taking control over money

Taking Control Over Money obviously requires starting to learn about how to invest the savings that you manage to accumulate.  So, check your answers below and then see my own description of what your score means.  While I have provided the answers and their explanations as written by the original authors, I have included my own explanations and updates in footnotes.  I have also shared my own score below.

1.      A mutual fund’s performance is best measured by:

         a.      Income Return

         b.      Total Return

         c.      Yield

         d.      Capital Gains Distributions

         e.      Don’t Know

The correct answer is b.  Total return is the best measure of a mutual fund’s investment performance. A fund’s total return is the change in the value of an investment in the fund, taking into account any change in the fund’s share price during a specific period and assuming the reinvestment of any income dividends and capital gains distributions. 

2.      If a fund charges an expense ration of 1% in 2006:

         a.      You will pay a one-time fee amounting to 1% of the number of shares held in the account.

         b.      Your fund investment’s returns will be reduced by 1% in 2006.

         c.      Your fund investment is reduced by 1% at the time you buy shares.

         d.      You will pay a sales charge of 1% to a broker at the time you buy shares.

         e.      Don’t know. 

The correct answer is b.  An expense ratio is an annual fee that reflects the operating expenses of a mutual fund.  Such expenses are deducted each year directly from a fund’s earnings, thereby reducing your returns. 

3.      Common stocks always provide higher returns than bunds or money market investments.

         a.      True

         b.      False

         c.      Don’t know. 

The correct answer is b.  Over certain periods of time, bond and money market instruments have outperformed stocks. 

4.      When you invest in an employer’s retirement savings plan such as a 401 (k), your contributions are taxed:

         a.      When you withdraw them during retirement

         b.      Before you invest them

         c.      Once a year on or before April 15th

         d.      When you reach age 65

         e.      Don’t know

 

The correct answer is a.  A 401(k) is a tax-advantaged way to save for retirement.[1]

5.      If interest rates decline, the price of an existing bond or bond fund generally will:

         a.      Increase

         b.      Decrease

         c.      Stay about the same

         d.      Don’t know 

The correct answer is a.  Bond prices and interest rates generally move in opposite directions. When interest rates rise, bond prices typically decline.  And when rates decline, bond prices rise.  Share prices of bond mutual funds are affected in the same way. 

6.      A fund’s after-tax return may be influenced by:

         a.      The fund’s pre-tax return

         b.      The fund’s buying and selling of securities

         c.      The fund’s distribution of capital gains and dividends

         d.      All of the above

         e.      Don’t know 

The correct answer is d.  Your after-tax return is determined by the fund’s pretax return, a manager’s buying and selling of the fund’s securities, and any distribution of capital gains and dividends.  The fund’s pretax return reflects its return prior to taxes and represents an important factor in determining its ultimate after-tax return.  A fund that sells many securities for a profit, for example, may distribute sizable capital gains distributions.[2] 

7.      The goal of an index mutual fund is to:

         a.      Track the investment return of a specified stock or bond benchmark

         b.      Beat the investment return of a specified stock or bond benchmark

         c.      Buy only stocks in Standard and Poor’s 500 index

         d.      Invest in the best-performing sectors of the stock market

         e.      Don’t know 

The correct answer is a.  Index mutual funds (or passively managed funds) seek to match the investment returns of a specified benchmark, such as the Standard and Poor’s 500 Index or the Wilshire 5000 Total Market Index. 

8.      If you invest in a 401(k) plan at work, you are not eligible to contribute to an IRA:

         a.      True

         b.      False

         c.      Don’t know. 

The correct answer is b.  Participation in a 401(k) plan at work does not preclude you from contributing to an IRA.  Your status as an active participant in a 401(k) plan, may, however, affect your ability to deduct your IRA contribution on your federal income tax return. 

9.      Dollar-cost averaging is:

         a.      A strategy that entails buying low and selling high

         b.      A way to sell fund shares to minimize capital gains

         c.      An approach in which you invest the same amount of money in a fund or stock at regular intervals

         d.      None of the above

         e.      Don’t know 

The correct answer is c.  Dollar-cost averaging is an investment approach in which a fixed amount of money is invested at regular intervals on an ongoing basis.  Since the amount invested is constant, you are able to buy more shares of an investment when a share price is low and fewer when the price is high, resulting in a lower average cost of your shares during the time that you are contributing.  If you contribute to your employer’s 401(k) plan on a regular basis, for example, you are employing dollar-cost averaging. 

10.    From 1926-2001, the average total return per year for the U.S. stock market was:

         a.      4% per year

         b.      11% per year

         c.      22% per year

         d.      33% per year

         e.      Don’t know 

The total return on U.S. stocks from 1926-2001 has averaged 11% per year.  Returns can vary dramatically over shorter time periods.  During the 1990’s for instance, stocks returned more than 18%. The returns achieved by stocks in the 1970’s were far less robust at about 6%.[3] 

11.    Mutual funds are insured by the Federal Deposit Insurance Corporation

         a.      True

         b.      False

         c.      Don’t Know 

The correct answer is b.  Unlike bank accounts, mutual funds are not insure or guaranteed by the FDIC or any other government agency. 

12.    If two mutual funds hold the same securities, but one has higher operating expenses than the other, which of the following statements is true?

         a.      The fund with the higher expenses will have a higher return    

         b.      The fund with the lower expenses will have a higher return

         c.      You can’t say which fund would have a higher return, because expenses have no effect on returns

         d.      None of the above

         e.      Don’t know. 

The correct answer is b.  Investment expenses have a major impact on investment returns.  All mutual funds have expenses, but some funds cost significantly more to own than others.  Because expenses that you pay directly reduce your investment returns (they’re deducted before you get your return), it pays to do your homework on a fund’s expenses and fees before you invest. 

