Personal Finance IQ

1
Personal Finance IQ

• How Smart Are You?

2
True or False?

• 1. Surveys indicate that a high proportion of
  Americans feel financially insecure. This
  insecurity is primarily because the incomes of
  Americans are low.
• False.
• The average income of Americans is currently the
  highest in history. The insecurity results from
  bad choices, unsound financial planning and low
  savings rates.

3
True or False?

• 2. Financial success is primarily the result of
  setting long-term goals and developing a plan to
  achieve them.
• True.
• Setting goals and developing a plan to achieve
  them is the foundation for sound personal
  finance.

4
True or False?

• 3. If you are going to increase your wealth, it
  is vitally important for you to allocate funds
  regularly into savings and investments.
• True.
• Allocation of a sizeable portion of your income
  into saving and investment is a key to building
  wealth. Most financial experts recommend that
  people save and invest at least 10 percent of
  their income. Automatic payroll deductions into
  a savings/investment account can provide
  discipline in this area.

5
True or False?

• 4. If you have 50,000 of outstanding debts and
  the market value of your assets is 30,000, your
  net worth is negative 20,000.
• True.
• Net worth equals assets minus liabilities.

6
True or False?

• 5. The purpose of a budget is to increase
  awareness of how funds are spent and to help the
  individual or household develop a plan to control
  spending more effectively and save for the
  future.
• True.
• A monthly budget will help you control spending
  and make regular saving and investment a
  permanent part of your lifestyle.

7
True or False?

• 6. It makes sense to allocate funds regularly
  into a special savings account so you will be
  better able to deal with future surprise
  expenditures.
• True.
• Everyone will incur unforeseen expenditures the
  only surprising element is when they will occur.

8
True or False?

• 7. Corporate stock investments are a particularly
  attractive method to save funds for unexpected
  future expenditures such as those associated with
  auto repairs and health problems.
• False.
• Funds for a potential emergency need to be easily
  convertible to cash at a predictable value. The
  short-run value of stocks is volatile and,
  therefore, you do not want to have to sell them
  at an inappropriate time.

9
True or False?

• 8. When purchasing a house, you will often be
  able to bargain for a lower price and arrange a
  loan at a lower interest rate if you are able to
  make a sizeable down payment (for example, 20
  percent).
• True.
• The down payment reduces the risks confronted by
  both the seller and mortgage lender. This will
  increase the buyers bargaining power.

10
True or False?

• 9. It is costly to purchase a new car every two
  or three years because new cars depreciate
  rapidly during their first few years of use.
• True.
• During the first three years, new cars typically
  lose 40 to 50 percent of their initial value.
  This depreciation increases the cost of regularly
  purchasing a new car.

11
True or False?

• 10. If you can afford the monthly payment, you
  will be able to save money by purchasing a new
  car rather than a used one because the
  maintenance cost will be lower for the new car.
• False.
• The depreciation costs will almost always be
  higher for the new car, and this will generally
  more than offset the higher maintenance costs of
  the used car.

12
True or False?

• 11. When auto dealerships or furniture stores
  offer zero-interest financing for 36 months, you
  will be able to save money by purchasing from
  these sellers.
• False.
• Sellers often use zero interest financing as a
  marketing device, but the lower interest rate
  charges are generally built into their selling
  price. In essence, the cost of financing is
  incorporated into the sales price of their goods.

13
True or False?

• 12. If you make the minimum monthly payment on
  your outstanding credit card balance, you will
  not incur any interest charges.
• False.
• You will be charged an interest rate, and often a
  high rate, on the unpaid outstanding balance.

14
True or False?

• 13. If your credit card balance is well below the
  limit, you do not need to save for emergency
  expenditures because the unused borrowing power
  on your credit card is like funds in an emergency
  savings account.
• False.
• Unlike an unused credit card limit, funds in a
  savings account are an asset. Further, it will
  be more economical to use savings to cover
  unexpected expenses than to borrow the funds via
  a credit card.

15
True or False?

• 14. The use of credit cards to purchase and
  finance spending on items like food, clothing,
  and entertainment is highly likely to lead to
  serious financial problems.
• True.
• Nondurable consumer items like these have
  virtually no value after they are purchased. Use
  of financing to purchase them will reduce your
  wealth and lead to financial difficulties.

16
True or False?

• 15.The interest rates charged on outstanding
  credit card balances are usually quite low
  because these loans are highly secure.
• False.
• Credit card loans are unsecured and, therefore,
  risky. This is a major reason why interest rates
  on credit cards are high.

17
True or False?

• 16. Saving, and the power of compound interest,
  can make it possible for you to consume more and
  achieve a higher living standard in the future.
• True.
• Funds saved will grow in value which will make
  higher future consumption possible.

18
True or False?

• 17. If you have funds in an investment account
  earning a 10 percent average annual rate of
  return, it will take approximately 7 years for
  the funds in the account to double.
• True.
• The rule of 70 indicates that 70 divided by the
  rate of return will approximate the number of
  years it takes a value to double. In this
  example, 70/10 indicates this investment will
  double in 7 years.

