Dispelling Common Money Myths: 3 Facts to Enhance Your Financial Well-Being

• Understanding risk is crucial for making informed decisions.
• Common misconceptions about investing and managing finances that stump many Americans.

A recent report reveals that many U.S. adults struggle with making informed financial decisions due to a low level of financial literacy. One contributing factor is the persistence of misconceptions about money management and investing.

The TIAA Institute-GFLEC Personal Finance Index measures an individual's understanding of their personal finances by asking questions related to borrowing, saving, earning, and investing. This annual survey has been conducted since 2017.

In the latest version, only half the time did most people get the correct answers.

According to economist Annamaria Lusardi, who founded the Global Financial Literacy Excellence Center and is a senior fellow at the Stanford Institute for Economic Policy Research, adults struggle to understand the concept of risk consistently. However, Lusardi emphasizes that when examining the foundation of financial decision-making, a crucial question is the relationship between return and risk.

Many Americans are stumped by three common misconceptions about investing and managing finances, which are based on inaccurate information.

1. Diversification

A common misconception is that investing in an individual company's stock offers a more secure return than investing in a stock mutual fund or exchange-traded fund.

Putting all your eggs in one basket is equivalent to investing in one stock, which increases the risk of losing your savings if the company experiences difficulties.

Through diversification, many mutual funds and exchange-traded funds mitigate the risk of tracking a broad market index like the S&P 500 by purchasing the stocks of various companies.

Another smart option for your retirement savings are target-date funds.

According to Paul Yakoboski, a senior economist with the TIAA Institute, you don't need to be an investment expert to begin investing; you can start with the target-date fund in most retirement plans, which is suitable for young people.

Workplace retirement plans, such as 401(k)s, increasingly favor target-date funds, which adjust their investment mix as investors near retirement, shifting from stocks to bonds or cash.

2. Return and risk

It is a common misconception that stocks provide the highest return with minimal risk compared to savings accounts and bonds over time.

While the U.S. stock market typically provides the highest investment returns, it also comes with a higher level of risk due to the volatility of stocks compared to bonds or cash in a savings account.

"According to Lusardi, a member of the CNBC Global Financial Wellness Advisory Board, a higher return on an asset is always associated with a higher level of risk. People often believe they can achieve a higher return without any risk, but in reality, higher returns always come with higher levels of risk."

Experts typically advise keeping money out of the market if you have a short-term goal, while investors with a longer timeline may have greater opportunities to weather risk.

High-yield savings accounts are a popular choice for savers and short-term investors seeking a steady return, with current interest rates ranging from 4% to 5%, according to Bankrate. Unlike investments, which are subject to daily fluctuations in the stock market and can result in higher risk, federally insured deposit accounts offer almost no risk to money.

3. Compound interest

You would have $104 in your savings account after 5 years if you left the $100 with an interest rate of 4% per year.

If a $100 deposit is left in a savings account with an interest rate of 4% per year for 5 years, it will total $121.67 with compound interest.

You can increase the rate at which your savings grow by earning interest on both the initial deposit and the interest earned through compound interest. The Securities and Exchange Commission offers a calculator to determine the interest you're earning on your savings.

Financial advisors suggest that compounding can be a valuable tool for savers and investors, but it's not always necessary to have a complex portfolio.

He stated that rewards come from maintaining dedication, sticking to a routine, and adding to previous efforts.

JOIN: Money 101 is an 8-week course on financial freedom that will be sent to you weekly via email.