online at a very reasonable price. They're fun, funny, and more than a little useful!