In this post, I want to talk about how people become financially literate and from whom they learn about finances. In many of the surveys I have reviewed, including the ones I have designed, people report that they rely on family and friends for financial advice. In focus groups as well, people state that they learn from their family and friends. This is an important finding. I believe that people rely so much on friends and family because they want advice from people they trust and who have their best interests at heart. There are, however, limitations and drawbacks to relying solely on friends and family for financial advice.
One limitation of learning from our friends is that we tend to choose friends who are like us. So, if you are an artist, you are likely to be surrounded by people who know how to draw but do not necessarily know how to invest retirement savings. Furthermore, many financial matters are private. You may assume that your friend John is financially savvy, but you have probably not seen his 401(k) statement, and it is hard to tell from his house or car whether he is good at picking mutual funds. Nevertheless, he may be happy to offer you tons of financial advice.
Like friends, family members, parents in particular, are a popular source of financial advice, and many have argued that financial education does start at home. There are, nevertheless, drawbacks to advice from this source. First, not everybody has parents who are financially literate. Approximately half of the families in the United States do not invest in the stock market (at least when considering investment of private wealth). Thus, for many, it is not possible to learn about the stock market from parents. Second, parents—particularly older ones—lived in a very different economic environment than the one the current generation of working Americans are facing. Most parents of today’s young and middle aged adults had pensions that were defined benefit plans, experienced inflationary periods that decreased the burden of their debt, and hardly invested in the “global economy.” Financial markets have changed substantially from the time this generation of parents bought their homes, got their pensions, and invested their savings.
I do not mean to imply that we cannot learn from family and friends. One valuable lesson can be to avoid the mistakes that those around us have made, such as not preparing adequately for retirement, not having enough insurance, or having too much debt—mistakes that are proven to be all too common among many Americans today. But relying on such advice seems to me often too little and sometimes too late.
In my view, financial education belongs in schools. Finance and economics are sciences and should be taught as such. Moreover, people need to be financially literate before they engage in financial contracts and not after having learned how much financial mistakes can hurt. Finally, having financial education in schools offers a better chance that students whose parents do not work on Wall Street will be able to access financial knowledge.
There is an additional benefit: if everyone learns about finance in school, we can then talk to our friends about art, about history, about something other than our finances. One of the great benefits of obtaining financial savvy and know-how is that we are then able to devote ourselves to what really matters to us, without the distraction of financial worries.
Monday, 17 November 2008
Saturday, 8 November 2008
The National Financial Literacy Challenge
From November 3 until November 26, 2008, high school students can participate in the National Financial Literacy Challenge. This online 35-question test measures financial knowledge and serves to document the state of financial literacy among participating high school students. Please help me spread the word about this test and encourage the school in your district to register to participate.
It is important that we measure financial literacy among high school students. These young people soon will or already are confronting financial decisions, such as taking out student loans to pay for college, managing credit cards, and saving or spending income from summer employment and allowances. Are young people well equipped to make these decisions? We do not know, and we need to find out! Several states have mandated financial education in high schools and there is a lot of discussion about whether financial literacy should be integrated into high school curricula. I particularly encourage the schools where financial literacy has been mandated or where courses on financial literacy are offered to participate in this test. All tests are imperfect to some degree, but we need some measurement of how much our students know and how well we are doing at teaching financial literacy.
And there are rewards for participating in this test (can you tell that economists devised it?). Students scoring in the top 25th percentile nationwide will earn a certificate of recognition from the U.S. Department of the Treasury. Students scoring exceptionally high will win a National Financial Literacy Challenge Award medal (hey, this would look good on a resumé). And there are monetary rewards too. The Charles Schwab Foundation will award a scholarship of $1,000 to up to 100 students who get a perfect score of 100%. In addition, the Foundation will award $1,000 to each of those students’ schools.
For more information or to register, please follow the link below:
http://flc.treas.gov/index.htm
Just to make you smile, I am including here a test that is part of the newspaper advertising copy for this challenge.
A bond is:
(a) a British spy
(b) glue
(c) a type of loan that pays interest
It is important that we measure financial literacy among high school students. These young people soon will or already are confronting financial decisions, such as taking out student loans to pay for college, managing credit cards, and saving or spending income from summer employment and allowances. Are young people well equipped to make these decisions? We do not know, and we need to find out! Several states have mandated financial education in high schools and there is a lot of discussion about whether financial literacy should be integrated into high school curricula. I particularly encourage the schools where financial literacy has been mandated or where courses on financial literacy are offered to participate in this test. All tests are imperfect to some degree, but we need some measurement of how much our students know and how well we are doing at teaching financial literacy.
