Misconceptions about managing your money, and what to know instead

Many American adults make financial decisions with a generally low level of financial knowledge., a new report reveals. Part of the problem: People continue to believe common misconceptions about managing and investing their money.

The TIAA Institute-GFLEC Personal Finance Index measures an individual’s knowledge of their personal finances. The index, conducted annually since 2017, asks respondents about borrowing, saving, earning, investing and other money-related areas.

In the last version, most people got the answers right only about half the time.

Understanding risk consistently proves to be the most difficult concept for adults to understand, said economist Annamaria Lusardi, founder of the Global Financial Literacy Excellence Center in 2011 and a senior fellow at the Economic Policy Research Institute of Stanford. Still, “when we try to examine the foundations of financial decision-making, a key question is the relationship between return and risk,” she said.

Here are the facts behind three common misconceptions about investing and money management that confuse many Americans:

Misconception: Investing in the stocks of a single company generally offers a safer return than a stock mutual fund or exchange-traded fund.

FACT: Investing in a stock is like putting all your eggs in one basket. This exposes your savings to significant losses if the business is in difficulty.

Many mutual funds and exchange-traded funds, especially those that track a broad stock index like the S&P 500, hedge this risk through diversification, buying the stocks of many different companies.

When it comes to your retirement savings, target date funds can be another smart option.

“You don’t have to be an investing guru, you can always start with the target date fund that is in most retirement plans to get yourself in the game for a young person,” Paul said Yakoboski, senior economist at the TIAA Institute. .

Target date funds have become the most popular investments in workplace retirement plans, such as 401(k)s. As investors approach retirement, the fund’s investment mix becomes more conservative, decreasing the share of stocks and increasing the share of bonds or cash.

Misconception: Over time, stocks generally offer the highest return with little risk compared to savings accounts and bonds.

FACT: The U.S. stock market is considered to offer the highest investment returns over time, but there is higher risk because stocks are more volatile than bond prices or cash in a savings account.

“An asset that brings a higher return also has a higher expected risk,” said Lusardi, who is also a member of CNBC’s Global Financial Wellness Advisory Council. “People have the impression that I can get a higher return without risk… but fundamentally, a higher return is always a reward for higher risk.”

Investors who have a longer time frame to achieve their goal often have greater opportunities to address this risk. But if you have a short-term goal, experts generally advise keeping money out of the market.

For short-term savers and investors looking for a steady return, high-yield savings accounts can be an attractive option, with the highest interest rates currently ranging between 4% and 5%, depending on Bankrate. There is almost no risk to the money in federally insured deposit accounts, unlike investments that are subject to daily fluctuations in stocks, which can result in much higher risk.

Misconception: If you had $100 in a savings account and the interest rate was 4% per year, you would have $104 after 5 years if you let the money grow.

FACT: A $100 deposit left in a savings account earning an interest rate of 4% per year over 5 years would total $121.67 with compound interest.

Compound interest can accelerate the growth of your savings since you earn interest on the original amount deposited plus any interest earned. Use the Securities and Exchange Commission’s Compound Interest Calculator to calculate the interest you earn on your savings.

Compounding can be one of the greatest gifts for savers and investors, many financial advisors say. You’re not necessarily rewarded for the complexity of your portfolio, said certified financial planner Preston Cherry, a member of the CNBC FA Council and founder of Concurrent Financial Planning in Green Bay, Wisconsin.

“You are rewarded for your commitment, your consistency and your capitalization,” he said.

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