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Have you ever been brutally honest with yourself about how much you really understand personal finance? Well, buckle in, cause today you can test your knowledge with a personal finance quiz!
This quiz comes from the National Financial Capability Study (NFCS), by FINRA. This study polls 25,000 Americans every few years to see how we’re doing financially. And to gauge how well we understand personal finance. The national results are pretty enlightening.
Spoiler alert: we’re not as financially savvy as we think we are. Only 37% of respondents answered more than 3 questions (out of 5) right. But what’s really interesting is that 76% of respondents polled said they were financially literate.
So what’s going on here? Maybe we just don’t understand the meaning of “financially literate”. Like what financial knowledge do you need to know to be financially literate?
Well, according to the NFCS, there are 5 questions to test financially literacy, and a 6th bonus question for a challenge. How many can you get right?
Can You Pass This Personal Finance Quiz?
Let’s Explain the Answers…
Not sure about these answers? Let’s take a closer look at them.
Oh, and let’s also talk about why you need to know this stuff.
Question 1: Suppose you have $100 in a savings account earning 2 percent interest a year. After five years, how much would you have?
At the end of five years, you’ll have more than $102 thanks to the magic of compound interest.
Our Savings and Sangria regulars know all about compound interest. It seems like we mention it almost every week 😉
For those of you who don’t know, compound interest is making money on the money your money is making.
Ok, you have $100 in this savings account. And your money makes $2 in interest that first year thanks to the 2% interest rate. The next year, you get to earn interest on the original $100 you invested, but you also get to earn interest on the $2 your money made last year!
So the second year, with the same 2% rate, your $102 would earn $2.04, so you’d have $104.04 at the end of that year. And this pattern repeats every year, so by the end of 5 years, your savings account would have grown to $110.41.
Now, $10.41 doesn’t sound like much, right? Right. It’s not.
But that was only a $100 sitting in a savings account with a 2% interest rate.
What happens when you consistently save a few hundred dollars each month, starting in your 20’s, in a retirement account earning a 7% return?
You turn your total investment of $220,000 into $1,203,031!
And that’s not all. By the time you retire at 65, you’re earning $80,901/year in interest alone!
Don’t believe us? Read all about it!
7% by the way, is conservative. Over the long-term, 10-11% is totally doable.
Question 2: Imagine that the interest rate on your savings account is 1 percent a year and inflation is 2 percent a year. After one year, would the money in the account buy more than it does today, exactly the same or less than today?
The money in your account would buy less a year from now than it would today because of inflation.
Inflation is just how fast prices are rising. You know how your grandpa talks about getting a Coke “for a nickel” when he was a kid? Yeah, a Coke is $1.50 now thanks to inflation.
Prices will rise every year unless there’s something seriously wrong (like during the Great Recession).
And if prices rise faster than your savings earns interest, you end up with less buying power as time goes by.
In the US, the average inflation rate per year is 3.27%. So to make sure you’re staying ahead of inflation, you need to be earning a better rate than 3.27% on your investments.
Your savings account probably won’t beat 3.27%. Right now, you’re lucky to get 1.5% interest on a savings account. That’s why you must make the leap from “saver” to “investor”.
Beat inflation by going from “saver” to “investor”
Index Fund Investors can reasonably expect to average at least 7% over the long-term. Some years will be lower, and some higher depending on current market conditions, but investing is a long game, so you have time to ride the ups and downs of the market.
So why would you keep money in a savings account at all? Because that money is available whenever you need it. What if your car breaks down when the stock market sucks and your investments are all down? You don’t want to pull money from those investments before the market recovers! So you keep your emergency fund in a savings account for easy access and no losses.
Generally, you want to have enough in your emergency savings account to cover 1-3 month’s worth of expenses when you’re young. That way you have a cushion even if you lose your job and need a minute to find a new one. You’ll want to keep more in your emergency fund as you get older because it takes longer to replace a higher-level, better-paying job. You know, the kind of job you might want in middle-age.
But once you have your emergency fund stocked, you shouldn’t keep more money in savings. You should be investing it. Investing in a retirement account is investing priority #1, followed by investing in your Dream Fund. Learn more about the saving/investing trifecta: Emergency Fund/Retirement Fund/Dream Fund.
Ready to make the leap from “saver” to “investor”? You can become an investor today with as little as $5.
Question 3: If interest rates rise, what will typically happen to bond prices? Rise, fall, stay the same, or is there no relationship?
First, what the eff is a bond exactly?
Bonds are like little loans investors make to organizations (often federal agencies or branches of the government). You agree to let the organization use your money for a certain amount of time, and when that time is up, you get your investment back plus the agreed upon interest.
