Personal Finance IQ How Smart Are You?. True or False? 1. Surveys indicate that a high proportion of Americans feel financially insecure. This insecurity

Personal Finance IQPersonal Finance IQ

How Smart Are You?How Smart Are You?

True or False?True or False?

1. Surveys indicate that a high 1. Surveys indicate that a high proportion of Americans feel proportion of Americans feel financially insecure. This insecurity financially insecure. This insecurity is primarily because the incomes of is primarily because the incomes of Americans are low. Americans are low.

False. False. The average income of Americans is The average income of Americans is

currently the highest in history. The currently the highest in history. The insecurity results from bad choices, insecurity results from bad choices, unsound financial planning and low unsound financial planning and low savings rates. savings rates.


2. Financial success is primarily 2. Financial success is primarily the result of setting long-term the result of setting long-term goals and developing a plan to goals and developing a plan to achieve them. achieve them.

True.True. Setting goals and developing a Setting goals and developing a

plan to achieve them is the plan to achieve them is the foundation for sound personal foundation for sound personal finance. finance.


3. If you are going to increase your 3. If you are going to increase your wealth, it is vitally important for you wealth, it is vitally important for you to allocate funds regularly into to allocate funds regularly into savings and investments. savings and investments.

True.True. Allocation of a sizeable portion of your Allocation of a sizeable portion of your

income into saving and investment is a income into saving and investment is a key to building wealth. Most financial key to building wealth. Most financial experts recommend that people save experts recommend that people save and invest at least 10 percent of their and invest at least 10 percent of their income. Automatic payroll deductions income. Automatic payroll deductions into a savings/investment account can into a savings/investment account can provide discipline in this area. provide discipline in this area.


4. If you have $50,000 of 4. If you have $50,000 of outstanding debts and the outstanding debts and the market value of your assets is market value of your assets is $30,000, your “net worth” is $30,000, your “net worth” is negative $20,000. negative $20,000.

True. True. Net worth equals assets minus Net worth equals assets minus

liabilities.liabilities.


5. The purpose of a budget is to 5. The purpose of a budget is to increase awareness of how funds increase awareness of how funds are spent and to help the individual are spent and to help the individual or household develop a plan to or household develop a plan to control spending more effectively control spending more effectively and save for the future. and save for the future.

True.True. A monthly budget will help you control A monthly budget will help you control

spending and make regular saving spending and make regular saving and investment a permanent part of and investment a permanent part of your lifestyle. your lifestyle.


6. It makes sense to allocate 6. It makes sense to allocate funds regularly into a special funds regularly into a special savings account so you will be savings account so you will be better able to deal with future better able to deal with future surprise expenditures. surprise expenditures.

True.True. Everyone will incur unforeseen Everyone will incur unforeseen

expenditures; the only surprising expenditures; the only surprising element is when they will occur.element is when they will occur.


7. Corporate stock investments are a 7. Corporate stock investments are a particularly attractive method to save particularly attractive method to save funds for unexpected future funds for unexpected future expenditures such as those expenditures such as those associated with auto repairs and associated with auto repairs and health problems. health problems. False. False. Funds for a potential emergency need to Funds for a potential emergency need to

be easily convertible to cash at a be easily convertible to cash at a predictable value. The short-run value predictable value. The short-run value of stocks is volatile and, therefore, you of stocks is volatile and, therefore, you do not want to have to sell them at an do not want to have to sell them at an inappropriate time. inappropriate time.


8. When purchasing a house, you will 8. When purchasing a house, you will often be able to bargain for a lower often be able to bargain for a lower price and arrange a loan at a lower price and arrange a loan at a lower interest rate if you are able to make interest rate if you are able to make a sizeable down payment (for a sizeable down payment (for example, 20 percent). example, 20 percent).

True. True. The down payment reduces the risks The down payment reduces the risks

confronted by both the seller and confronted by both the seller and mortgage lender. This will increase mortgage lender. This will increase the buyer’s bargaining power. the buyer’s bargaining power.


9. It is costly to purchase a new car 9. It is costly to purchase a new car every two or three years because every two or three years because new cars depreciate rapidly during new cars depreciate rapidly during their first few years of use. their first few years of use.

True.True. During the first three years, new cars During the first three years, new cars

typically lose 40 to 50 percent of their typically lose 40 to 50 percent of their initial value. This depreciation initial value. This depreciation increases the cost of regularly increases the cost of regularly purchasing a new car. purchasing a new car.


10. If you can afford the monthly 10. If you can afford the monthly payment, you will be able to save payment, you will be able to save money by purchasing a new car money by purchasing a new car rather than a used one because the rather than a used one because the maintenance cost will be lower for maintenance cost will be lower for the new car. the new car.

False. False. The depreciation costs will almost The depreciation costs will almost

always be higher for the new car, and always be higher for the new car, and this will generally more than offset the this will generally more than offset the higher maintenance costs of the used higher maintenance costs of the used car. car.


