Financial Literacy: How Do You Stack Up?

Key Points – Financial Literacy: How Do You Stack Up?

How Will You Fare on the TIAA Institute’s Financial Literacy Quiz?
Financial Literacy Covers Interest Rates, Inflation, Risk Diversification, and So Much More
Understand Your Financial Situation — Maybe You Can Retire Now
It’s OK to Not Ace the Financial Literacy Quiz — That’s Why We’re Here to Help!
13 minutes to read | 21 minutes to watch

Our Commitment to Financial Literacy

When Dean Barber founded Modern Wealth Management in 1996, he did so with one goal in mind—to provide financial education. So, when Financial Literacy Month comes around each April, Dean and his team make sure to celebrate it in the best way they know how. And that’s to continue our commitment to financial literacy.

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Our Commitment to Financial Literacy

A Financial Literacy Quiz from the TIAA Institute

Along with being passionate about financial literacy, Dean always enjoys some friendly competition. Logan DeGraeve echoes Dean’s sentiments, so Dean thought it would be a great idea to quiz Logan on his financial literacy. The questions for this quiz were comprised from a 2020 study by the TIAA Institute.

Components of the Quiz

This quiz has two components, the first of which the TIAA Institute calls, “The Big Three.”

The second component gets into more advanced aspects of financial literacy, such as:

Bond Pricing
Mortgages
Compound Interest

Some Sobering Financial Literacy Statistics Before the Quiz

While Logan was very excited to be quizzed by Dean on his financial literacy, Dean first wanted to share a few startling statistics from the TIAA Institute’s study.

Pre-Quiz Financial Literacy Expectations

71% of the adults ages 38 to 64 who took the quiz rated themselves as having high financial knowledge.
62% of millennials (37 and younger) also ranked themselves as having high financial knowledge.

Financial Literacy Reality

34% of the adults ages 38 to 64 answered all three of the Big Three questions correctly.
16% of the millennials answered all three of the Big Three questions correctly.

Dean and Logan weren’t very surprised by the start contrasts between the pre-quiz expectations and financial literacy reality. Nevertheless, those statistics just made them realize how important it is for them to educate Modern Wealth Management clients and prospective clients so they can all live their one best financial lives.

“We’ve always been big advocates of educating the public,” Logan said. “It doesn’t matter if you’re a client or not. Our job is to help build a smarter public when it comes to financial planning.”

Financial Literacy Quiz Time!

So, let’s see if Logan could join those 16% of millennials who could answer all three of the Big Three questions correctly. It’s financial literacy quiz time! We’ll list the Big Three questions first and then do a quick a review with the correct answers and Logan’s answers (hopefully they’re the same!) before finishing with two more questions that were on the TIAA Institute’s quiz.

Question 1: Interest Rates

Suppose you had $100 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?

A. More than $102.
B. Exactly $102.
C. Less than $102.
D. Don’t know.
E. Prefer not to say.

Question 2: Inflation

Imagine that the interest rate on your savings account was 1% per year and inflation was 2% per year. After one year, how much could you buy with the money in this account?

A. More than today.
B. Exactly the same.
C. Less than today.
D. Don’t know.
E. Prefer not to say.

Question 3: Risk Diversification

Buying a single company’s stock usually provides a safer return than a stock mutual fund?

A. True.
B. False.
C. Don’t know.
D. Prefer not to say.

Big Three Answers

Question 1: Interest Rates

Logan’s Answer: A. More than $102.

Correct Answer: A. More than $102.

Logan’s Takeaway: That’s the whole adage of getting that compound interest going. It’s the whole principle of investing. Your money is going to work for you.

Question 2: Inflation

Logan’s Answer: C. Less than today.

Correct Answer: C. Less than today.

Logan’s Takeaway: It’s the same conversation we’re having with a lot of our clients today. They really like having the extra cash on the side, but it’s not earning anything. And inflation, depending on what we’re talking about, is going up by X%.

Dean’s Example: A simple example would be gasoline prices. Today, can you buy more or less gas with $20 than you could six months ago? The prices are inflating, so obviously you’re buying a lot less gas with that same $20. That’s the concept of inflation. You can buy less goods and services with the same amount of money.

Given our current inflationary environment, we’re going to go a little bit more in depth with Question 2 before moving on the answer for Question 3. Inflation is a vitally important aspect of financial literacy.

