In case spiraling credit card debt and overdrawn bank accounts weren’t enough of a clue, there’s now more evidence that many Americans are out of their depth when it comes to personal finance. GoBankingRates asked more than 500 people a few questions about money, loans, and credit, and their answers reveal a nation where a sizable minority is struggling with basic financial literacy.
Overall, between a half and two-thirds of survey respondents answered the questions correctly. But many didn’t know what a 401(k) was, had a hazy understanding of net worth, and couldn’t identify key factors that affect their credit score. That jibes with other surveys that have found many Americans are clueless when it comes to personal finance 101. Forty percent of people who investment app Stash surveyed didn’t understand how inflation works, while 16% didn’t know whether it was better to have a higher or lower interest rate on their mortgage.
Many people do realize their financial knowledge isn’t quite up to snuff, at least. Only 15% of Americans Equifax surveyed gave themselves an “A” in financial literacy, though many also said they were taking steps to learn more about money matters. That’s good news because being familiar with how interest works, what goes in to determining a credit score, how to save for retirement, and other personal finance basics makes it easier to achieve your long-term goals.
Curious how your personal finance knowledge measures up to that of your fellow Americans? Check out the questions many respondents to the GoBankingRates survey bungled, and see whether you can get them right.
Question: Which of the following describes a 401k?
Only 63% of survey respondents correctly identified a 401(k) as a retirement savings vehicle. Twenty percent were on the right track but missed the mark by saying a 401(k) was a tax credit for retirement. Smaller shares of people said it was a kind of insurance claim, type of tax form, or a tax-free Health Savings Account. Older people were more likely to get this question right than younger respondents.
Next: Got this question wrong? Find out what a 401(k) really is and how it works.
401(k)s: The basics
A 401(k) is a type of tax-advantaged retirement savings vehicle. It’s what’s known as a “defined-contribution plan,” and your employer sets it up. You make contributions to your retirement savings directly from your paycheck. Sometimes, your employer will match a portion of your contributions, as well.
If you have a traditional 401(k), you don’t have to pay any tax on the money you contribute until you start making withdrawals at retirement. In addition, you choose how the money in your 401(k) is invested, which means your total retirement savings will be determined both by how much money you (and your employer, if it matches) put into the plan, as well as by how well your investments perform. This is different from a pension, where you don’t control the investments and where you’re guaranteed to receive a certain monthly benefit when you retire.
Next: A question about a commonly advertised financial product.
Question: What does a CD offered by a bank stand for?
No, we’re not talking about those plastic discs people used to use to listen to music. Six percent of people GoBankingRates surveyed thought this question had to do with compact discs. But 68% of respondents correctly identified a CD as a certificate of deposit. Others thought the term referred to “cash deposit,” “check deposit,” “check delivery,” or “credit deferment.” Only 36% of 18- to 24-year-olds got this questions right, while 80% of those over 45 knew the correct answer.
Next: You might know CD means certificate of deposit, but do you know why you might want to buy one from a bank?
CDs: The basics
A CD is a type of savings vehicle. Banks sell them to people who are looking for a safe place to stash their money while earning a higher rate of return than they would if they just left their money in a savings account. Cautious investors also like them because there’s little risk involved. The Federal Deposit Insurance Corporation insures the money, so your principal is always safe.
When you buy a CD, you agree to let the bank keep your money for a certain length of time, such as one year or five years. The longer the bank has your money, the higher rate of interest you’ll be offered. Once you invest in the CD, you won’t be able to get your money back without paying an early withdrawal penalty. For that reason, they’re not a great place to store any money you might need in the short term. CD interest rates are also low right now, which means you won’t see huge returns. But if you want to earn some money on your savings without taking on much risk, certificates of deposit could be a good choice.
3. Net worth
Question: What is net worth?
Americans of all ages were uncertain about the meaning of net worth. Fifty-nine percent correctly identified it as the value of all of a person’s assets minus their liabilities. But 16% thought the term referred to your income after taxes (perhaps because they were confusing it with the accounting term “net income after taxes”), 10% thought it was the value of someone’s liabilities minus their assets, and 8% thought it was the value of all non-cash assets.
