Test yourself: See if you're one of the few who can answer these 2 basic retirement questions

By Mark Hulbert

Financial literacy can make a big difference in how well prepared we are for retirement

Odds are you can't correctly answer this basic question about retirement investing.

It was included in a survey released earlier this week by the TIAA Institute and the Global Financial Literacy Excellence Center (GFLEC). More than half of the respondents got the answer wrong.

The question is below; the correct answer is at the end of this column:

Latisha plans to start saving for retirement by setting aside $2,000 this year. Her employer offers a 401(k) plan that fully matches a worker's contributions up to $5,000 each year. Under which scenario does Latisha have the largest amount in retirement savings at year-end?

She contributes $2,000 to the 401(k) plan and invests the money in a mutual fund that earns a 5% return during the year.She contributes $2,000 to an IRA (individual retirement account) and invests the money in a mutual fund that earns a 5% return during the year.It doesn't matter - she will have the same amount of year-end savings either way.

This question was one of five retirement fluency questions that were part of the TIAA/GFLEC survey. Another focused on how Social Security benefits are calculated, and even fewer (42%) answered it correctly:

Which statement about Social Security is false?

The amount someone receives in Social Security benefits depends upon his/her earnings during the last two years of full-time employment.A worker receives Social Security benefit payments if he/she becomes disabled before retiring.Social Security benefit payments will continue as long as an individual is alive, no matter how long he/she lives.

The point of these questions is not to make us feel bad about ourselves. The authors of the survey found that financial literacy can make a big real-world difference in how well prepared we are for retirement.

This is illustrated in the chart below. Of those who correctly answered at least four of the five retirement fluency questions, 75% were "very" or "somewhat" confident that they will have enough money to live comfortably throughout their retirement years. That compares to just 41% among those who correctly answered none of the five questions.

Furthermore, notice that there's a monotonic relationship between the number of retirement fluency questions correctly answered and retirement confidence.

Luck versus literacy

Some of you may still wonder if it's worth it. Financial planning requires mastery of a number of different fields, ranging from econometrics to human psychology. Just deciding when to start claiming Social Security benefits is a complex calculation involving close to one hundred separate variables.

Acquiring this mastery can be lengthy and arduous, and the potential benefit can be offset by one or two strokes of bad luck. As legendary investor Benjamin Graham, the author of The Intelligent Investor, famously admitted near the end of his illustrious career as an investment adviser (as well as being a mentor to Warren Buffet): "One lucky break, or one supremely shrewd decision - can we tell them apart? - may count for more than a lifetime of journeyman efforts."

It would be a mistake to see luck and literacy as in tension with each other, however. Opportunity knocks at the door of those who are ready for it.

Graham followed up his quote above with this point: "Behind the luck or the crucial decision, there must usually exist a background of preparation and disciplined capacity. One needs to be sufficiently established and recognized so that these opportunities will knock at his particular door. One must have the means, the judgment and the courage to take advantage of them."

Luckily, you don't have to become a master at all aspects of retirement planning. You can engage the services of a qualified financial planner who has acquired that mastery. Just don't think it isn't worth the effort.

Answers

The correct answer to the first question is #1, since it leads to a retirement portfolio that is twice as large as #2 - $4,200 at the end of the year, in contrast to $2,100.

The correct answer to the second question also is #1, since the amount you receive in Social Security benefits is a function of your 35 highest-paid years - not just the last two.

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com

April is National Financial Literacy Month. To mark the occasion, MarketWatch is publishing a series of "Financial Fitness" articles to help readers improve their fiscal health, and offer advice on how to save, invest and spend their money wisely. Read more here.

More: Take MarketWatch's 2024 Financial Literacy Quiz

Also read: Financial Literacy Month is about more than saving or budgeting. It's about taking stock of your life.

-Mark Hulbert

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04-22-24 1136ET

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