When interest rates rise, bond prices fall. And when interest rates fall, bond prices rise. This is because as interest rates go up, newer bonds come to market paying higher interest yields than older bonds already in the hands of investors, making the older bonds worth less.
What does this mean for you?
Honestly, it’s not super important to your life at this point.
Bonds are a good investment option for older investors who are more interested in protecting their money than growing it.
As a young investor, you can take more risk with your investments (and hopefully reap better rewards!) because you have time to recover from the periodic market dips. But older investors are retired and living on the money their investments produce, so they can’t afford to take much of a hit.
So for now, just know that bonds are safer than stocks, but the reward potential is much less, so you don’t need to invest in bonds until you’re close to retirement.
Question 4: True or false: A 15-year mortgage typically requires higher monthly payments than a 30-year mortgage but the total interest over the life of the loan will be less.
This is true. You’ll pay more each month for a 15-year mortgage, but you’ll save a ton of money in interest payments compared to a 30-year mortgage.
Wants to save $100,000 on your home? Here’s how you can do it.
Let’s say you take out a $200,000 home loan with a 5% interest rate. You have two options:
- Take a 30-year loan, and pay $1,073.64/mo
- Take a 15-year loan, and pay $1,581.59/mo
If you take the 30-year loan, at 5% interest, you’ll end up paying $186,511.57 in interest alone!
If you take the 15-year loan at 5% interest, you’ll end up paying just $84,685.71 in interest.
So you pay $508 more every month, but you end up saving over $100,000.
A 15-year mortgage might not always be practical. In pricey housing markets, the monthly differential could be too much to overcome.
For example, when we bought our San Diego house in 2016, our monthly payment on a 30-year mortgage was a doable $2,550. The monthly payment on a 15-year mortgage would have been $3,756. Not gonna happen.
But if you can afford the 15-year option, you’ll come out well ahead in the end!
(Btw, none of these monthly amounts include property taxes or insurance, so your full monthly costs would be higher.)
Question 5: True or false: Buying a single company’s stock usually provides a safer return than a stock mutual fund.
False, false, false. Buying stock in a single company is super risky.
If the company starts sucking, the stock price could go down, and you could lose money.
And the company could start sucking for totally unexpected, unforeseeable reasons.
Chipotle is a perfect example. Everything looked great for them in 2015. Their stock price was way up to $749. Then E. coli hit, and boom, their stock plummeted. Over the next year, their stock dropped to $370. Investors lost as much as $379 per share! And no amount of financial analysis could have predicted it.
Buying an individual company’s stock is a risky game, and I don’t play it. And neither should you.
Mutual funds are different. Stock mutual funds are like sampler sets of a bunch of different stocks. When you buy a share of a fund, you’re automatically investing in a bunch of different companies instead of putting all your eggs in one basket. This is what investors mean when they talk about “diversifying your portfolio”. Mutual funds = automatic diversification!
But you need to be careful with mutual funds because of the potential fees. The fees are paid out of your portfolio earnings instead of your pocket, so it’s easy to lose track of the fees you’re paying.
Index funds are a special class of mutual funds with really low fees. Stick with index funds unless you are a super-savvy investor with a really good reason to choose a different type of mutual fund.
BONUS QUESTION: Suppose you owe $1,000 on a loan and the interest rate you are charged is 20% per year compounded annually. If you didn’t pay anything off, at this interest rate, how many years would it take for the amount you owe to double?
This is a more sophisticated financial question.
It involves the “rule of 72”, a fancy financial heuristic used to estimate an investment’s time-to-double. If you divide 72 by your interest rate per period, the result is the approximate number of periods required for the investment to double.
So in this question, 72 (years) divided by 20 (annual percentage rate) = 3.6 (years until your debt doubles).
One person’s debt is another person’s investment. If you have a $1,000 loan, that loan is an investment by your lender. They lend you the $1,000 expecting a full return of the loan plus the interest rate.
So the interest is bad for the borrower but good for the lender. 20% is a high interest rate, but if you look at your credit card bill, you might be surprised to see interest rates over 20%.
That’s why you want to pay off high-interest debt asap!
Need help paying off debt? Read our post, How to Pay Down Debt When You Can’t Even Pay All Your Bills.
What Did We Learn?
The big lesson from the National Financial Capability Study (NFCS) is that we don’t know as much as we think we do. And what we don’t know can hurt us financially.
How is Personal Finance not required high school curriculum?!
That’s why Savings and Sangria wants to help young women understand personal finance. And be financially prepared for the future! We’ve got lots of great resources to help you get started.
If you’re brand new to personal finance, start with Everything You Need to Know About Personal Finance Fits on an Index Card.
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