And there are rewards for participating in this test (can you tell that economists devised it?). Students scoring in the top 25th percentile nationwide will earn a certificate of recognition from the U.S. Department of the Treasury. Students scoring exceptionally high will win a National Financial Literacy Challenge Award medal (hey, this would look good on a resumé). And there are monetary rewards too. The Charles Schwab Foundation will award a scholarship of $1,000 to up to 100 students who get a perfect score of 100%. In addition, the Foundation will award $1,000 to each of those students’ schools.
For more information or to register, please follow the link below:
http://flc.treas.gov/index.htm
Just to make you smile, I am including here a test that is part of the newspaper advertising copy for this challenge.
A bond is:
(a) a British spy
(b) glue
(c) a type of loan that pays interest
Monday, 27 October 2008
Financial Literacy and the Current Crisis
I was asked in a TV interview whether financial illiteracy has contributed to the current financial crisis. I do not have data yet on the current crisis, but the data I collected last year on debt literacy indicate that many people do not know about the power of interest compounding and tend to underestimate how quickly debt can grow if one borrows at high rates. Most importantly, those who had low debt literacy were more likely to report having difficulties paying off debt. So, my suspicion is that individual debt illiteracy has played a role in the current crisis. Exacerbating individual lack of financial literacy has been the role played by those lending institutions that did not do their part in checking borrowers’ backgrounds or calculating how much debt those borrowers could really afford to take up.
And in this current world of derivates, ARMs, subprimes, and preferred stocks, it is even harder to understand what is going on in both individual accounts and in global markets and what people need to know in order to successfully navigate the financial system. In my view, we need to stick to a few fundamental concepts: the power of interest compounding, the effects of inflation, the principles of risk diversification, the incentives offered by the tax system. Knowledge of these simple principles can go a long way in helping us make sound saving and investment decisions.
People have been crying out that financial education is expensive. Well, bailouts can be even more expensive; I think we understand that now. But I have not heard of plans for any money to be allocated to improving financial literacy as part of the rescue plan. This is a pity because, having seen the consequences of illiteracy not only at the micro level but also at the macro level, we need education now more than ever.
If you would like to watch the TV interview (Financial Literacy and You), it can be accessed at: http://www.tvo.org/TVO/WebObjects/TVO.woa?video?TAWSP_Int_20081021_779352_0
And in this current world of derivates, ARMs, subprimes, and preferred stocks, it is even harder to understand what is going on in both individual accounts and in global markets and what people need to know in order to successfully navigate the financial system. In my view, we need to stick to a few fundamental concepts: the power of interest compounding, the effects of inflation, the principles of risk diversification, the incentives offered by the tax system. Knowledge of these simple principles can go a long way in helping us make sound saving and investment decisions.
People have been crying out that financial education is expensive. Well, bailouts can be even more expensive; I think we understand that now. But I have not heard of plans for any money to be allocated to improving financial literacy as part of the rescue plan. This is a pity because, having seen the consequences of illiteracy not only at the micro level but also at the macro level, we need education now more than ever.
If you would like to watch the TV interview (Financial Literacy and You), it can be accessed at: http://www.tvo.org/TVO/WebObjects/TVO.woa?video?TAWSP_Int_20081021_779352_0
Thursday, 16 October 2008
Learning From this Crisis: A Discussion About Risk
As the financial crisis continues to unfold, it is important to reflect on the lessons we can learn from this experience and how those lessons can help us better manage household finances. In this blog, I want to focus on risk and risk management. Not only have prices in the stock and housing markets, in which many households invest, been gyrating, new financial instruments have made household balance sheets even more sensitive to the behavior of financial markets. For example, both the assets and the liabilities of households with adjustable rate mortgages, or ARMs, will be affected by a change in interest rates. Risk management is becoming more important than ever. Yet, according to several of the surveys on financial literacy I have conducted, the concept of risk diversification proves to be a difficult one for respondents, many of whom stated that they did not know how to answer to the survey question that dealt with this concept.
I want to discuss here the dangers posed by lack of diversification among the assets that are most common in household portfolios.
