A Financial Literacy Test: How Knowledgeable Are You?

by Gary Foreman

A Financial Literacy Test photo

How much do you know about personal finance and money? Take this financial literacy test to see if you at least know these basics.

Most of us like to think that we’re smart. On some subjects we probably are. But, if truth be told, there are others where we aren’t really smart because we haven’t been educated. 

One of those areas is personal finance. You make money decisions pretty much every day of your life. And you’re reasonably sure that you know what you’re doing. Want to test that assumption? Take this Financial Literacy Test and see how much you really know about personal finance.

No worries! It’s an open book test with the answers immediately following the questions.

1. If you put $100 into a savings account and the account earned 2% interest per year, would you want the interest to be posted yearly, monthly or daily? And why?

You would want to choose the most frequent posting. You would want the interest to be posted daily. The reason is simple. On the second day you would be earning interest on your initial savings PLUS the interest earned and posted after day one. That’s the advantage of compound interest. If it were posted annually, your $100 would still only be worth $100 364 days later.

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2. Why is ‘compound interest’ sometimes called a double-edged sword?

Because compound interest makes savers wealthier and borrowers poorer.

Here’s how. The saver earns interest on the money they’ve saved, in effect gaining income without working. That tends to make them richer over time.

The borrower adds interest to money that he already owes. An unpaid debt gets bigger and bigger without the borrower doing anything. He gets poorer without buying anything.

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3. True or False: If I buy something today, it doesn’t affect what I can buy in the future.

False. What you buy today has a definite impact on what you can buy tomorrow. If you use your savings to buy a car today, you cannot use that money as a down payment on a house tomorrow. And, if you buy a Starbucks today, that money (and the interest it would earn) will not be available to fund your retirement later.

Buying on credit doesn’t change the answer. Adding a new purchase to your credit card balance will increase your minimum monthly payment (limiting your buying power) and reduce the amount of credit available to you.

4. If you have a 30-year mortgage but pay it off in 20 years, will you pay the same amount of interest? Or will you reduce the amount of interest you pay?

Early mortgage payments reduce the amount that you owe. Since you owe less than expected per the original agreement, the amount of interest that you owe is also reduced. So if you pay off your mortgage early you would pay less interest over the life of the mortgage.

5. You want to invest in the stock market. Is it safer to buy stock in a single company or mutual fund?

A mutual fund is safer. A fund owns many stocks. So the decline of any one stock has a small effect on the total value of the fund or your investment. Investing in a single stock can provide a greater return if the stock price increases, but a decrease in price will affect your entire investment.

6. Suppose you borrowed $1,000 from your brother-in-law. If the interest rate is 20% per year, would it take more or less than 5 years to double if you didn’t make any payments?

It would take less than 5 years. After one year you would owe $1,200. After 2 years you would owe $1,200 plus 20% of $1,200, or $1,440. By the end of year 5 you would owe nearly $2,500.

7. If you had $100 in savings and earned 2% per year, and inflation was 4% per year, could you buy more or less with your money next year? And what is the result called?

You would be able to buy less. Your $1 in savings would only have grown by 2% to $1.02. If inflation were 4%, prices would be 4% higher in a year. The $1 item would now cost $1.04.

The “real interest rate” is the amount of interest earned minus the inflation rate. In this case, interest (2%) minus inflation (4%) = -2%.

8. Some say that lower interest rates are good for everyone. Is that true?

Lower interest rates benefit the borrower but not the lender. Lower interest rates are considered good for the economy. They make it easier for a business to borrow money to expand their business and hire more employees.

Lower rates are also good for individual borrowers. Mortgages, auto loans and other loans cost less. That allows more people to afford to buy homes and other things.

But lower rates are bad for savers. They’re the ones who collect interest on loans and savings. Lower rates mean they earn less on that money.

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9. What’s the main purpose of a budget or spending plan?

Most people think of a budget as a way to control spending. If they budget a set amount for entertainment, when they reach that number they’re required to quit spending. A budget can help moderate spending.

But a budget can also be a wonderful management tool to help you find areas to save money. For instance, by comparing your actual expenses to your budget, you can identify where to look for savings. A spending plan can also remind you where most of your money is going. That’s important when you’re looking for savings. There’s little sense searching areas where you spend little money.

10. Is it true that riskier investments tend to earn more?

It is true that investments that earn more are generally riskier. But, it’s not always true that riskier investments always earn more. Because they’re risky, they often fail and lose money.

So how did you do?

Whether you did well or not, hopefully you learned something about personal finance that you didn’t know before taking the quiz!

Reviewed September 2020

About the Author

Gary Foreman is a former financial planner and purchasing manager who founded The Dollar Stretcher.com website and newsletters in 1996. He's the author of How to Conquer Debt No Matter How Much You Have and he's been featured in MSN Money, Yahoo Finance, Fox Business, The Nightly Business Report, US News Money, Credit.com and CreditCards.com. Gary shares his philosophy of money here. Gary is available for audio, video or print interviews. For more info see his media page.

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