A Healthier 2018 – Six Questions

Old Chinese proverb goes “I hear and I forget; I see and I remember; I do and I understand.” Knowledge was passed by the ancients to their children often by stories and demonstration. Formal schools later emerged in China about 3,000 years ago. However, they were established for the nobles, the masses could only dream, and education was key to achieving coveted positions in civil service. Power, status and wealth accompanied those positions.

Studies were multi-disciplined and students who mastered the Six Arts were recognized for having achieved a state of perfection. The arts included Confucianism, music, archery, charioteering, calligraphy and mathematics.

The education system evolved. Mao’s Cultural Revolution in the 60’s was the most radical and controversial. He pressed elimination of the “Four Olds” – ideas, customs, culture and habits. Society stagnated for a decade.  Teachers and intellectuals were persecuted, books destroyed and schools shut down. Academic and scientific institutions would later recover, however, the impacts persist.

“Six Questions to Help Determine Your Financial Health” by Annamaria Lusardi was a popular wealth management article in the WSJ for 2017. It summarized the National Financial Capability Study on financial literacy. Average American scored 3.2 out of 6 questions. Below is the latest test and some relevant life issues.

Why is financial literacy vital to your success? If you had a magic wand and your retirement was guaranteed, you’ll face other financial decisions and possible reboots in your life. Family, job and business changes, and not getting out of this world alive are just a few. Life is complex and requires a variety of skills and resources. Here we go – see how you do.

  1. Suppose you have $100 in savings earning 2% a year. After five years, how much would you have? More than $102, exactly $102, less than $102, or don’t know. This illustrates time value of money, comparing investment options, and verify how much you should have in your account.
  2. Imagine the interest rate on your savings is 1% annually while inflation is 2%. After one year, would the money in your account buy you more than it does today, the same, less or don’t know? Inflation is a hidden menace. How “safe” is a safe return?
  3. If interest rates rise, what will typically happen to bond prices? Rise, fall, stay the same, or there is no relationship. Interesting rebalancing dilemma facing investors today – do you reposition stock gains in long-term bonds? How much money do you lend at low current rates?
  4. 15-year mortgage typically requires higher monthly payments than a 30-year mortgage but the total interest cost over life of the loan will be less. True, false, or don’t know? Debt reduction is high priority. Refinancing thoughts: (a) shorten the loan by paying more on your mortgage and save refinance costs, plus you can revert to the lower payment in tough times, and (b) check the new tax law for deductibility of mortgage interest. Are you overpaying for a car? “It only costs $100 a month” to bump up $5,000 to a $25,000 loan (5-year); and better credit score saves about $2,500 ($20,000 loan at 4% vs 8%).
  5. Buying a single company stock usually provides a safer return than a stock mutual fund. True, false, or don’t know? People may prefer stocks vs boring mutual funds or ETFs. Some are very successful (diligent and disciplined) stock investors. Remember, animals herd on the savanna – safety in numbers.
  6. Suppose you owe $1,000 at 20% interest annually. If you pay nothing, how many years will it take for the debt to double? Less than 2 years, 2 to 4, 5 to 9, or 10 or more. Make payments on time. “Rule of 72” relates the number of years for principal to double at a specified return. Divide the return (or number of years) into 72. $100 bill is worth half in 24 years at 3% inflation. Portfolio doubles in 10 years if earning 7.2% a year.

How’d you do? Answers are A, C, B, A, B, B. And another proverb says, “Walking ten thousand miles beats reading ten thousand books.” Experience and seeing the world are also great teachers. Good luck.

About Brian Loy

Brian Loy writes insightful and inspiring articles about the ever-changing world of personal finance and the global trends that affect the risk and return on investments and shape the financial- and retirement-planning process.
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