50% of Americans don't know if it's better to invest in a single stock or a mutual fund
Recent headlines have touted stock market records and low unemployment numbers. But behind the data, the vast majority of Americans are still stressed about their finances and would have trouble paying out-of-pocket for a minor emergency, according to a new report from J.D. Power.
More than 75% of Americans say they are stressed about their money, J.D. Power found, and 35.5% have less than $1,000 saved across checking, savings, retirement and other investment accounts. While economic trends look positive, a skyrocketing stock index doesn't mean much if you don't have enough money to invest, Bob Neuhaus, vice president, global financial services at J.D. Power, tells CNBC Make It.
The trouble is deeper than an inability to save, Neuhaus says. In the report, 50% of Americans said they didn't know whether buying a single company's stock "usually provides a better return" than investing in a mutual fund. And over 35% could not answer the following question: At a 2% interest rate, how much would $100 be worth after five years?
"I think people in the financial industry often make the assumption that people understand these products, but this data says that's wrong," says Neuhaus. "They don't understand the basics of interest rates, the basics of inflation and the basics of investing."
For the record, mutual funds usually provide better returns than investing in a single company's stock because this strategy spreads out risk. Your returns don't depend on the ups and downs of a single company. Instead, they reflect the gains or losses of a broader sector or stock index, which is comprised of many companies. That's what is known as diversification, which has been proven to be a more effective long-term investing strategy than picking single stocks.
Financial illiteracy can affect your bottom line
This financial illiteracy has serious consequences, Neuhaus says. Not understanding interest rates could mean paying more over time with high interest products like credit cards, he says. Not knowing how important diversification is in investing could mean that Americans build less wealth over time.
There's no easy answer when it comes to fixing these problems. Banks and other financial institutions could do a better job offering financial literacy tools to their account holders, Neuhaus says. But consumers also have to want to learn and know the options available to them.
"You hear that the stock market is wonderful and the employment numbers are at an all time low," says Neuhaus, "but you still have to address how to make people more financially healthy."
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