Take the Test to Predict Your Retirement! (Part 2)

Since you loved to test yourself last week, here is the rest of the quiz.

As a reminder, the test can statistically predict how comfortable your retirement will be!

Two thirds of the population can’t answer the questions.

Please play the game and write your answers somewhere. It could be on a piece of paper, your cell phone, your tablet, your computer, or even your hand. Just write them down somewhere so there is no confusion. Rest assured that nobody will know. It will be our little secret.

Are you ready for the 3 questions*?

Question 1: If interest rates rise, what will typically happen to bond prices?

1. Rise
2. Fall
3. Stay the same
4. There is no relationship

Question 2: True or false: A 15-year mortgage typically requires higher monthly payments than a 30-year mortgage, but the total interest over the life of the loan will be less.

1. True
2. False

Question 3: Suppose you owe $1,000 on a loan with a 20% interest rate per year, compounded annually. If you didn’t pay anything off, at this interest rate, how many years would it take for the amount you owe to double?

1. Less than 2 years
2. 2 to 4 years
3. 5 to 9 years
4. 10 or more years

Here are the correct answers:

Question 1: If interest rates rise, what will typically happen to bond prices? 

Answer 2:  Fall

This is a classic rule of personal finance you need to remember:

• When interest rates rise, bond prices fall.
• When interest rates fall, bond prices rise.

Why? Because as interest rates go up, newer bonds come to market, paying higher interest yields than older bonds already in the hands of investors, making the older bonds worth less.

Conversely, if interest rates fall, the bond’s interest rates become more attractive, so people will bid up the price of the bond.

Question 2: True or false: A 15-year mortgage typically requires higher monthly payments than a 30-year mortgage, but the total interest over the life of the loan will be less.

Answer 1:  True

Of course, we have to assume that interest rate is the same for both loans.

With a shorter loan duration, you repay the principal at a faster rate. So the monthly payment for a 15-year loan is higher.

In that case, you will pay less in interest over the life of a 15-year loan than you would with a 30-year loan.

Here’s an example:

Let’s say you get a 30-year mortgage at 6% on a $150,000 home. You will pay $899 a month in principal and interest charges. Over 30 years, you will pay $173,757 in interest alone.

But a 15-year mortgage at the same rate (6%) will cost you less in interest. You will pay $1,266 each month but only $77,841 in total interest—almost $100,000 less.

Question 3: Suppose you owe $1,000 on a loan with a 20% interest rate per year, compounded annually. If you didn’t pay anything off, at this interest rate, how many years would it take for the amount you owe to double?

Answer 2:  2 to 4 years

This is definitely not an easy question.

Someone who doesn’t understand how compound interest operates might conclude that borrowing at 20% per year would lead to doubling in 5 years. However, someone who knows about interest on interest would understand that the answer should be somewhat less than 5 years.

One way to figure it out is to apply the Rule of 72, which is a simple way to estimate how long it takes for an investment to double. So if you divide 72 by the interest rate, 20%, you get 3.6, so the correct answer is “2 to 4 years.” 

How well did you do on the test?

Phil Zeltzman, DVM, DACVS
Meredith Jones, DVM
Co-Founders of Veterinary Financial Summit

* Source: https://www.usfinancialcapability.org/quiz.php, a website created by FINRA (Financial Industry Regulatory Authority).