When it comes to finances, most Americans think they know what they're talking about.
Nearly three-quarters (71%) of U.S. adults gave themselves a high rating regarding how much they know about general finance topics, according to a report from the FINRA Investor Education Foundation. On the surface, that seems like positive news.
However, when put to the test about this knowledge, the majority of Americans failed. Participants were given a 6-question quiz about relatively basic concepts like diversification, compound interest, and inflation. Only 40% of people were able to get at least four questions correct, and just 7% answered all questions correctly.
While not everyone needs to be a finance whiz, understanding some of the more common financial concepts can help you make smart long-term money decisions. Thinking you know more than you really do can also be dangerous, because you may think you're doing what's best for your bank account when you might actually be doing more harm than good.
The good news, though, is that it's relatively easy to brush up on your financial knowledge to start making the best choices for your future.
Making sense of financial jargon
It's understandable why not many people have a strong grip on financial concepts. Not only is the financial world filled with jargon, but it's also not the most exciting topic to think about. However, as mundane as some of these topics are, they are crucial to understand if you want to make the most of your money.
One of the most commonly misunderstood financial concepts is compound interest -- only 30% of those who took the FINRA quiz were able to correctly answer how compound interest affects their money. Yet compound interest is a critical component of saving for the future, particularly when it comes to retirement.
Compound interest essentially has a snowball effect on your money. You're earning interest on your interest, so your money grows exponentially faster over time. Instead of earning interest on just your initial deposit, you start earning interest on the total amount in your account. So if you're saving for retirement, the longer you leave your money in your account, the more it will grow.
Another concept that those who took the quiz struggled with was regarding risk and diversification. When asked whether buying a single company's stock was safer than investing in a mutual fund, only 43% of participants correctly answered "no," while 45% admitted that they didn't know the correct answer.
Understanding risk is critical when investing your money for retirement, because it can affect how much you're able to save. Investing in a mutual fund or index fund allows you to limit your risk by investing in dozens (or even hundreds) of different stocks at once. So if one or two stocks in the fund take a nosedive, your money will still be safe. On the other hand, if you were to invest all your money in a single company's stock and that company dropped in value or went out of business, you'd lose most, if not all, of your savings. Investing your money in the right places is one of the most important things to do to ensure your money is as safe as possible.
Boosting your financial knowledge
Everyone wants what's best for their money, but sometimes you don't know what you don't know. You may think you have a good understanding of how to manage your finances, so you may not even realize you could be making better decisions.
One way you can ensure you're doing everything you can to make the most of your money is to talk to a financial professional. Approximately 60% of organizations offer online financial guidance, a survey from financial services company Alight Solutions found, and 61% of companies offer one-on-one financial counseling. If your company offers any type of financial help, it's a good idea to take advantage of it -- even if you think you don't need it.
Finance can be a tricky topic, and saving for retirement is serious business. Even one seemingly minor mistake -- like investing all your money in a single stock rather than diversifying and limiting your risk -- can potentially spell disaster for your savings. Even if you've got a good handle on your money and think you're making all the right decisions, it never hurts to get a second opinion and see where there are areas to improve.
Nobody knows everything, and sometimes you simply may not realize where you're falling short financially. By trying to learn as much as you can, though, you can ensure you're doing everything you can to protect every dollar.