11. When auto dealerships or furniture 11. When auto dealerships or furniture stores offer zero-interest financing stores offer zero-interest financing for 36 months, you will be able to for 36 months, you will be able to save money by purchasing from save money by purchasing from these sellers. these sellers.

False. False. Sellers often use zero interest Sellers often use zero interest

financing as a marketing device, but financing as a marketing device, but the lower interest rate charges are the lower interest rate charges are generally built into their selling price. generally built into their selling price. In essence, the “cost of financing” is In essence, the “cost of financing” is incorporated into the sales price of incorporated into the sales price of their goods.their goods.


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.


13. If your credit card balance is well below 13. If your credit card balance is well below the limit, you do not need to save for the limit, you do not need to save for emergency expenditures because the emergency expenditures because the unused borrowing power on your credit unused borrowing power on your credit card is like funds in an emergency savings card is like funds in an emergency savings account. account. False. False. Unlike an unused credit card limit, funds in a Unlike an unused credit card limit, funds in a

savings account are an asset. Further, it will be savings account are an asset. Further, it will be more economical to use savings to cover more economical to use savings to cover unexpected expenses than to borrow the funds unexpected expenses than to borrow the funds via a credit card. via a credit card.


14. The use of credit cards to purchase 14. The use of credit cards to purchase and finance spending on items like and finance spending on items like food, clothing, and entertainment is food, clothing, and entertainment is highly likely to lead to serious highly likely to lead to serious financial problems. financial problems.

True.True. Nondurable consumer items like these Nondurable consumer items like these

have virtually no value after they are have virtually no value after they are purchased. Use of financing to purchased. Use of financing to purchase them will reduce your wealth purchase them will reduce your wealth and lead to financial difficulties.and lead to financial difficulties.


15.The interest rates charged on 15.The interest rates charged on outstanding credit card outstanding credit card balances are usually quite low balances are usually quite low because these loans are highly because these loans are highly secure. secure.

False. False. Credit card loans are unsecured Credit card loans are unsecured

and, therefore, risky. This is a and, therefore, risky. This is a major reason why interest rates major reason why interest rates on credit cards are high. on credit cards are high.


16. Saving, and the power of 16. Saving, and the power of compound interest, can make compound interest, can make it possible for you to consume it possible for you to consume more and achieve a higher more and achieve a higher living standard in the future. living standard in the future.

True. True. Funds saved will grow in value Funds saved will grow in value

which will make higher future which will make higher future consumption possible.consumption possible.


17. If you have funds in an investment 17. If you have funds in an investment account earning a 10 percent account earning a 10 percent average annual rate of return, it will average annual rate of return, it will take approximately 7 years for the take approximately 7 years for the funds in the account to double. funds in the account to double.

True. True. The rule of 70 indicates that 70 The rule of 70 indicates that 70

divided by the rate of return will divided by the rate of return will approximate the number of years it approximate the number of years it takes a value to double. In this takes a value to double. In this example, 70/10 indicates this example, 70/10 indicates this investment will double in 7 years.investment will double in 7 years.


18. Corporations are required by law to 18. Corporations are required by law to pay a specified dollar amount per pay a specified dollar amount per share to their common stock share to their common stock shareholders each year. shareholders each year.

False. False. Some corporations may pay dividends Some corporations may pay dividends

to shareholders, but there is no to shareholders, but there is no obligation to do so. In fact, the initial obligation to do so. In fact, the initial investment may not even be returned investment may not even be returned to the stockholders. In contrast, to the stockholders. In contrast, entities issuing bonds are required to entities issuing bonds are required to pay bondholders a specified rate of pay bondholders a specified rate of return, along with the principal, when return, along with the principal, when the bond matures.the bond matures.


19. The administrative costs of managed 19. The administrative costs of managed equity mutual funds will generally be equity mutual funds will generally be lower than for indexed equity funds lower than for indexed equity funds because managed funds typically spend because managed funds typically spend less on research and stock trading than less on research and stock trading than indexed funds. indexed funds.

False.False. The administrative costs are higher for The administrative costs are higher for

managed equity mutual funds because fund managed equity mutual funds because fund managers spend more on both research and managers spend more on both research and stock trading. Indexed funds spend little on stock trading. Indexed funds spend little on these items because they merely hold each these items because they merely hold each stock in the same proportion as its stock in the same proportion as its representation in a major stock index such as representation in a major stock index such as the Standard and Poor’s 500. the Standard and Poor’s 500.


20.Historically, the rate of return 20.Historically, the rate of return on a diverse holding of on a diverse holding of corporate stocks has been corporate stocks has been higher than the return derived higher than the return derived from low-risk bonds. from low-risk bonds.

True.True. Over the last hundred years, the Over the last hundred years, the

nominal rate of return on stocks nominal rate of return on stocks has been approximately 11 has been approximately 11 percent, compared to 7 percent percent, compared to 7 percent for bonds.for bonds.


21. Diversification of one’s portfolio is 21. Diversification of one’s portfolio is important for the reduction of risk important for the reduction of risk because the value of a narrow set because the value of a narrow set of assets may change of assets may change dramatically over a short period of dramatically over a short period of time. time.