1. The danger of investing everything in a single stock.
One of the painful lessons that is right in front of us is the peril of investing in a single stock. Sure, all indexes are down and losses are large, but those who have invested solely in the stock of ailing banks now run the risk of losing everything. The importance of keeping a well-diversified portfolio should not be underestimated, particularly in the current situation. Clearly, in a crisis that is becoming global, most stock markets have been going down and portfolio diversification does not eliminate losses. However, it limits them and can provide a floor that prevents losses from being as extreme as they might otherwise be. While the experience of Enron stockholders may have been easy to forget, the magnitude of the current crisis should send a strong warning about the danger of putting all of one’s savings into a single stock.
2. The danger of investing everything in the house.
While we may not think of our house as an investment, in fact the house is often the most important asset we have. In some cases, it is the only asset people have. A large home, a nice backyard, plenty of room where our children can play are all features we want and cherish. However, when we buy, or when we plan to put an addition on the house, we have to consider what that will do to our portfolio. If we put everything we have into the house, we become very exposed to fluctuations in home prices. As the current experience shows, home prices can go down, and go down a lot! And we should not take comfort in the fact that we do not plan to sell our house any time soon. In the current labor market, mobility is important. Today’s workers change jobs many times in the course of a career, and one can hardly expect to be in one place throughout his/her lifetime. Moreover, and particularly in less populated areas, houses are not a good “hedge” against labor income risk. If a big firm in a small city goes under, local home prices are likely to drop. But this means that home values will decrease precisely when workers need their housing wealth the most: they may have to sell and move or they may need a home equity line of credit to offset the loss of employment income.
Risk is a part of our life, negative shocks happen, crises happen, and other shocks may lie ahead. More than ever before, we need to learn to deal with risk to insure the well-being of ourselves and our families.
I want to discuss here the dangers posed by lack of diversification among the assets that are most common in household portfolios.
1. The danger of investing everything in a single stock.
One of the painful lessons that is right in front of us is the peril of investing in a single stock. Sure, all indexes are down and losses are large, but those who have invested solely in the stock of ailing banks now run the risk of losing everything. The importance of keeping a well-diversified portfolio should not be underestimated, particularly in the current situation. Clearly, in a crisis that is becoming global, most stock markets have been going down and portfolio diversification does not eliminate losses. However, it limits them and can provide a floor that prevents losses from being as extreme as they might otherwise be. While the experience of Enron stockholders may have been easy to forget, the magnitude of the current crisis should send a strong warning about the danger of putting all of one’s savings into a single stock.
2. The danger of investing everything in the house.
While we may not think of our house as an investment, in fact the house is often the most important asset we have. In some cases, it is the only asset people have. A large home, a nice backyard, plenty of room where our children can play are all features we want and cherish. However, when we buy, or when we plan to put an addition on the house, we have to consider what that will do to our portfolio. If we put everything we have into the house, we become very exposed to fluctuations in home prices. As the current experience shows, home prices can go down, and go down a lot! And we should not take comfort in the fact that we do not plan to sell our house any time soon. In the current labor market, mobility is important. Today’s workers change jobs many times in the course of a career, and one can hardly expect to be in one place throughout his/her lifetime. Moreover, and particularly in less populated areas, houses are not a good “hedge” against labor income risk. If a big firm in a small city goes under, local home prices are likely to drop. But this means that home values will decrease precisely when workers need their housing wealth the most: they may have to sell and move or they may need a home equity line of credit to offset the loss of employment income.
Risk is a part of our life, negative shocks happen, crises happen, and other shocks may lie ahead. More than ever before, we need to learn to deal with risk to insure the well-being of ourselves and our families.
Thursday, 2 October 2008
Some Comments on the Current Crisis
I have not been writing for a while, but have been reading about and watching the current economic crisis unfold. This is humbling, and there are many reasons to worry. One of the assumptions behind the sound functioning of markets is that the agents who stand behind demand and supply are well informed and rational. But, as I have argued in many previous blogs, there is reason to question that assumption in the face of widespread financial illiteracy. Of course, my studies of illiteracy focus on consumers, but the current events make me wonder about politicians. Perhaps there is need for a crash course in financial markets and money and banking down in Washington. I do not mean this in a sarcastic way, but rather express it with genuine concern; the lessons we should have learned from the past are seemingly being ignored. My views may be colored by the fact that I was a student of Ben Bernanke at Princeton, but his article on the collapse of the financial sector as a factor in transforming a recession into the Great Depression still resonates (for anyone interested in reading it, the article was published in the American Economic Review back in 1983). It teaches us that the financial sector is vital to the workings of the economy and that shutting it down may send the economy into a tailspin. The role of the financial system in the economy is critical: it channels the funds of savers to the firms and entrepreneurs who need them. Lack of credit prevents not only businesses from investing but also households from consuming and buffering against economic shocks. In other words, a financial system that is not working or that is limping can affect the macro economy and each of us individually. We do not want the economy to go that route.