Inflation Is Like the Silent Killer

Here’s a Deanism for you about inflation that you might have heard from him before, “Inflation doesn’t ever really cause people to go broke, but it will make people live like you’re broke.” The reasoning is because inflation is causing them to not do as much with the same money as they did before.

Planning for Inflation

When you’re financial planning, whether you’re doing it on your own or working with a financial planner, you need to plan for inflation. We haven’t seen a lot of inflation until lately, so working with a financial planner can be very beneficial so you understand inflation’s impact on different things.

“The people that come to us and already have a plan in place, we see all too often that some advisor had only been factoring in a 1% or 2% inflation rate for them,” Dean said. “That is terrifying. All you need to do is take the inflation rate up to the long-term norm of 3.9%, which is what we use, and their plans would fail.”

Remember that the 3.9% is just for goods and services. Things like health care and college need to have higher inflation rates of around 7% attached to them.

Question 3. Risk Diversification

Logan’s Answer: B. False.

Correct Answer: B. False.

Logan’s Takeaway: I see this all the time with my clients that have a ton of company stock. The company has been good to them, but they need to diversify out. Make sure that one company doesn’t hinder their ability to retire and do the things that they want to do.

Dean’s Example: Enron would be a perfect example of that. For people that don’t remember Enron, almost of all their company stock was in people’s 401(k)s. When Enron went belly up, a lot of people lost their life savings.

On to the Final Two Questions

So, how did you do on the Big Three financial literacy questions? We’re hoping you matched Logan and went three for three. If not, please don’t hesitate to reach out to us about getting educated on that subject area(s). Each of those Big Three categories is critical to comprehensive financial planning, so we want you to be as well-versed on them as possible.

Now, on to the final two financial literacy questions.

Question 4: Bond Pricing

If interest rates rise, what will typically happen to bond prices?

A. They will rise.
B. They will fall.
C. They will stay the same.
D. There is no relationship between bond prices and interest rates.
E. Don’t know.
F. Prefer not to say.

Question 5: Mortgages

A 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.

A. True.
B. False.
C. Don’t know.
D. Prefer not to say.

The Final Two Financial Literacy Quiz Answers

Question 4: Bond Pricing

Logan’s Answer: B. They will fall.

Correct Answer: B. They will fall.

Dean’s Example: Think of it like a teeter-totter. The easiest way I’ve been able to get people to understand teeter-totters is by having interest rates on one end of the teeter-totter that are sitting on the ground. On the other end, bond values are way up in the air. As soon as interest rates start to rise, the bond values will begin to fall.

If you’re at the far end of the bonds end of the teeter-totter, those are your longer-term bonds (i.e.: 20-year and 30-year treasuries). The further out on the teeter-totter that you are, the more sensitive the interest rates are.

Your shorter-term bonds would be like when you’re a kid sitting on the middle of the teeter-totter. You only did it once or twice because it wasn’t fun. There was no action there. But that can be a safer place to hold money because those shorter-term bonds will mature. And as interest rates rise, you’ll get to buy new bonds at higher interest rates.

Logan’s Takeaway: Dean makes a great point. We have clients all the time that say they don’t like bonds and that bonds are boring. But ultimately, bonds are a stay-rich investment. Not all bonds are created equal. Make sure you’re looking at duration at what bonds you’re holding right now.

Total Wealth Asset Allocation

There are bonds that are making money in this rising interest rate environment. However, they aren’t your traditional bonds. You aren’t just going to be able to buy from the bond aggregate and need to be selective with what kind of fixed income that you want to put into your portfolio.

“The problem is that for most people, most of their wealth is inside of their 401(k) plan, and they don’t have those alternatives for fixed income inside their 401(k) plan,” Dean said. “So, if someone is working with a CERTIFIED FINANCIAL PLANNER™ Professional and has money inside and outside their 401(k), the CFP® Professional needs to look at the choices they have within the 401(k). Let’s line that up because those are going to be limited. That will dictate how you want to invest outside of your 401(k).”

Dean firmly believes that it’s all about total wealth asset allocation. It’s not just about the asset allocation in your 401(k), IRA, or joint or trust account. It’s all of it.

Question 5: Mortgages

Logan’s Answer: A. True.

