Test Your Financial Literacy Knowledge
One of the biggest barriers to learning any new skill is overconfidence. Even the best of them can find themselves guilty of overconfidence, but quickly acknowledging your weaknesses can make the learning processes much easier.
Surprisingly, Americans seem to be suffering from a bit of overconfidence when it comes to their money savviness—at least according to a study called Financial Literacy and Retirement. The study highlighted their research for the National Financial Capability Study—a massive initiative undertaken to quantify financial literacy rates in the United States by state.
What was discovered was that while over 70 percent of Americans rate their financial literacy knowledge highly, most received a score of about 54 percent when given a five-question financial literacy quiz.
The gap in financial literacy knowledge was further magnified when the researchers broke their results down by demographics—young people below the age of 35, women, Hispanics and the less-educated all scored below average when surveyed.
"Our work demonstrates widespread financial illiteracy; for instance many households are unfamiliar with even the most basic economic concepts needed to make sensible saving and investment decisions" Olivia Mitchell, one of the co-authors of Financial Literacy and Retirement, said in an email. "This has serious implications for saving, retirement planning, retirement, mortgage, and other financial decisions, and it highlights a role for policymakers to improve financial literacy in the population."
If you want to see how you'd fare then stop reading now and take the quiz. Answers and explanations are all below.
1. A 15-year mortgage typically requires higher monthly payments than a 30-year mortgage, but the total interest paid over the life of the loan will be less.
a. True: Let's say you have your heart set on a home that costs $300,000, and don't know whether to go with either a 15-year or 30-year mortgage. With the 30-year mortgage you can expect to make smaller monthly payments on your home, but it'll cost you more in interest. In comparison, a 15-year mortgage will require higher monthly payments, but you'll be rewarded with a lower interest rate.
Now, let's say that you have the choice of choosing either a 30-year mortgage priced at 10 percent interest or a 15-year mortgage priced at 8 percent. As Bankrate.com's mortgage calculator shows, a 30-year mortgage will end up costing you an extra $647,777 over its lifetime, while you'll pay just $216,052 in interest with a 15 year mortgage.
c. Don't know
2. If interest rates rise, what will typically happen to bond prices?
a. They will rise
b. They will fall: Bond prices are fixed, while interest rates generally fluctuate. Say for example that the U.S. government was selling $500 bond with a coupon rate of 8 percent. This means that once that bond matures, you'd get back your $500 plus an additional $40. But, if market interest rates were, say 12%, then it would make no sense for an investor to purchase that bond since they could do better purchasing securities that paid market interest rates.
In this case, the only time it would make sense to purchase the bond is when the $40 you'd get back is equal to a 12 percent return—in this case, the bond would have to fall to just over $333. On the other hand, if interest rates dropped to 6 percent then the you can expect the price of that bond to rise to about $667.
Here's a video that further explains the relationship between bond prices and interest rates.
c. They will stay the same
d. There is no relationship between bond prices and the interest rate
3. 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. Less than today: Imagine you have $1,000 in the bank and want to purchase a television worth the same amount. After one year you'll have $1,010 in your account, but that same television will now cost you $1,020. In another year you'll have $1,010.10 in your account and the television will cost you $1,040.40. You get the point.
c. Exactly the same
d. Don't know
4. Buying a single company's stock usually provides a safer return than a stock mutual fund.
b. False: Diversification is the key phrase here. When you invest in one company's stock, you're essentially putting all of your eggs in one basket. If the company's stock tanks, then you could lose most if not all of your investment. On the other hand, stock mutual funds pool together funds from groups of investors and is managed by fund manager. That manager then invests all of that money into different types of securities—stocks, bonds, you name it—to spread the risk. This way, if the stock the mutual fund is invested in tanks, investors can at least look to the other securities for a return.
c. Don't know
5. Suppose you had $100 in a savings account and the interest rate was 2% per year. After 5 years, how much do you think you would have in the account if you left the money to grow?
a. More than $102: The only math you'll need to do is figuring out 2 percent of $100—which is $2. That means you'll have $102 in your account after one year. Since you can expect your money to continue growing after that then the answer must be more than what you would have after your first year.
b. Exactly $102
c. Don't know