Do you know enough about investing?
Like it or not, managing personal finances and saving for retirement demands knowing at least a few basics about investing. Take this investing 101 quiz by MoneyRates.com to get an idea of how well you understand some important investment fundamentals:
Investing 101 Quiz
1. True or false: Stocks are always riskier than bonds.
The correct answer is False. Stocks are generally more risky than bonds, but some bonds carry a considerable default risk. A bond issued by a financially troubled company or an unstable country may well be riskier than the stock in a thriving company.
2. Which is the long-term average annual rate of return on stocks historically?
A. 7.5 percent
B. 10 percent
C. 12.5 percent
D. 15 percent
The correct answer is 10 percent. Though remember that from year to year, returns historically have been all over the map, often considerably higher or lower than 10 percent. In fact, there have been times when returns have come up well short of the 10 percent annual average over 10 and even 20-year periods. Also, while history is a guide to what stocks are capable of, those returns were earned under some very specific economic conditions which may be very different from today's environment. There is no guarantee that history will repeat itself.
3. True or false: Once you reach the required age, withdrawals from 401(k) plans are tax-free.
The correct answer is False. While you can withdraw without an additional penalty once you meet the age requirement, withdrawals from retirement plans for which contributions had their taxes deferred will typically be subject to ordinary income taxes.
4. Which is the limit on FDIC insurance per depositor at any one bank?
D. There is no limit
The correct answer is $250,000. Generally speaking, the FDIC insurance limit is $250,000 per depositor per institution. However, if you have a joint account the coverage limit is $250,000 per joint account owner.
5. True or False: You can increase your FDIC insurance coverage by splitting a large account into two smaller accounts at the same bank.
The correct answer is False. The limit applies to any depositor at a given institution, so if you want to get coverage for more than the usual limit you will probably have to split your money among two or more different banks. However, separate coverage does apply if you have two accounts that represent different legal entities, such as a taxable account and a qualified retirement account.
6. How many stocks does it take to achieve effective diversification?
A. About 20
B. About 50
C. At least 100
D. At least 1,000
The correct answer is About 20. But there are some twists to this. Theoretically, 20 stocks is sufficient to diversify away most of the individual volatility risk created by any one stock in the portfolio, but that still leaves two diversification issues. First, the value of diversifying is reduced if the stocks you choose have similar characteristics to one another - for example, a portfolio of 20 tech stocks would have less true diversification than a portfolio of 20 stocks distributed across different sectors. Second, while this kind of diversification can reduce individual security risk, you still have the systematic risk of exposure to the stock market. To diversify away from this, you need to also invest in other asset classes.
7. True or false: Dividend-paying stocks are safer than non-dividend-paying stocks.
The correct answer is False. Some of the most successful companies on the stock exchange choose not to pay a dividend because they believe they can put the money to better use by reinvesting it. Meanwhile, dividends are not guaranteed, and a stock can fall even with a dividend.
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8. True or false: Treasury bonds are completely safe because they are backed by the U.S. government.
The correct answer is False. The U.S. government backing provides for their stated interest payments and payment of face value upon maturity, but Treasury bonds can be subject to considerable price swings prior to their maturity dates.
9. True or false: Taking capital gains late in the year can be a prudent decision, despite the tax consequences.
The correct answer is True. Many people are overly focused on tax consequences, but those consequences must be balanced against potential price fluctuations. First, while the tax rate applies only to the gain on a stock, price fluctuations affect the entire value of the stock. Thus, unless the percentage gain is extremely large, price fluctuations have the potential to be more costly than tax consequences. Second, putting a sale off until after year-end does not eliminate tax consequences, it only delays them for a year.
10. Which is the age at which one can generally start withdrawing from tax-deferred retirement plans without a penalty?
B. 59 1/2
D. 70 1/2
The correct answer is 59 1/2. Withdrawals prior to that age will generally incur a 10 percent tax penalty, unless you qualify for a hardship distribution.
11. True or false: Mutual funds are guaranteed by the U.S. Securities and Exchange Commission.
The correct answer is False. While mutual funds have to be registered with the U.S. Securities and Exchange Commission, the SEC makes no guarantee of their value nor assurances about their investment soundness.
12. What generally happens to bond prices if interest rates rise?
A. Prices will fall
B. Prices will rise
C. Prices will fall then rise
D. Prices will remain the same
The correct answer is Prices will fall. Bond prices will generally fall if interest rates rise.
13. True or false: IRA contributions are not always tax-deductible.
The correct answer is True. Contributions to a traditional IRA are generally tax-deductible, while contributions to a Roth IRA are not. Also, keep in mind that there are limits to how much you can contribute to an IRA.
14. True or false: Putting a large chunk of your 401(k) in the stock of your employer is a sound investment because you probably know that company better than any other.
The correct answer is False. Your employer's stock may indeed be a good investment, but you have to balance the company's prospects against the increased risk of banking both your current job and your future retirement savings on the same company.
If you got at least 12 answers correct, you have a reasonably broad-based knowledge of investment fundamentals. If you got 9 to 11 correct, you were frequently right but could definitely afford to learn more about investment basics. Finally, if you got 8 or fewer answers correct, you failed investing 101 and need to study up on the fundamentals of investing as soon as possible - your money is depending on it.
Comment: How many investing questions did you answer correctly?
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