• Suppose you had $100 in a savings account and the interest rate was 2 percent a year. After five years, how much do you think you would have if you left the money to grow? More than $102, exactly $102 or less than $102?
• Imagine that the interest rate on your savings account was 1 percent a year and that inflation was 2 percent. After one year, would you be able to buy more than, the same as or less than you could today with the money?
• Do you think this statement is true or false: “Buying a single company stock usually provides a safer return than a stock mutual fund”?
Anyone with even a basic understanding of compound interest, inflation and diversification should know that the answers to these questions are “more than,” “less than” and “false.” Yet in a survey of Americans over age 50 conducted by the economists Annamaria Lusardi of George Washington University and Olivia S. Mitchell of the Wharton School of the University of Pennsylvania, only a third could answer all three questions correctly.
From a Center for Economic and Financial Literacy survey:
"1 in 3 people didn't know how much money a person would be spending on gifts if they spent 1% of their $50,000/year salary."
"65% of people answered incorrectly when asked how many reindeer would remain if Santa had to lay off 25% of his eight reindeer."
– Personal Finance for Dummies, 7th edition, 2012, page 9
As I always say, a model is only as good as its interpretation. The interpretation to reality is the most important part of the model to get right, and the right interpretation is usually substantially different from literal.