True. True. Diversification reduces risk. For Diversification reduces risk. For

example, the value of corporate example, the value of corporate shares (or shares of companies in shares (or shares of companies in the same industry) may change the same industry) may change substantially relative to the broad substantially relative to the broad stock market. Consider Enron.stock market. Consider Enron.


22. An indexed equity mutual fund will 22. An indexed equity mutual fund will provide shareholders with a return provide shareholders with a return each year that is exactly equal to each year that is exactly equal to the change in the consumer price the change in the consumer price index during that year. index during that year.

False.False. The stockholdings of an indexed fund The stockholdings of an indexed fund

mirror the S&P 500 or another broad mirror the S&P 500 or another broad stock market index. Neither the return stock market index. Neither the return nor the composition of these holdings nor the composition of these holdings is related to the CPI. is related to the CPI.


23. An unexpected increase in the rate 23. An unexpected increase in the rate of inflation will tend to reduce the of inflation will tend to reduce the market value of outstanding bonds market value of outstanding bonds yielding a fixed nominal interest yielding a fixed nominal interest return. return.

True. True. The higher inflation rates will lead to The higher inflation rates will lead to

higher interest rates, which will higher interest rates, which will depress the value of outstanding depress the value of outstanding bonds paying lower rates. bonds paying lower rates.


24. 24. As people approach retirement, they As people approach retirement, they should invest a larger share of their should invest a larger share of their retirement funds in stocks and a smaller retirement funds in stocks and a smaller share in bonds and other fixed return share in bonds and other fixed return assets.assets. False.False. As retirement approaches and funds will be As retirement approaches and funds will be

needed for spending, it is prudent to switch needed for spending, it is prudent to switch from stocks to bonds (particularly Treasury from stocks to bonds (particularly Treasury Inflation Protected Securities (TIPS) and Inflation Protected Securities (TIPS) and other less risky investments.other less risky investments.


25. If career objectives may cause you to 25. If career objectives may cause you to move from an area during the next two or move from an area during the next two or three years, you should purchase a home three years, you should purchase a home if your mortgage payments are less than if your mortgage payments are less than your rental costs.your rental costs.

False.False. Houses are illiquid assets, and there are Houses are illiquid assets, and there are

substantial costs associated with their substantial costs associated with their purchase and sale. When a person is likely purchase and sale. When a person is likely to move in the near future, these costs will to move in the near future, these costs will generally overwhelm any savings derived generally overwhelm any savings derived from lower mortgage payments relative to from lower mortgage payments relative to rental costs. rental costs.


26.A history of late payments on 26.A history of late payments on credit cards, a defaulted car credit cards, a defaulted car loan and an unstable loan and an unstable employment history will employment history will adversely affect your credit adversely affect your credit score. score.

True.True. All of these factors reduce your All of these factors reduce your

credit worthiness and therefore credit worthiness and therefore your credit score.your credit score.


27. Deferred tax saving plans such as 27. Deferred tax saving plans such as a traditional Individual Retirement a traditional Individual Retirement Account (IRA) or 401k plan will Account (IRA) or 401k plan will reduce your current tax liability reduce your current tax liability because funds placed into these because funds placed into these plans are tax deductible. plans are tax deductible.

True. True. Funds allocated into these accounts Funds allocated into these accounts

can be subtracted from your gross can be subtracted from your gross income which will reduce your tax income which will reduce your tax liability. liability.


28. If it is possible to earn an interest 28. If it is possible to earn an interest rate of 7 percent, the cost of rate of 7 percent, the cost of spending $4 per day on a premium spending $4 per day on a premium cup of coffee over a 40 year period cup of coffee over a 40 year period will be more than $300,000.will be more than $300,000.

True. True. At a 7 percent return, $4 a day or At a 7 percent return, $4 a day or

$360 per quarter will yield $360 per quarter will yield approximately $313,147 when approximately $313,147 when compounded quarterly over 40 years. compounded quarterly over 40 years. This highlights that seemingly minor This highlights that seemingly minor reductions in current spending and reductions in current spending and increases in saving can have a huge increases in saving can have a huge long-term payoff. long-term payoff.


29.Your take home pay will be 29.Your take home pay will be less than your gross earnings less than your gross earnings because of taxes and benefits because of taxes and benefits provided through payroll provided through payroll deductions.deductions.

True.True. Take home pay equals gross Take home pay equals gross

earnings minus taxes and other earnings minus taxes and other deductions. deductions.


30. If you want to avoid financial 30. If you want to avoid financial anxiety, it would be wise to anxiety, it would be wise to gradually increase the gradually increase the outstanding balance on your outstanding balance on your credit cards to their credit limit. credit cards to their credit limit.

False.False. Whether done gradually or Whether done gradually or

quickly, pushing credits to their quickly, pushing credits to their limits is a sure way to produce limits is a sure way to produce financial anxiety.financial anxiety.

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Personal Finance IQ How Smart Are You?. True or False? 1. Surveys indicate that a high proportion of Americans feel financially insecure. This insecurity