On January 1st you put $50,000 in a savings account that earns 1%. Over the next 12 months, inflation runs 2%.  On December 31st, will the money in your bank account be able to buy more or less that it could have bought at the start of the year?(1)

More than a third of the individuals asked this question in a nationwide poll responded incorrectly. That is, they didn’t understand that when prices are going up at a faster rate than the return your money is earning, your purchasing power – the lifestyle you can afford to buy – declines.

The first-of-its-kind survey, funded by the Financial Industry Regulatory Authority’s (FINRA) non-profit Investor Education Foundation, included nearly 1,500 Americans chosen to represent a demographically correct cross-section of the U.S. adult population – by race, ethnicity, age, income, education, and other factors. It’s the first comprehensive look at how we save, borrow, and plan for our financial future. It differs from previous studies in both its scope and content, compiling not only a bunch of statistics about how much money we have or haven’t saved, but also delving into the attitudes and behaviorsthat help or hinder our financial security. 

The bottom line: We’ve got a lot of work to do. There are significant and serious holes in Americans’ knowledge of the most basic financial concepts. 

Geri Walsh, vice president of Investor Education at the FINRA Foundation, sidesteps my question about what grade she’d give us by saying, “The data is so complex.  It’s impossible to give Americans a single grade.”  However, she admits being “deeply troubled by the results.”

For instance, “a majority believe they’re good at handling day-to-day finances, but engage in behaviors that cause them to over-draw their accounts.”  Half said they have difficulty paying their monthly expenses.  One out of four individuals who have a checking account (12% have no bank account of any kind) admitted they overdraw it “on occasion,” triggering huge fees. Sixteen percent of those with a mortgage said they were late with at least one monthly payment in the past two years.

Most Americans (58%) have no “rainy day” fund to tide them over in the event of a financial emergency such as an unexpected medical expense. (One rule of thumb is to have enough money to cover 3-6 months worth of living expenses in a savings or money market account.) The result?  “When a financial crisis hits, they’re not prepared,” says Walsh, “They can’t absorb the impact of a job loss or disability.”  That can trigger a deep spiral into debt and even bankruptcy.

Making matters worse, those least likely to have a rainy day fund are those mostlikely to be hit with a negative financial shock. As a group, in the past 12 months, individuals who did not have money earmarked for emergency expenses were one and a half times more likely to have experienced a big drop in income.

There’s also a serious lack of attention to long-term financial issues.  Despite 20 years of warnings that we need to accept greater responsibility for our retirement income and the fact that Social Security is looking less and less secure, only 42% of us have attempted to calculate how much we ought to be saving.  While 79% said they regularly contribute to a retirement savings plan through their job and/or an individual retirement account (IRA), almost one-in-five had no idea what their money was invested in. 

Citing earlier research by Princeton University, Walsh said that one of the barriers to long-term financial planning is that “people can’t envision their future.” For instance, the importance of saving for retirement is “very challenging for a younger person to grasp.”  But, she says, it can also be psychologically overwhelming for someone in their 40s and 50s.  “It’s really hard to imagine not only that you are going to get old and what your financial needs will be, but who that person will be.”

Unfortunately, the FINRA Foundation survey found that “not only are people not saving for the unknown, they’re also not saving for the known. Only 40% of individuals with children had saved anything to pay for the cost of college. And, according to Walsh, those who were saving “weren’t taking advantage of tax-advantaged methods which could save them more money.”

The FINRA Foundation intends to use the data from this study and two others coming out in 2010 to identify regions and demographic groups that are most in need of financial education. “We finally have a baseline of data that show where the gaps exist,” says Walsh.  The intent is to develop programs and materials to close the knowledge “gap.”  She says there are plans to repeat it every two to five years to see “how Americans are stacking up.”

One big challenge will be convincing us that we needto be educated about financial issues. Although 75% of those surveyed described themselves as “good at dealing with day to day financial matters” and “pretty good at math,” only 10% were able to correctly answer all 5 basic math questions.  “People really believe they’re good at math and finances,” says Walsh.  “But when you look at their behavior, it tells a different story.”

By the way, the answer to the question at the top of the story is, of course, “less.” On December 31st your $50,000 will be worth $50,500.  However, to cover the increased cost of living over the year, you’d need $51,000 to buy the same basket of goods and services that $50,000 would have bought on January 1.