Financial Illiteracy: Common Misconceptions About Money Management Pose Risks for Adults

Many adults are making financial decisions with a generally poor level of financial literacy according to a new report. The TIAA Institute-GFLEC Personal Finance Index measures individuals’ knowledge about borrowing, saving, earning, investing and other money related areas annually since 2017. Most people only got the correct answers around half the time in the latest version due to their difficulty comprehending risk consistently. Annamaria Lusardi, founder of Global Financial Literacy Excellence Center in 2011 who is also a senior fellow at Stanford Institute for Economic Policy Research, explained that when looking into financial decision-making, understanding the relationship between return and risk is crucial but it’s been found to be one of the most challenging concepts. The article discusses three common misconceptions about investing and managing finances that many Americans fall prey to:
1) Investing in a single company’s stock usually provides safer returns than mutual funds or exchange-traded funds (ETF). However, this is not true as putting all your eggs in one basket exposes you to significant loss if the particular company experiences trouble. Many mutual funds and ETFs mitigate risk through diversification by buying stocks from multiple companies.
2) Over time, stocks generally give higher returns with little or no risk compared to savings accounts or bonds; but as stock prices can be more volatile than bond rates or cash in a bank account, this is not accurate. The U.S. Stock market offers the highest investment return over an extended period of time, however it comes at a greater level of risk which investors should bear in mind while making decisions for short-term goals. Experts advise keeping money out of stock markets and opting instead for high yield savings accounts that provide almost no risk due to federally insured deposit amounts unlike investments exposed daily fluctuations seen with stocks resulting in much higher risks.
3) If you have $100 deposited at a 4% interest rate per annum over five years, your money would amount up to $104 according to popular belief; but the correct answer is actually around $121 after accounting for compounded interest due to earning additional interests on principal amounts as well.
Compounding can prove quite beneficial to savers and investors with CFP Preston Cherry stating that commitment, consistency, and compounding are rewarded rather than complexity in portfolio decisions. Sign up here to enroll in the eight-week learning course about financial freedom delivered weekly via email.