It's not your fault if you're confused by dense fine print on credit card or student loan statements. But there's a difference between misunderstanding intentionally obtuse language, and simply not knowing core financial concepts.
Alas, you are likely doing worse on that latter front than you realize, at least according to the results of a recent survey from the investing startup Stash.
In fact, Stash's survey — which polled more than 25,000 people, including some of its own customers — found that many adults seem to be confused on key facts about money: One in four mistakenly believe investing is a good way to get rich quick, and nearly one in six couldn't distinguish between a high- and low-interest-rate mortgage.
When it comes to even finer points of money? It's even easier to get mixed up. About two in five survey respondents failed to understand some basic concepts around building wealth and growing richer: Inflation, diversification, and compounding. Learn these, and you'll be ahead of the rest.
What inflation does to savings
Stash posed a simple question to people to see if they understand how inflation works: If inflation is 2% and your savings account earns 1% interest in a given year, will you be able to buy more or less stuff once the year is up? Nearly 40% of respondents got the answer (less stuff) wrong.
Inflation is simply another way of describing rising costs and the corresponding decline in how far the same amount of money goes. If the rate of inflation is higher than the rate on your savings account, your money won't go as far. (The inflation rate in the U.S. in 2016 was 2.1%, in case you're wondering. That's up from 0.7% in 2015 but well below the 13.3% inflation rate in 1979.)
All the more argument for getting yourself a higher-interest savings account to park your emergency fund, and a putting the rest of your savings into investments like stocks and bonds, whose value usually increases faster than that of cash.
Whether stocks or funds are riskier
Diversification is a way to make your investments less risky. There's some truth to the cliche that you don't want to put all your eggs in one basket, because the basket may break and then you've lost all your eggs. Likewise, you don't want to sink all your savings into a single company, because the company may go under and you'll lose all your money.
Roughly 41% of investors aren't clear about the concept, according to the survey, which asked respondents to choose which of two investments was less risky, a single stock or an exchange-traded fund, which contains lots of different stocks. Eleven percent of investors thought the single stock was better, and 30% of them weren't sure about the difference.
Indeed, access to diversification is the main reason why business leaders like Warren Buffett recommend investing your money in things like index funds and ETFs, as opposed to trying to pick individual stocks, or even paying a fancy investment advisor to pick them for you.
How good compounding is — actually
To figure out if Americans understand compounding, Stash asked them to estimate how much money would be in an account with $100 earning 10% interest compounded annually after five years. Would there be more than $150, they asked, less than $150 or exactly $150?
The answer is that you'd actually earn about $161, give or take, because when your investments earn interest, that interest starts earning interest, too. Think that's a small difference? If we were talking $1,000, that compounding 10% would earn you about $1,610 — aka an extra $110 you didn't expect. And over the years, your money would multiply even more.
In short, compounding is one of the main forces that helps your money grow, and it's also the key advantage to getting started on investments as early (and young) as you can.
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