There is an inherent instability in both the banking system, with its fractional reserve system (only a small fraction of deposits are kept in the banks, so if all depositors wanted to withdraw their deposits, there would not be enough funds to make it possible) and in financial markets, in which large sums of money can be moved very quickly. Several institutions and mechanisms are in place to counteract that instability, one example being the Federal Deposit Insurance Corporation, or FDIC. Some may argue that these institutions do not work very well; for example, what banks pay to be insured by the FDIC often does not reflect their actual risk. In reality, financial markets continually innovate. Moreover, financial instruments have become very complex in terms of risk. Derivates, such as options and futures, make it possible to take up large amounts of risk. Regulation has certainly not kept up with that.
When a financial crisis occurs, it is important to act quickly. Now more than ever we need to have economics and finance rule politics.
There is an inherent instability in both the banking system, with its fractional reserve system (only a small fraction of deposits are kept in the banks, so if all depositors wanted to withdraw their deposits, there would not be enough funds to make it possible) and in financial markets, in which large sums of money can be moved very quickly. Several institutions and mechanisms are in place to counteract that instability, one example being the Federal Deposit Insurance Corporation, or FDIC. Some may argue that these institutions do not work very well; for example, what banks pay to be insured by the FDIC often does not reflect their actual risk. In reality, financial markets continually innovate. Moreover, financial instruments have become very complex in terms of risk. Derivates, such as options and futures, make it possible to take up large amounts of risk. Regulation has certainly not kept up with that.
When a financial crisis occurs, it is important to act quickly. Now more than ever we need to have economics and finance rule politics.
Wednesday, 20 August 2008
Are We a Nation of Financial Illiterates? Some Comments
Stephen Dubner, one of the authors of Freakonomics, has posted an article on his blog (link is just below) that addresses this question: Are we are a nation of financial illiterates?
http://freakonomics.blogs.nytimes.com/2008/07/21/are-we-a-nation-of-financial-illiterates/
If you have read Freakonomics, you know he is a gifted writer. In his blog, he poses three critical questions. I modified these questions slightly (they are listed below), and added some discussion.
1. Are we a nation of financial illiterates?
2. How did we get that way?
3. How important is widespread financial literacy to the health of a modern society?
The answer to the first question is unfortunately a yes. In surveys after survey after survey, we find that the majority of the U.S. population lacks knowledge of some of the most fundamental financial concepts, such as the power of interest compounding, the workings of risk diversification, and basic asset pricing. In one of my most recent surveys, I measured “debt literacy,” or knowledge of the concepts related to debt and borrowing. Results are humbling: only one-third of the population has a good grasp of the workings of credit cards and understands how quickly credit card debt can grow when borrowing at the standard rates.
The answer to the second question is more complicated. While the quality of schooling education in general may be cause for concern (relevant statistics are not comforting), the financial landscape in the United States has changed dramatically in recent decades. One of the most notable changes has to do with retirement planning. In the past, the average worker did not have to make any decisions about his or her pension. Pensions were mostly defined benefit plans entirely overseen by the employer, so there was little incentive or rationale for individuals to learn about saving and investment. Today, the average worker needs to decide how much and how best to save for retirement—a decision that can be daunting and, if implemented poorly, that can result in inadequate preparation for retirement. Thus, the incentives and the reasons to learn how to save and invest were less pressing. Similarly, until quite recently, the financial instruments that people needed to deal with were fairly basic. When purchasing a new home, a typical household in the 1960s or 70s would likely get a 30-year fixed rate mortgage from a local bank. Today, the complexity of mortgages has increased dramatically and so has the number of lenders, making the process of financing a home a much more complicated endeavor. So, in answer to the question—how did we come to be a nation of financial illiterates?—perhaps it’s not that we have become less financially literate than in the past, but that the world around us, with it’s increasingly complex financial instruments and increasing demand for personal responsibility, is changing.