Correct Answer: A. True.

While Logan went five for five on the financial literacy quiz, he and Dean are more concerned that such a low percentage of people correctly answered even all three of the Big Three questions.

Dean’s Overall Takeaway: It’s troubling, but then you get into more complex issues, too. For example, let’s say you’re starting your 401(k) plan. Should you defer into the Roth option of the 401(k) if it’s available or the pre-tax (normal) 401(k)? What’s the difference between the two? What happens when you retire and you have money inside of a Roth IRA versus inside of a traditional IRA? Then, what are the Required Minimum Distributions on a Roth IRA versus a Traditional IRA?

Logan and I could sit here going over question after question pertaining to financial literacy. The bottom line is that the older you get, the more money you make, and the closer to retirement you get, the financial situation that people find themselves in doesn’t get simpler. It gets more complex.

Understanding Your Situation – Maybe You Can Retire Now

Here’s another example from Logan that he’s seen happen more often than he’d like. Let’s say someone waited until 65 to consult a financial planner and thinks that they’re going to retire at 67 because it’s their full retirement age to claim Social Security. Logan wants everyone to know that that doesn’t have to be the case.

“What’s sad is that people are being robbed of their most precious commodity, which is time,” Logan said. “Meet with a CERTIFIED FINANCIAL PLANNER™ Professional, make a financial plan, and figure out when you can retire. People have the same misconception of thinking they can’t retire before getting on Medicare.”

Health Care Costs in Retirement

More to that point of Medicare, though. There’s no doubt that health care costs are out of control. A lot of people don’t understand what those health care costs are going to be, but know it’s expensive and don’t look into retiring before 65.

“I was recently visiting with a couple of my clients that we’ve been working with for a few years to get them to retirement,” Dean said. “The husband just turned 62 and wife just turned 60. I told them that the plan is still set for them to retire this year, but they still thought they needed to save more and mentioned health care. I said, ‘Let’s throw an additional $25,000 a year in there for health care for the years leading up to Medicare. Their plan still works.’ The point I tried to make was that they’ve reached the pinnacle of financial independence.”

Are You Financially Independent and Don’t Know?

What exactly does financial independence mean, though? Financial independence means that if someone is working only because they really want to work and not because of needing to make more money since they’ve reached the point where their money can take care of them.

“We see that more often than not. A lot of people can retire sooner than they do, but just didn’t have the clarity that they could. When people come in and visit us, they want to know if they’re OK financially and then what to do with what they have. They’ll have Social Security, maybe a pension, and a 401(k), but need to know what to do with all of it. We need to show them how to get their money to work for them and get the most tax-efficient paycheck to their bank account.”

Break Down Health Care Costs in a Financial Plan

Having a financial plan in place is critical, but if it doesn’t break down the health care costly separately, you’re doing it wrong. You can’t lump in health care costs with your travel budget or normal expenses. They need to be broken down separately because of inflation. While some people may argue that health care service isn’t as good as it used to be, but people are living longer.

For example, let’s say someone’s grandparents and parents passed away in their early 80s. While family genetics can be a good indicator of how long you’ll live, but there’s much more you need to consider when retirement planning to make sure you don’t run out of money.

“When we make a financial plan for people, we’re usually planning for them to live into their low-to mid-90s,” Logan said. “If someone thinks they’ll live until they’re 80 and get to their 81st birthday, we’ll remind them of the conversations we had. Things are different from when your grandparents passed away.”

Understand Your Options for Claiming Social Security

Social Security is another misunderstood part of people’s retirement. So many people believe that Social Security is an entitlement program, but it’s not. It’s your money. You put money into it and your employer then must make a dollar-for-dollar match. Here’s another thing to keep in mind about Social Security.

“Let’s say you have a married couple and one of the two never works outside of the home to stay at home with the kids. Does the spouse that never worked a job get Social Security even without paying into it?” Dean said. “Yes, they do because of spousal benefits. That spouse is going to get up to 50% of their spouse’s full retirement amount, assuming that they wait until full retirement to claim Social Security.”

And Widow Benefits

While this isn’t something a scenario that we wish for to play out, remember that there are widow benefits starting at 60 if you are a surviving spouse with Social Security. Then, there are scenarios with Social Security and ex-spouses as well. But a lot of people aren’t aware that those various types of Social Security benefits exist.