Net worth: The basics
Net worth — or the difference between what you have and what you owe — is a simple concept to understand, but it might not be immediately clear why it’s important. But knowing your net worth is useful because it provides a quick snapshot of your financial situation.
Plus, if you track your net worth over time, you can get a sense of how you’re progressing financially. Someone who starts out tracking their net worth in their early 20s — when high student loan debt and few assets mean they’re in the red — might have a big sense of accomplishment a few years down the road once they’ve paid off some of what they owe and accumulated enough money to move them into the black.
To figure out your net worth, simply total the value of everything you own, such as your home, bank accounts, retirement accounts, and any other assets. Then, make a list of all your liabilities, or the money you owe, such as your mortgage loan balance, student loan debt, or credit card debt. Subtract the liabilities from your total assets, and you have your net worth.
Question: What does HELOC stand for?
Don’t know what a HELOC stands for? You’re not alone. Twenty-two percent of survey respondents thought this was a trick question and said HELOC wasn’t a real thing. Fifty-nine percent correctly answered that the term stood for home equity line of credit. Another 9% selected the similar, but incorrect, answer of home equity line of cash.
Still confused about what a HELOC is? Read on.
HELOCs: The basics
A home equity line of credit is revolving line of credit where your home serves as collateral. It works a bit like a credit card, as Bankrate explained. How much credit you get will depend on how much equity you have in your home. You can then borrow money as you need it during the term of the loan. That’s different from a home equity loan, where you get a single lump sum and then make fixed payments every month.
HELOCs are one way to access the value of your home without selling. People might turn to them to help pay for large purchases, such as a wedding, college tuition, or home improvements. Their flexibility is appealing, but if you’re not careful, you might end using the money recklessly. And if you can’t later repay the debt your lender could foreclose, and you’ll lose your home.
You can give yourself some credit if you get the next question correct.
5. Credit scores
Question: Which of the following does not impact your credit score?
GoBankingRates asked people to choose from income, payment history, current debt, credit history, and types of current credit for this question. Sixty percent of people surveyed correctly said how much money you earn doesn’t affect your credit score. Forty percent, however, mistakenly thought factors, such as payment history and current debt, didn’t affect your score. In reality, those are all factors that affect your credit score.
Credit scores: The basics
Credit score confusion is rampant. Income doesn’t have a direct relationship to your score. But how much debt you have relative to your credit limit, payment history, length of credit history, types of credit you have (such as credit cards and installment loans), and whether you’ve recently opened new lines of credit all make a difference.
Knowing what goes into calculating your credit score (and what money mistakes can trash your credit) is important. If you can keep your credit score high, you’ll find it easier to get a mortgage or other loans and will be offered better rates when you do borrow. If your credit is bad, even everyday tasks, such as buying a new cellphone or renting an apartment, can be a challenge.
You might know about credit scores, but do you know who keeps track of all the info that goes into your score?
6. Credit bureaus
Question: What are the three major credit bureaus?
Repeat after us: Experian, Equifax, TransUnion. Those are the three major credit bureaus in the U.S. Sixty-five percent of survey respondents identified them correctly. Twenty-one percent of people confused credit bureaus with credit card companies, selecting Visa, Mastercard, and American Express as an answer. Ten percent thought of big banks, such as Bank of America, Wells Fargo, and Chase. And 2% thought the term has something to do with tax preparers, such as H&R Block and Turbo Tax. Another 2% had travel on the brain: They chose Expedia, Orbitz, and Kayak for their answer.
Credit bureaus: The basics
The big three credit bureaus keep track of your individual credit history. They use that information to generate a score lenders and others can use to decide whether they’ll lend you money or engage in another financial transaction. You want to remember their names because you can request your credit report from each — for free.
Experts generally recommend checking your free credit report once per year to make sure there aren’t any errors. If you pull your credit history and see there are accounts you don’t remember opening or debts you’ve paid that are still listed as owed, you can take steps now to get the mistakes corrected before you are denied credit when you need it. To request your free report, visit AnnualCreditReport.com.