The 5 Retirement Concepts Everyone Should Know: Do You?

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It’s no secret that many Americans put retirement on the back burner. According to a recent Bankrate retirement poll, one-third of Americans say they’re not saving enough for retirement and only 28 percent say they’re meeting their retirement saving goals. Another one-third aren’t saying anything at all.

To find out some of the driving forces behind why some people have better financial behavior and understand financial concepts better than others, the National Bureau of Economic Research (NBER) studied how well certain demographic groups understand and retain information about retirement. The study included a sample of around 3,000 households. Within the sample, 30 percent of the participants were below the age of 40; the largest group, 55 percent, were between 41 and 64; and 15 percent of the participants within the sample were over the age of 65. The study also included a focus group made up of young adult “savers,” who had already begun saving for retirement and “non-savers,” who had not yet begun saving. NBER then delivered information to the participants either through a video, through a narrative, or both. At the end, NBER wanted to see how much the participants knew.

The NBER theorizes that retirement can be broken down into five core sub-concepts — compound interest, inflation, risk diversification, tax treatment of retirement savings accounts, and employer matching. If you notice, most discussions pertaining to retirement involve some, or all, of these ideals. How much do you know about each? Let’s see how you stack up against the NBER participants.

1. Compound Interest

Most retirement funds earn compound interest. Although people generally understand that interest accumulates on these funds, some don’t understand the difference between simple interest, which is interest on the principal balance only versus compound interest, which is interest on the principal and interest on the principal accumulates. Sound a bit confusing? Think of it this way: mathematically, time, as a variable, is multiplied by your rate with simple interest. With compound interest, you increase your rate by time exponentially. So, using simple interest, an account with a starting balance of $100,000 and a 5 percent rate will earn $100,000 in interest in 20 years ($100,000 x .05 x 20.)

Let’s say instead of using simple interest, we use compound interest. That same $100,000 would grow to $265,329 in 20 years {$100,000 x [(1+.05)^20]}. Compound interest is a major reason why starting retirement savings while you’re young is so important. It gives your money more time to grow.

The majority of the participants in the survey had an understanding of compound interest. More than half of the respondents across all income ranges, genders, and education levels were able to answer questions correctly. However, these factors did impact the results. Those who earn more than $75,000 per year had a higher rate of understanding than those who earn under $35,000 annually, the 65 and older group also scored better than the 18 to 40 age group, and those with college education scored higher than those with only a high school education.