The Financial Literacy Test You Need to Pass

Literacy in at least one language, both spoken and written, is useful to anyone. However, this is not the only type of literacy you must be an expert on.
You must also be very clever and crafty when it comes to managing and growing your finances in order to get ahead. To better assist the road to financial success, here’s a financial literacy test to help you out.  Without reading ahead, try answering the following questions.

  1. What is your current net worth?
  2. Which is more relevant, saving up for retirement or paying off debts with high-interest rates?
  3. When is the best time for you to start saving up for your retirement?
  4. How much do you think you’d need to have saved up for retirement?
  5. Do real estate, bonds and stocks increase quickly over extended periods?

Now let’s go over each question and see what your answer unfolds.

What is your current net worth?

Technically, there aren’t any correct or wrong answers for this, though; either a $0 or a negative $50,000 answer would undeniably be unwelcome and unfortunate. Alternatively, the right way to answer is to know approximately what your net worth really is (roughly).

In order to better manage your finances to achieve a happy and worry-free future, it is vital to look more closely at your financial health.

To find out what your exact net worth is, simply add up all of your assets – incorporating your cash, savings, investing accounts and the your home’s value, car plus other properties. Then get the sum of all of your debt, your mortgage balance, credit card account or car loan, and subtract it from the total amount of your assets and properties. What did you get?

Usually your net worth, in principle, is positive and is geared to increase. If it’s below what you wish it to be or negative, find out some possible budget adjustments to upsurge the net worth.

Which is more relevant- saving up for retirement or paying off debts with high-interest rates?

Reducing your debt should be your first priority. It is more significant than ever to save up for our retirement, now that a multitude of companies are phasing out pensions.

You may aim to earn and save close to the long term annual average growth rate of the stock market, say 10%, with stock investments, and while this can grow $10,000 into roughly $26,000 within 10 years. However, if you have a credit card debt worth $10,000 charged with 25% interest, expect this figure to skyrocket to more than $90,000.

It’s acceptable to maintain low-interest rate debt, like mortgage, as you save and invest for your future retirement; however, debt with high-interest rates should be sorted out ASAP. Or else, your debt will most likely grow faster than what you own.

When is the best time for you to start saving up for your retirement?

The soonest time possible is the best answer here. To reckon that it’s prudent to put it off while you’re in your 20’s or 30s would be a huge mistake. One will become (has to be) more aggressive if he starts saving and investing on the later part of life for retirement. For example, if he starts at age 45, he’ll have 20 years to accumulate his nest egg, while others who started at age 25 accumulate 40 years – double than the former.

That’s paramount, because your money needs to grow and a longer period will help it do so.

Think of it this way, if you’ve been saving and investing $5,000 each year, and annually it increases 10%, it will end up at $315,000 in 2 decades. And in 40 years, it wouldn’t just be double. It would be $2.4 million! If you start saving at the age of 18 with $1,200 and it increases at 10% for 47 years (until the retirement age, 65), it will top $100,000. Your earliest original dollars will have the ultimate probability for growth.

How much do you think you’d need to have saved up for retirement? 

There’s no generic answer for this question. It’s up to you to decide as to how much you’d wish to end up with a satisfactory estimate.

To begin with, keep in mind (according to many experts) that a 4% yearly withdrawal rate out from your savings for retirement is safe (modified for inflation yearly), if you wish for your finances to last. Hence, calculate how much yearly income you’d want in retirement, then multiply it by 25 to rule out the range of savings you need. Aiming for $50,000 annually? Go for $1.25 million.

By all means, income for Social Security can be factored in and all other anticipated income (the Social Security average benefit as of June, was $1,335/month, or $16,000/year). If one earns above-average and estimate a Social Security annual income of $22,000, he only has to target $28,000 yearly on his own, which will end up with a $700,000 savings.

Do real estate, bonds and stocks increase quickly over extended periods?

It’s obvious. The answer is stocks. Tendency is, you can leave a huge amount of money on the table while on your investing lifetime if you don’t have knowledge of the ways you can possibly earn on different types of investments.

Below are data by Jeremy Siegel, a School Professor from Wharton Business, who calculated the balance returns for bills, gold, stocks, bonds and the dollar, from 1802 until 2012:

ASSET CLASS ANNUALISED NOMINAL RETURN
Stocks 8.1%
Bonds 5.1%
Bills 4.2%
Gold 2.1%
U.S. Dollar 1.4%

Source: Stocks for the Long Run.

By the way, from 1926 to 2012, the annualized rate for stocks was 9.6%. Bonds are overpowered by stocks in the long run and-sometimes- the short run. Siegel’s data indicate stocks outperforming bonds in 96% of all 20-year holding periods between 1871 and 2012, and 99% of all 30-year holding periods.

Concurrently, Robert Shiller’s research (a Nobel-prize-winning economist known for his research in the housing market) has home prices with 5% average yearly growth in the after-war period since the time of the Second World War

Never condemn one’s self towards financial illiteracy. To make your future brighter, always read and learn about smart financial management. Keep yourself knowledgeable and updated and give yourself a financial literacy test or evaluation.

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