Test your financial IQ
By Gordon Powers, Sympatico / MSN Finance
It’s no secret that people have widely varying tolerances for risk, and different levels of patience. Unfortunately, particularly when it comes to investing, most of us only figure this out after the bottom falls out of our plans.
Thankfully though, Yale professor Shane Frederick has come up with a simple way of predicting our taste for risk-taking. He calls it the Cognitive Reflection Test. Try it before you continue on …
(1) A bat and a ball cost $1.10 in total. The bat costs $1.00 more than the ball. How much does the ball cost? _____ cents
(2) If it takes 5 machines 5 minutes to make 5 widgets, how long would it take 100 machines to make 100 widgets? _____ minutes
(3) In a lake, there is a patch of lily pads. Every day, the patch doubles in size. If it takes 48 days for the patch to cover the entire lake, how long would it take for the patch to cover half of the lake? _____ days
Each of the CRT questions has an immediate, intuitive answer – which happens to be completely wrong. The correct answers are:
1. 5 cents (not 10 cents)
2. 5 minutes (not 100 minutes)
3. 47 days (not 24 days).
If you didn’t nail them, don’t feel too bad. Roughly a third of Frederick’s subjects got all three answers wrong, while only 17% nailed all three.
Frederick discovered striking correlations between those scoring correctly on all three CRT questions and their tendency to take sensible financial gambles. For instance, most high scorers preferred a small chance at big money rather than a guaranteed few bucks … which, if you only have two options, is the rational choice.