The answer to the third question—how important is financial literacy to the health of modern society?—is not an easy one either. It is difficult to assess the effects of financial literacy. Financial literacy is not distributed randomly among the population; it is often the result of personal choice, of parents’ education, and of an individual’s access and exposure to financial education. There are very few experiments we can rely on to assess whether or not financial illiteracy results in financial mistakes. Nevertheless, studies consistently show that those who display low levels of financial literacy are less likely to display healthy financial behavior. And in the modern economic system in which we all live, we have to make sure we are well equipped to make the financial decisions that confront us.
Coming back to Dubner’s blog, I am happy to see that it has generated a lot of comments (more than 200 as of today). One reader responded to Dubner’s posting with a fourth question (slightly modified here):
4. Which name doesn’t belong: Faulkner, Curie, Pasteur, Friedman?
My answer is Faulkner. The other authors have made important discoveries that have shaped science and public policy. One of the remarkable lessons we have learned from Milton Friedman is that “inflation is always and everywhere a monetary phenomenon.” This means that if the central bank does not change the money supply, prices will not keep increasing, even in the presence of an oil shock. Now, this is pretty useful to know, don’t you think?
http://freakonomics.blogs.nytimes.com/2008/07/21/are-we-a-nation-of-financial-illiterates/
If you have read Freakonomics, you know he is a gifted writer. In his blog, he poses three critical questions. I modified these questions slightly (they are listed below), and added some discussion.
1. Are we a nation of financial illiterates?
2. How did we get that way?
3. How important is widespread financial literacy to the health of a modern society?
The answer to the first question is unfortunately a yes. In surveys after survey after survey, we find that the majority of the U.S. population lacks knowledge of some of the most fundamental financial concepts, such as the power of interest compounding, the workings of risk diversification, and basic asset pricing. In one of my most recent surveys, I measured “debt literacy,” or knowledge of the concepts related to debt and borrowing. Results are humbling: only one-third of the population has a good grasp of the workings of credit cards and understands how quickly credit card debt can grow when borrowing at the standard rates.
The answer to the second question is more complicated. While the quality of schooling education in general may be cause for concern (relevant statistics are not comforting), the financial landscape in the United States has changed dramatically in recent decades. One of the most notable changes has to do with retirement planning. In the past, the average worker did not have to make any decisions about his or her pension. Pensions were mostly defined benefit plans entirely overseen by the employer, so there was little incentive or rationale for individuals to learn about saving and investment. Today, the average worker needs to decide how much and how best to save for retirement—a decision that can be daunting and, if implemented poorly, that can result in inadequate preparation for retirement. Thus, the incentives and the reasons to learn how to save and invest were less pressing. Similarly, until quite recently, the financial instruments that people needed to deal with were fairly basic. When purchasing a new home, a typical household in the 1960s or 70s would likely get a 30-year fixed rate mortgage from a local bank. Today, the complexity of mortgages has increased dramatically and so has the number of lenders, making the process of financing a home a much more complicated endeavor. So, in answer to the question—how did we come to be a nation of financial illiterates?—perhaps it’s not that we have become less financially literate than in the past, but that the world around us, with it’s increasingly complex financial instruments and increasing demand for personal responsibility, is changing.
The answer to the third question—how important is financial literacy to the health of modern society?—is not an easy one either. It is difficult to assess the effects of financial literacy. Financial literacy is not distributed randomly among the population; it is often the result of personal choice, of parents’ education, and of an individual’s access and exposure to financial education. There are very few experiments we can rely on to assess whether or not financial illiteracy results in financial mistakes. Nevertheless, studies consistently show that those who display low levels of financial literacy are less likely to display healthy financial behavior. And in the modern economic system in which we all live, we have to make sure we are well equipped to make the financial decisions that confront us.
Coming back to Dubner’s blog, I am happy to see that it has generated a lot of comments (more than 200 as of today). One reader responded to Dubner’s posting with a fourth question (slightly modified here):
4. Which name doesn’t belong: Faulkner, Curie, Pasteur, Friedman?
My answer is Faulkner. The other authors have made important discoveries that have shaped science and public policy. One of the remarkable lessons we have learned from Milton Friedman is that “inflation is always and everywhere a monetary phenomenon.” This means that if the central bank does not change the money supply, prices will not keep increasing, even in the presence of an oil shock. Now, this is pretty useful to know, don’t you think?
Tuesday, 5 August 2008
Why Financial Literacy Matters
In my previous blog, I posted three questions that can be used to measure financial literacy. In this posting, I want to discuss the answers to those questions and why getting them right matters.
The first question is:
Suppose you had $100 in a savings account and the interest rate was 2% per year. After 5 years, how much do you think you would have in the account if you left the money to grow?