19
True or False?

• 18. Corporations are required by law to pay a
  specified dollar amount per share to their common
  stock shareholders each year.
• False.
• Some corporations may pay dividends to
  shareholders, but there is no obligation to do
  so. In fact, the initial investment may not even
  be returned to the stockholders. In contrast,
  entities issuing bonds are required to pay
  bondholders a specified rate of return, along
  with the principal, when the bond matures.

20
True or False?

• 19. The administrative costs of managed equity
  mutual funds will generally be lower than for
  indexed equity funds because managed funds
  typically spend less on research and stock
  trading than indexed funds.
• False.
• The administrative costs are higher for managed
  equity mutual funds because fund managers spend
  more on both research and stock trading. Indexed
  funds spend little on these items because they
  merely hold each stock in the same proportion as
  its representation in a major stock index such as
  the Standard and Poors 500.

21
True or False?

• 20.Historically, the rate of return on a diverse
  holding of corporate stocks has been higher than
  the return derived from low-risk bonds.
• True.
• Over the last hundred years, the nominal rate of
  return on stocks has been approximately 11
  percent, compared to 7 percent for bonds.

22
True or False?

• 21. Diversification of ones portfolio is
  important for the reduction of risk because the
  value of a narrow set of assets may change
  dramatically over a short period of time.
• True.
• Diversification reduces risk. For example, the
  value of corporate shares (or shares of companies
  in the same industry) may change substantially
  relative to the broad stock market. Consider
  Enron.

23
True or False?

• 22. An indexed equity mutual fund will provide
  shareholders with a return each year that is
  exactly equal to the change in the consumer price
  index during that year.
• False.
• The stockholdings of an indexed fund mirror the
  SP 500 or another broad stock market index.
  Neither the return nor the composition of these
  holdings is related to the CPI.

24
True or False?

• 23. An unexpected increase in the rate of
  inflation will tend to reduce the market value of
  outstanding bonds yielding a fixed nominal
  interest return.
• True.
• The higher inflation rates will lead to higher
  interest rates, which will depress the value of
  outstanding bonds paying lower rates.

25
True or False?

• 24. As people approach retirement, they should
  invest a larger share of their retirement funds
  in stocks and a smaller share in bonds and other
  fixed return assets.
• False.
• As retirement approaches and funds will be needed
  for spending, it is prudent to switch from stocks
  to bonds (particularly Treasury Inflation
  Protected Securities (TIPS) and other less risky
  investments.

26
True or False?

• 25. If career objectives may cause you to move
  from an area during the next two or three years,
  you should purchase a home if your mortgage
  payments are less than your rental costs.
• False.
• Houses are illiquid assets, and there are
  substantial costs associated with their purchase
  and sale. When a person is likely to move in
  the near future, these costs will generally
  overwhelm any savings derived from lower mortgage
  payments relative to rental costs.

27
True or False?

• 26.A history of late payments on credit cards, a
  defaulted car loan and an unstable employment
  history will adversely affect your credit score.
  
• True.
• All of these factors reduce your credit
  worthiness and therefore your credit score.

28
True or False?

• 27. Deferred tax saving plans such as a
  traditional Individual Retirement Account (IRA)
  or 401k plan will reduce your current tax
  liability because funds placed into these plans
  are tax deductible.
• True.
• Funds allocated into these accounts can be
  subtracted from your gross income which will
  reduce your tax liability.

29
True or False?

• 28. If it is possible to earn an interest rate of
  7 percent, the cost of spending 4 per day on a
  premium cup of coffee over a 40 year period will
  be more than 300,000.
• True.
• At a 7 percent return, 4 a day or 360 per
  quarter will yield approximately 313,147 when
  compounded quarterly over 40 years. This
  highlights that seemingly minor reductions in
  current spending and increases in saving can have
  a huge long-term payoff.

30
True or False?

• 29.Your take home pay will be less than your
  gross earnings because of taxes and benefits
  provided through payroll deductions.
• True.
• Take home pay equals gross earnings minus taxes
  and other deductions.

31
True or False?

• 30. If you want to avoid financial anxiety, it
  would be wise to gradually increase the
  outstanding balance on your credit cards to their
  credit limit.
• False.
• Whether done gradually or quickly, pushing
  credits to their limits is a sure way to produce
  financial anxiety.

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This set of questions, answers and explanations
was developed by

• James Gwartney, the Director of the Gus A.
  Stavros Center for the Advancement of Free
  Enterprise and Economic Education at Florida
  State University, and
• Tawni Hunt Ferrarini, the Director of the Center
  for Economic Education and Entrepreneurship at
  Northern Michigan University.  The authors
  appreciate the time and talent of the numerous
  experts who reviewed and critiqued this document.
• Visit CommonSenseEconomics.com to advance your
  personal financial literacy.