13.    According to a recent tax law change, investors under age 50 can contribute up to ________ to their IRA for 2006?

         a.      $2000

         b.      $3000

         c.      $4000

         d.      $5000

         e.      Don’t know 

The correct answer is c.  Investors under the age of 50 are permitted to contribute up to $4000.00 ($5000.00 if over 50 and “catching up”) in an IRA for the tax year 2006. Contribution limits to IRAs, 401(k)s and other workplace savings plans were increased in 2001 but were due to expire in 2010. The Pension Protection Act of 2006 makes these increases permanent.[4] 

14.    If you own only U.S. stocks in your investment portfolio, you can reduce your overall risk by adding international stocks.

         a.      True

         b.      False

         c.      Don’t know 

The correct answer is a.  The returns of international markets can differ significantly from those of the US market.  By investing in international funds, you can diversify your portfolio and help reduce its overall volatility. 

15.    Which of the following is not an attribute of mutual funds?

         a.      Diversification

         b.      Professional management

         c.      Guaranteed return

         d.      None of the above.

         e.      Don’t know 

The correct answer is c.  Mutual funds offer diversification and professional management, but do not guarantee returns.  Returns vary based on the fund’s underlying investments and the performance of the securities market. 

16.    Which type of investment has generally offered the best protection against inflation of long periods of time?

         a.      Money market funds and bank accounts

         b.      Government National Mortgage Association securities (Ginnie Maes)

         c.      Stocks

         d.      Corporate bonds

         e.      Don’t know. 

The correct answer is c.  Rising prices due to inflation can erode the real value, or purchasing power, of investments.  Over long periods, stock investments have outpaced inflation by a larger margin than bonds or cash investments. 

17.    Income earned on municipal bonds or dividends paid by municipal bond funds are generally exempt from federal income tax.

         a.      True

         b.      False

         c.      Don’t know. 

The correct answer is a.  Municipal bonds pay interest that is tax-exempt from federal income tax and, in many instances, from state income tax in the issuer’s state.  While the income from a municipal bond fund is exempt from federal income tax, realized capital gains – either as a result of a fund distribution or a profit from a sale of fund shares – are taxable. In some cases, the alternative minimum tax may apply. 

18.    A charge to purchase mutual fund shares is frequently called:

         a.      A bid/ask spread

         b.      An expense ratio

         c.      A sales load

         d.      A price/earnings ratio

         e.      Don’t know.

 

The correct answer is c.  There are several ways a fund may charge a sales load:  a front-end load—you pay the fee upfront; a back-end load – you pay the fee when you sell the fund shares; or a level load—you pay an annual fee, in addition to operating expenses, each year you are invested in the fund.[5]

 

19.    Generally, a portfolio that has 80% of its assets invested in stocks would be best suited for:

         a.      An 18-year-old using the assets to pay for college expenses over the next four years

         b.      A 35-year-old investing for retirement

         c.      A 75-year-old investing for income and capital preservation

         d.      None of the above

         e.      Don’t know

 

The correct answer is b.  A 35-year-old investing for retirement has a longer time horizon for his or her investment goal.  The longer your time frame, the greater your ability to ride the ups and downs of the markets by selecting investments that may be more volatile in the short-term with the hopes of greater returns over time.

 

20.    If you invest in a long-term bond with an average maturity of 10 years, you must hold on to the investment for 10 years.

         a.      True

         b.      False

         c.      Don’t know 

The correct answer is b.  Similar to mutual funds, investors can redeem their shares in a bond mutual fund at any time.  Bond funds have average maturities that range from short-term to intermediate-term t long-term.  Average maturity measures the average length of time until all the bonds held in the fund are scheduled to e repaid, not how long an investor is required to hold shares in the bond fund.

 

WHAT YOUR SCORE MEANS: 

Give yourself 5 points for each correct answer.  Then look at the following to determine how well you can take control over your investments:

If you scored a 90-100, consider yourself to have an A for “Authority” in investment savvy.  You have a good idea of the basic concepts of investing and a sound mind with respect to strategy.  You can probably invest on your own given your level of knowledge.  

An 80-90 means you get a B for “Brush-up.” You know a lot, but you need to be refreshed on some of the fundamentals.  Do some more homework before you make any huge investment decisions.  

A score of 70-80 is a C for “Consumer Beware.”  You should not yet invest on your own until you get a bit more knowledgeable about the basics:  you need to walk before your run, so, if you are throwing money around, be careful (of course).  You might want to stick to mutual funds and even go with those funds that do the work for you such as target investment date or mixed-allocation funds.  

A 60-70 is a “D” for “Don’t go it alone.” You need to work with a good company that will put your money in a good place or a fee-based financial advisor. Be careful here:  you do not want to get scammed into buying recommended funds with high expense ratios or sales loads.  Some “investment advisors” peddle certain products that make the managers rich, but do not do much for your bottom line.  You should think about sticking to the many low expense funds which exist as well as low-fee brokers (Charles Schwab is a low-fee firm that has different levels of help for people with different levels of skill; Vanguard has a line of products that require no investing skill on your part – call them, set up your account, and they’ll help you figure out which of their fund offerings are best for your time horizon.  Other, similar firms exist as well). 

Finally, below 60, E for “Eeks.”  Get yourself advice before you take any steps.  Just don’t leave your money under the mattress while you wait for advice to come to you.  You need to take the advice I gave to the D’s – go to a fee-based certified financial planner or a company like Schwab or Vanguard and make sure your money is taken care of for you. 

I got a 90 – and one that I got wrong was just dumb on my part.  All this research I have been doing should begin to pay off.