This question measures numeracy and knowledge of the power of interest compounding. The fact that interest grows on interest is an important concept to understand and explains how your investment can grow quickly over time.
There are two lessons to be learned from this concept:
1) To make the power of interest compounding work in your favor, it is important to start to save when you are young. Just a simple example: $1 invested at a 7% interest rate increases more than 7 fold in 30 years. This is pretty good, yes? (But see discussion of inflation below.)
2) It is important to borrow as little as possible with credit cards or through other high cost means. Borrowing at an interest rate of 20% means that it takes fewer than 5 years for your debt to double. To me, this seems to quickly hurt.
The second question is:
Imagine that the interest rate on your savings account was 1% per year and inflation was 2% per year. After 1 year, would you be able to buy more than, exactly the same as, or less than today with the money in this account?
This question measures knowledge of inflation. Inflation is simply the change in prices overtime. If prices increase, it means you can buy less with your money.
There are two lessons to be learned from this concept:
1) You need to protect against the erosion of your purchasing power. Because of inflation, the money you have today will buy less in the future, so you need to invest your money at an interest rate that is higher than the inflation rate. If inflation is at 3% and you earn 1% on your savings account, believe me, you are not doing well!
2) It is important to take inflation into account when planning for the future. In other words, do not expect the prices tomorrow to be the same as the prices today.
The third question is:
Do you think that the following statement is true or false? “Buying a single company stock usually provides a safer return than a stock mutual fund.”
This question measures knowledge of risk diversification. This is a very important concept that relates to the old adage 'don’t put all of your eggs in one basket.' A simple fall and you have a "frittata," as we say in Italian.
Again, there are lessons to be learned from this concept:
1) Make sure that a single event does not put a big dent in your investment. For example, why invest in a single stock? Why give all of your money to your brother-in-law who wants to open a cigar shop? Firms can fail and people can stop smoking.
2) Investing in your company stock is very risky; if your company goes under, you will lose the money you invested when you need it most. Even if you like your company a lot, why take so much risk? Clearly, I am lucky; Dartmouth is not listed on the NASDAQ and I do not have to face this decision.
The first question is:
Suppose you had $100 in a savings account and the interest rate was 2% per year. After 5 years, how much do you think you would have in the account if you left the money to grow?
This question measures numeracy and knowledge of the power of interest compounding. The fact that interest grows on interest is an important concept to understand and explains how your investment can grow quickly over time.
There are two lessons to be learned from this concept:
1) To make the power of interest compounding work in your favor, it is important to start to save when you are young. Just a simple example: $1 invested at a 7% interest rate increases more than 7 fold in 30 years. This is pretty good, yes? (But see discussion of inflation below.)
2) It is important to borrow as little as possible with credit cards or through other high cost means. Borrowing at an interest rate of 20% means that it takes fewer than 5 years for your debt to double. To me, this seems to quickly hurt.
The second question is:
Imagine that the interest rate on your savings account was 1% per year and inflation was 2% per year. After 1 year, would you be able to buy more than, exactly the same as, or less than today with the money in this account?
This question measures knowledge of inflation. Inflation is simply the change in prices overtime. If prices increase, it means you can buy less with your money.
There are two lessons to be learned from this concept:
1) You need to protect against the erosion of your purchasing power. Because of inflation, the money you have today will buy less in the future, so you need to invest your money at an interest rate that is higher than the inflation rate. If inflation is at 3% and you earn 1% on your savings account, believe me, you are not doing well!
2) It is important to take inflation into account when planning for the future. In other words, do not expect the prices tomorrow to be the same as the prices today.
The third question is:
Do you think that the following statement is true or false? “Buying a single company stock usually provides a safer return than a stock mutual fund.”
This question measures knowledge of risk diversification. This is a very important concept that relates to the old adage 'don’t put all of your eggs in one basket.' A simple fall and you have a "frittata," as we say in Italian.
Again, there are lessons to be learned from this concept:
1) Make sure that a single event does not put a big dent in your investment. For example, why invest in a single stock? Why give all of your money to your brother-in-law who wants to open a cigar shop? Firms can fail and people can stop smoking.
2) Investing in your company stock is very risky; if your company goes under, you will lose the money you invested when you need it most. Even if you like your company a lot, why take so much risk? Clearly, I am lucky; Dartmouth is not listed on the NASDAQ and I do not have to face this decision.
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