The Dangers of Economic Ignorance and Your Retirement

It’s time for ‘pop quiz’ — the American name for a surprise test. Don’t worry, thousands of people all around the world have already taken it, including 1024 Australians.

1.  Suppose you had $100 in a savings account and the interest rate was 2% per year. After five years, how much do you think you would have in the account if you left the money to grow?
A) more than $102
B) exactly $102
C) less than $102

2.  Imagine that the interest rate on your savings account is 1% per year and inflation is 2% per year. After one year, would you be able to buy…
A) more than
B) exactly the same as
C) less than
…what you can purchase today with the money in this account.

3.  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.’
A) true
B) false

The correct answers are 1-A; 2-C; and 3-B.

Of course, the point of the exercise wasn’t to give you a quiz. Here’s what you really need to know: Only 43% of Australians aced the test. Germans performed best, with 53% getting all three answers right. 30% of Americans and 4% of Russians managed 3 out of 3. Yes, 4%.

Conclusion: Your fellow Australians are in for a rough time.

Around half of Australians don’t understand basic concepts crucial to their financial wellbeing. They don’t feel the need to learn what they need to know to prepare for a comfortable retirement.

Now it’s not my intention to criticise people who lack certain knowledge. There are lots of subjects I know very little about. And these people doubtlessly have other things on their mind, and could surely compose a quiz which I would fail.

But financial matters affect just about all of us. We have bank accounts which pay interest, owe money that costs interest and invest via Superannuation. Inflation affects all three. We also vote for political parties, and if the majority of us have difficulty understanding basic financial concepts, that is quite dangerous in a democracy.

What makes this state of affairs so risky to your investments and retirement is that you operate in an economic system. Your wellbeing is linked to those around you. If other people don’t understand the dangers of inflation and a lack of diversification, it can affect your financial affairs directly.

For example, the government is worried about Australians owning too high a proportion of shares in their Super accounts. Regulations intended to change this asset mix could disrupt share prices unexpectedly. If all Australian retirees suddenly have to sell a proportion of the shares they hold in Super, that’s a heck of a lot of supply coming onto the market.

More worrying is how people without financial savvy will react to retirement and the ability to access their Super.

When you hit retirement, your financial life changes. You must take on responsibility for budgeting in a different sense. You focus on outflows and selling assets instead of earning money and making ends meet. Your time horizon must change from ‘paycheck to paycheck’ to the entire remainder of your life.

Managing outflows for a long time horizon — retirement — is going to be difficult for those who don’t understand basic financial concepts.

A lack of diversification is highly likely to take a big bite out of your wealth at some point. Those who owned too high a proportion of shares before the financial crisis will have taken a severe hit in 2008. They would have sold vast amounts of shares at a discounted price to make ends meet, reducing their ability to recover financially from the stock market rally that followed.

The other topic which features in the quiz is inflation. Historically, whenever central bankers broke the taboo of printing money, it ended with severe inflation. Once you start printing money, it’s difficult to stop, so inflation is only a matter of time. At the moment, the money printing is offsetting vast forces of deflation. But eventually the balance will fall out of whack. A burst of inflation can wipe out retirement plans in particular, because they are long term. That’s where inflation does the most damage.

If people are unaware of financial matters, they are also unprepared and unable to deal with the consequences of being unprepared. People cannot be trusted to be responsible in retirement because they were not trusted during their working years. The government’s welfare and retirement planning system took away this responsibility. The age of entitlement may or may not have ended, depending on your faith in the Liberal party. But the entitlement mentality will live on.

Just how all this will affect financial markets, the government budget and welfare system, and your retirement isn’t obvious. But I doubt ignorance will be bliss over coming years. It will pay to be informed, perhaps more than ever.

Nick Hubble+
Editor, The Money for Life Letter

Ed Note: The above article is an edited extract from The Money for Life Letter.

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Nick Hubble is a feature Editor of The Daily Reckoning Australia . Nick has spent the last three years discovering lots of new, exciting and surprisingly simple ways to generate money for retirement. He’s put all these ideas into his investment publication The Money for Life Letter. If you're already a subscriber to these publications, or want to follow Nick's financial world view more closely, then we recommend you join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails.


One response to “The Dangers of Economic Ignorance and Your Retirement

  1. Prior to retiring I was amazed at how many of my work friends new so little about financing their future when they stopped working. Most had no idea about capital growth, compound interest, franked dividends, or simple superannuation savings accounts with most Australian banks. Worst of all, most didn’t even seem to care about financing their future, until the day they actually retired ?

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