Experts use these three questions to test financial literacy. Only 33% of adults choose the right answers to all three. Take the Financial Literacy Test and see how you compare.
Background: these questions were developed by a group of Finance PhD’s (3 professors at Dartmouth, Wharton & Harvard) for a study done for the National Bureau of Economic Research.
These questions have become the industry standard to test financial literacy. (So much so that they’re nicknamed “The Big Three” in financial circles.)
Correct answers: 1. a, 2. c, 3. b
How’d you do? If you got all three right, you are smarter than most people..
Each question tests a different concept. Understanding each one is important, but it’s even more important to put the concepts into practice.
The first question tests your understanding of interest rates. In particular, it tests your knowledge of compound interest, which Albert Einstein called “the 8th wonder of the world.”
If you got that question right, you understand that a dollar invested today will grow exponentially over time because the interest earned also earns interest.
Put into practice: the earlier you save, the more time it has to grow. Don’t wait to start saving for college or retirement. The best time to start saving was yesterday. The second best time is today.
The second question tests your understanding of inflation. A dollar today is worth less than a dollar tomorrow. And a dollar earning less interest than the rate of inflation will lose value over time.
If you got this question right, you understand that stuffing your money under the mattress is not an effective savings technique. You will actually lose money because money under a mattress doesn’t earn enough interest to keep up with inflation.
Put into practice: Inflation averages about 3% per year. So any investment that earns less than 3% is losing value. That’s why you should only keep enough in your savings account a 6-month emergency fund and short-term financial goals (less than 2 years away).
Bonus tip: With mortgage rates around 3% paying off your mortgage early is actually detrimental to your long-term finances.
The last question tests your understanding of diversification. Simply put – don’t put all your eggs in one basket
If you got this right, you understand that owning a mutual fund that owns a bunch of different stocks is safer than buying just one stock.
Put into practice: Owning too much of one stock includes your company stock. When your RSU’s vest and your ESPP shares are purchased, sell them immediately, and reinvest the money in a diversified portfolio.
Bonus tip: If you really, really want to keep your company stock, just make sure it’s not more than 10% of your overall portfolio.
Compound interest, inflation and diversification are simple enough concepts to understand, but putting them to work is another thing.
There’s often a gap between knowledge and behavior. Just because we know what we SHOULD do doesn’t mean we ACTUALLY do it.
We’ll help hold you accountable to yourself. In fact, we call our quarterly scheduled meetings with our members “Accountability Appointments”.
We make sure you not only know the right things to do… we also make sure you actually do them.
Schedule a Discovery Call with us to talk about how we can help your family.