New research suggests the average investor struggles to grasp the basic math required to calculate financial losses and gains. Photo by John Angelillo/UPI | License Photo
STIRLING, England, Aug. 17 (UPI) -- Managing financial investments requires basic math. For some, such a requirement is problematic. According to a new study published in the journal Judgment and Decision Making, many people underestimate their financial losses as a result of poor arithmetic.
When researchers at Stirling University had some 3,500 people complete a series of financial literacy tests, they found the majority underestimated the difficulty of breaking even after a financial loss. The test-takers consistently miscalculated the size of their losses and/or the gains necessary to recoup their losses.
"Those who are not expert investors assumed that after, for example, a 50 per cent loss, they only needed a 50 per cent gain to balance things out," Philip Newall, a behavioral scientists at the Stirling Management School, explained in a news release. "However, when you lose a certain percentage of an investment, you actually need a bigger percentage gain to get back to where you started."
Researchers used tests with varying percentages and even attempted incentivizing correct calculations with rewards, but at least a third of all study participants continued to get the basic arithmetic incorrect, regardless of the circumstances.
"Without an understanding of this concept, people frequently overestimate the final value of their investment, even when the percentage changes are dramatic," Newall said. "For example, many people thought that an asset with returns of 100 percent followed by a 100 percent fall had retained its original value when in fact it was worthless."
The researchers found that those with higher levels of financial literacy tended to perform better on the tests, as did those who took a longer time to think over the problems.
Given the variability of financial markets, it's essential for lay investors understand the risks associated with their investments, whether they be in pension funds, stocks or the housing market. Part of that understanding involves basic arithmetic.
Scientists say their latest findings reveal the need for better education, and perhaps, regulatory reforms.
"We are increasingly understanding the need for financial regulation to be informed by rigorous research from psychology and behavioral economics," concluded Liam Delaney, professor of economics at Stirling. "This research demonstrates how difficult people find it to understand complex financial products."