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Paul Winkler: And back here on The Investor Coaching Show, Paul Winkler talking about the world of money and investing.
Can you answer these six simple financial questions?
I have this article. Yeah. “I hope to retire someday. See if you can answer these six simple questions. So you think you’re financially astute. So they said, try taking this test. Hey, it has three basic questions.” They start off.
Now it says six, but there are three to start with on inflation and diversification. Despite being quite elementary, only 34% of adults, age 38 to 64 are able to answer these three correctly, only 34% of people among millennials. And I betcha everybody in my listening audience. I have a feeling, you probably all get this, but I just want to make a point about this. You know, you may say, well, you know, I don’t really pay attention to what my friends are doing with their investments or anything like that.
You know, I say you might be the only backstop between your friends, having a decent retirement and them just being into oblivion because they don’t understand enough to actually make good financial choices. And people think that other people know more than they do. I think it’s just amazing to me. They had millennials, there’s only 16% who were able to answer these questions. Results are sobering, but what’s more striking is the disconnect between the low scores and investor self-perception.
They found that 71% of older people actually rated themselves as having high financial knowledge. I millennials slightly lower than 62%. Now here’s what they were asking them. They said these three basic questions were on financial literacy. And the first one was this: suppose you had a hundred dollars in a savings account. And the interest rate was 2% per year after five years. How much do you think you would have in the account if you left the money to grow?
So they didn’t go and say, okay, now exactly how much would you have and what would be the dollar figure? And, you know, you put in a hundred bucks and you didn’t put anything else. And that interest rate was 2%. It’s five years later, they’re not going to say, was it, you know, $110.41? I mean, which is the right answer, you know, they’re not going to ask that they just want to know, would you have more than $102? Exactly. A hundred, two less than 102. And that was one of the ones that was missed.
Of course, $110 is greater. So the answer is more than $102. Right? Next question. Imagine that the interest rate on your savings account was 1% per year. And the inflation rate was 2% per year after one year. How much would you be able to buy with the money in the account and that no, it wasn’t an exact number. They just wanted to know. Was it more, was it exactly the same or less? Well, of course it’s less because if your interest rate is 1% and inflation is two, then prices just went up.
Yeah. So let’s say you had a hundred dollars. Prices are now $102 for what used to be a hundred dollars, but your money only grew to $101, right? Because the 1% interest rate, so you basically have $100 to buy. Now that doesn’t include taxes. We can make it a real trick question. Tax is in there, but you know, you got $100 and the cost of goods is now $102. So it’s less, right? Well, people didn’t know the answer to that one.
Amazing buying a single company stock usually provides a safer return than a stock mutual fund. Well, we just, you know, you look at that and I’ve covered this so many times and just talked about how the top 10 companies, you know, if you bought the top 10, what happened going forward? You actually lost money. Well, that means that since markets normally go up, but on average, they went down and that study, that must mean that other companies must have done significantly better.
You know, then those top 10 companies on a forward moving basis. So in essence, what we’re looking at here is, is it safe for announcing? And people thought it was safer to own single companies, no way to diversify. Don’t put all your eggs in one basket, lots of different baskets, lots of, you know, put those eggs all over the place. You know, you’re going to be spreading it out and taking some of that risk off the table because you don’t know what company is going to do better than others going forward.
And one company may go under while the other company that is competing with them, ends up getting their business and they’re going, yeah, I love it. You know, our competitor just went out of business. That’s great. That helps us. Okay. So what were some of the other things?
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Bonds and interest rates
Another one was bonds, bond prices and interest rates. Another question was if interest rates rise, what will typically happen to bond prices? Well, if interest rates go up, bond prices go down. People didn’t know that another one suppose you owe a thousand dollars on a loan and the interest rate you charged 20% per year compounded annually. If you pay anything off at this interest rate, how many years would it take from the amount of debt to double, how much you owe to double? Is it less than two years, two years to five years, five years to 10 years. And this is a little bit harder question, but you know, the rule of 72 tells you how long it takes for money to double or debt to double.
You know, if I got a 12% interest rate on my debt, they’ll take six years from my debt to double well, if it’s 20%, that’s significantly higher. So it’s going to be significantly less than six years for it to double, right? And you know, it’s not going to be, obviously you can think about it. It’s not going to be less than two years. So indefinitely would be between two and five years. Well, people didn’t know the answer to that one either. If you’re not familiar with the rule of 72, it’s 72 divided by your interest rate tells you how long it takes for money to double.
But then another one they didn’t know, 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. Is that true or false? Well, people didn’t know the answer to that one. Well, of course the amount of interest you’re going to be paying as a whole lot less because the debt’s not outstanding as long. So yes, you made a higher payment on it, but the interest. So it’s just amazing to me how, and these are questions that aren’t really that impactful in the retirement planning process.
You know, what if we get into tax order of distribution, what if we get into how to measure risk of an investment portfolio standard deviation, if you’re looking at let’s see sequence of returns, risk, what if you’re looking at what types of investment plans to get, what asset categories, how to measure correlations between. That’s the complicated stuff. And they couldn’t even get these simple things. You think, I can see why investors are really challenged to get through retirement, because there’s just so much that they don’t know that really is super, super important in the investing process.
Even kids need to learn financial knowledge
But you know, the basics are missing. I’m always impressed because my son actually, you know, sometimes he’ll come and he’ll say, I’m not going to do this. I’m going to get the savings account over here.
Kids need to know this stuff. And yet they’re not often taught, but you know, kudos to the teachers that go through the effort of teaching these basic financial principles and double kudos to those kids that actually remember the stuff that they’re taught. It’s incredibly important. It could be the very difference between success and failure when it gets down to how kids will do financially later on, you know, because so often they’re impeded because they just really don’t know the things that they need to know.
And they make decisions that are against their best interests because they don’t know the math and they don’t understand how the financial world works. And so often you go, well, why don’t they just hire somebody to talk to somebody it’s typically because they’re afraid of being taken advantage of, and they’ll go and get one of these apps on their phone. And they think because they’re using an app on their phone that they’re not being taken advantage of. And they’re doubly being taken advantage of because not only do these companies take advantage of them, their lack of knowledge, but they also take advantage of them from a psychological standpoint.
Matter of fact, that was a big topic of conversation around our office. I was talking to a guy and he was saying, “have you seen the documentary social dilemma?” And I said, “no.” And he said, “go watch it.” And I said, “okay, I will.” I did. I was blown away. I don’t know if you’ve seen this, but it is something else. And it’s how social media manipulates and how they play around with how our brain operates and get you to do things.
How did they get you to click on things? How did they get you to watch how they get you to engage, even send emojis and you know, just all of this, they know where you are. They can figure out where you are. GPS tells them where you are and where you are in proximity to other people that are using the social media platforms. It’s just spooky. This is crazy. But you look at these things out there that kids are getting into when it comes to stock trades, I say kids because you know, they’re grown adults, but they’re playing around with these stock trading platforms.
Be an informed investor
And I’ve talked about them in previous weeks and how bad they are and how expensive they are. But people think that they’re free. They think they’re cheap. They think there’s, you know, they can get into investing and they don’t go and ask for advice from anybody that knows anything because they’re afraid of being misled and who can blame them. So many investment advisors out there selling garbage to people. And the reality of it is they’re often giving such bad advice because it’s driven by the sales process. That’s what I would say.
Make sure you’re dealing with degreed planners, and make sure that they have a fiduciary responsibility to you. They must keep your best interest first, make sure that they teach. So you understand what you’re doing, why you’re doing it, what to expect, because if you know these things, it’s hard to mislead an informed investor.
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