Can You Answer 3 Questions about Compound Growth, Inflation and Diversification?
As we age, the need for us to improve our cognitive abilities is matched by our need to improve our financial literacy. The FINRA Foundation's National Financial Capability Study. They've been studying financial literacy for more than a decade, and they say that our literacy is going down. The average respondent to their quiz were only able to answer half of the five financial literacy questions. I'm going to pose some of them to you right here. Let's see how you do.
Question 1: Suppose you've got $100 in a savings account and the interest rate is 2% per year. After five years, how much would be in the account if you left the money to grow? Would you have:
- More than $102
- Exactly $102
- Less than $102
The correct answer, of course, is more than $102 because of compounding.
Question 2: Imagine that the interest rate on your savings account was 1% a year. And inflation is 2% a year. After one year, how much would you be able to buy with the money in your account? More than today? Exactly the same or less than today. The answer, of course, is less than today, because the cost of goods would be rising faster than the amount of money you've got.
Question 3: Tell me whether you think the following statement is true or false. Buying a single company stock usually provides a safer return than a stock mutual fund. True or false? The answer, of course, it's false. Owning a single stock is much riskier than a diversified basket of stocks.
And these three simple questions. Most Americans got the answers wrong. And if you don't understand the very basics of compound growth and inflation and diversification, no wonder people are struggling to create wealth in America. So you need to make sure you're pretty good at this. And by being pretty good at this, it'll help demonstrate that you've got good cognitive skills that will make your life safer and more wealthy as well.