By Haddon Libby
How confident do you feel when making financial decisions? For example, is it better to buy or lease when getting a car? Should you own or rent your residence? When saving for retirement or for the future, do you feel comfortable making decisions regarding the purchase of a stock, bond, ETF, mutual fund,
The Financial Industry Regulatory Authority (FINRA) states seven in ten people feel that they have a ‘high degree of financial literacy’. When FINRA tested the survey respondents to see if they were in fact financially literate, the average respondent could only answer half of the six questions asked. FINRA found people in the northern Midwest states did better than Southern states.
Time for testing! Remember if you cheat, you are only hurting yourself. The correct answers are at the end.
The first question tests your mortgage loan knowledge:
- True or False: A 15-year mortgage requires higher monthly payments than a 30-year mortgage, but the total interest paid over the life of the loan will be less.
Next up is a question testing your understanding of interest rates:
- Multiple Choice: If you had $100 in a savings account and the interest rate was 2%, how much would you have in the account at the end of five years? A) More than $102; B) Exactly $102, or C) Less than $102.
Anytime we go to the store, we get a lesson in how inflation works:
- Multiple Choice: Imagine that the interest rate on your savings account was 1% per year and inflation was 2% per year. After 1 year, how much would you be able to buy with the money in this account? A) More than today; B) Exactly the same, C) Less than today
Do you understand risk?
- True or False: Buying a single company’s stock usually provides a safer return than a stock mutual fund.
Credit cards are a good lesson in the problems caused by the compounding of interest into debt. The next question tests your basic understanding of the financial impact caused by turning interest owed into debt.
- Multiple Choice: 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?A) Less than 2 years, B) At least 2 years but less than 5 years, C) At least 5 years but less than 10 years, D) At least 10 years.
Lastly, many people struggle to understand what a bond is. As a reminder, a bond is debt issued to the public by entities like the US Government or a corporation to fund its cash needs with a promise to be repaid at a future date.
- Multiple Choice: If interest rates rise, what will typically happen to bond prices?A They will rise, B) They will fall, C) They will stay the same, D) There is no relationship between bond prices and the interest rate.
Before the big reveal, know that only 7% of respondents answered each of the six questions correctly. 34% answered five questions correctly with 40% getting four correct.
North Dakota had the highest grade of all states at 55% with West Virginia having the lowest score at 43%. This means that people who can answer four of these questions are considered well above average.
Here are the answers…I really hope that you are not peaking. 1) True 2) A 3) C 4) False 5) B 6) B
Haddon Libby is the Founder and Chief Investment Officer of Winslow Drake Investment Management, a Fiduciary RIA practice. For more information on our services, please visit www.WinslowDrake.com.