Don’t Forget About Uncle Sam

Along with benefits that people might forget about, there are also forgotten taxes that are part of the retirement equation. If you haven’t previously watched it, we highly recommend watching our video, Retiring with $1 Million. People often have a set dollar amount that they want to accumulate before they retire. Let’s say in this case that it’s $1 million. Well, remember that once you reach $1 million (or whatever number you’re wanting to reach), that that $1 million isn’t completely yours. Uncle Sam hasn’t gotten his piece of the 401(k) pie yet.

“You may think that you’re 15-20 years out from retirement, which is great, but how you’re saving today and tomorrow is going to impact when you retire and what that looks like,” Logan said.

A Bonus Question on Social Security

Logan thought he was done being quizzed by Dean on his financial literacy, but not quite yet. Dean came up with another question on Social Security, so let’s see if you and Logan can answer it.

Question: Is Social Security a tax-free source of income?

A. Yes.
B. No.
C. It Depends.

Logan’s Answer: C. It depends.

Correct Answer: C. It depends.

Dean’s Takeaway: By itself, Social Security is a tax-free source of income. However, there’s something called modified adjusted gross income. It’s a calculation used to determine how much, if any, of your Social Security has become taxable. You can disqualify yourself and not have Social Security become tax-free by having too much provisional income. Up to 85% of your Social Security can then become taxable.

This leads to another question that you should be thinking about if you’re preparing for retirement. Where should you be saving prior to retirement so you can reduce the tax burden in retirement? You can’t look at things like Social Security, your investments, and your tax plan in a vacuum because it’s all correlated.

Don’t Get Blind-Sided When You Reach RMD Age

For example, let’s say someone was in a situation where Social Security wasn’t taxable, but then Required Minimum Distribution age hits. They finally need to start taking money out of their IRAs. Their taxes suddenly go way up.

“For every dollar you take out of your IRA, it’s going to cause another dollar of your Social Security to become taxable,” Dean said. “If you’re in the 22% tax bracket, that dollar withdrawal from your IRA is effectively taxed at 44% because the dollar of Social Security that wasn’t taxable before is now taxable.”

The same thing does for qualified dividends and capital gains. At a certain level, those aren’t taxable. If you go above that, they start becoming taxable. Extra income from Required Minimum Distributions can start causing other pieces of your income that weren’t taxable before to now be taxable.

It’s OK to for Your Financial Literacy to Not Be at 100%

Dean and Logan reviewed a lot of aspects on financial literacy here, but there’s no need to feel overwhelmed. It’s OK to not know the answers to all the questions they covered. Dean, Logan, and the other financial advisors do what they do so you can get the answers to the questions that you don’t know the answers to.

“A lot of people think that they can’t talk to a financial planner because they don’t even know what questions to ask,” Dean said. “The reality is that you shouldn’t know. A good CERTIFIED FINANCIAL PLANNER™ Professional is going to ask you the questions and educate you along the way. Over time, you will then get the clarity, confidence, and control that you want.”

A Financial Health Check-up

Going to the doctor isn’t something we want to do, but it’s obviously very important. Think of meeting with your financial advisor as you would think of having a check-up with your doctor.

“Financial health matters as well,” Logan said. “You can meet with us and ask us anything. It can be simple or something that’s more detailed.”

Dean, Logan, and the rest of our team want to share our knowledge about all the financial rules and complicated issues so that you can enhance your financial literacy. It’s all about taking those aspects of financial literacy and applying them to your personal situation.

“We have CPAs, estate planning attorneys, and insurance experts on staff,” Logan said. “That’s what they do every day, just like Dean and I focus on financial planning. There’s no reason to not make sure everything is in good order.”

So, please don’t hesitate to reach out to us with any financial literacy questions. You can schedule a complimentary consultation or 20-minute ask anything session with one of our CERTIFIED FINANCIAL PLANNER™ professionals. We can meet with you in person, by phone, or virtually.

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Investment advisory services offered through Modern Wealth Management, LLC, an SEC Registered Investment Adviser.

The views expressed represent the opinion of Modern Wealth Management an SEC Registered Investment Adviser. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Modern Wealth Management does not accept any liability for the use of the information discussed. Consult with a qualified financial, legal, or tax professional prior to taking any action.