Breaking the questions
down
Question #1:
Interest
Suppose
you have $100 in a savings account earning 2 percent interest a year. After five
years, how much would you have, more or less or exactly $102?
While the question is meant to the get at the respondent’s understanding of compound
interest, this is a math problem, and not the most straightforward one at that.
In full disclosure, we got this problem wrong because we misread that the
calculation was over five years not one year.
Question #2:
Inflation
Imagine
that the interest rate on your savings account is 1 percent a year and inflation is
2 percent a year. After one year, would the money in the account buy more than it
does today, exactly the same or less than today?
This
is a good question. Understanding the dynamic between your rate of return and
the cost of living is an important concept.
Question #3: Bonds
If
interest rates rise, what will typically happen to bond prices? Rise, fall, stay
the same, or is there no relationship?
This
is an economics question and, arguably, not relevant. Less than 1%
of Americans directly own bonds.
Question #4:
Mortgages
True
or false: A 15year mortgage typically requires higher monthly payments than a
30year mortgage but the total interest over the life of the loan will be less.
It’s
important to understand the financial structure of mortgages; however, selecting
the best mortgage is significantly more complicated. Note that less than 10% of
mortgages are 15year, mostly due to the fact that owners cannot afford the higher
monthly payment for the property they want. Purchasers need to also consider
fixed versus floating rate, down payment size, closing costs, and a variety of other
factors. Given the generational trend towards renting versus owning, a different
question may be more effective at testing financial literacy and reallife decision
making abilities.
Question #5: Stocks
and Risk
True
or false: Buying a single company's stock usually provides a safer return than a
stock mutual fund.
Less
than 15% of Americans own an individual stock. Individual stock ownership has
been progressively declining starting first with the advent of the mutual fund, the
more recent switch to ETFs, and now the rise of roboinvesting. Stock picking
should be considered an advanced financial skill rather than the a foundational one.
Bonus: Doubling and
the "Rule of 72"
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?
This
is another financial math fact. Akin to knowing that the individual digits of
any number divisible by nine adds up to nine. This bonus question is about the
rule of 72  divide 72 by the interest rate and you get the number of years until
your principal doubles. In this case, 72 ÷ 20 = 3.6. ROYGBIV anyone?
