
1.
When an investor sells an investment for more than they paid for it, the result is known as which of the following?
(Choose one.)
- Dividend
- Interest
- Capital gain
- Depreciation
(Answer below.)
2.
Essentially, why do certificates of deposit (CDs) pay higher interest rates than regular savings accounts?
(Choose one.)
- They restrict access to the money for a fixed period.
- They invest some of the deposit in riskier vehicles.
- They aren’t insured by the Federal Deposit Insurance Corp.
- They are subsidized by the Federal Reserve.
(Answer below.)
3.
Say an investor could avoid 1% in annual fees on an investment account earning an average annual return of 7%. Over 30 years, how much more money could that investor expect the account with lower fees to have?
(Choose one.)
- approximately 1% more.
- approximately 6% more.
- approximately 7% more.
- approximately 25% more.
(Answer below.)
4.
If an investment earns an average annual return of 6%, how long would it take for the initial investment to double?
(Choose one.)
- Seven years.
- 12 years.
- 14 years.
- 24 years.
(Answer below.)
5.
“Don’t put all your eggs in one basket” is shorthand for which of the following?
(Choose one.)
- Be careful cashing out of investments too quickly.
- Don’t lose sight of long-term plans.
- Diversify portfolio assets.
- Know how much of a bank deposit is insured.
(Answer below.)
Answers
1.
c. Capital gain
A capital gain is the profit that an investment generates. If an investment sells for less than the price the investor paid for it, it’s known as a capital loss. Either one might have tax consequences. A capital gain can be taxed as a form of income. Sometimes, investors can use a capital loss to offset a gain made on another investment sale to reduce tax exposure on the gain. To be clear, talk with your investment advisor and tax professional so you know what to expect.
Learn more
- Capital gains distributions, by Tom Pappenfus
- Deciding which retirement accounts to tap, a Money Talk Video with Dave Sandstrom
- Capital Gains Explained, from the Financial Industry Regulatory Authority
- Topic no. 409, Capital gains and losses, from the IRS
- Capital Gains: Definition, Rules, Taxes, and Asset Types, from Investopedia
- FAQ About Taxation for Mutual Fund Investors, from the Investment Company Institute
2.
a. They restrict access to the money for a fixed period.
In return for locking up your deposit for an agreed-upon term, banks and credit unions can offer CDs with a higher guaranteed interest rate than they’d allow on accounts that provide more flexible access. Most CDs include early withdrawal penalties, typically a portion of the interest earnings. “Certificates of deposit are considered to be one of the safest savings options,” according to Investor.gov. But by tying up the money at a set rate, the investor risks missing out on possibly better returns elsewhere before the CD matures.
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Learn more
- Certificates of Deposit (CDs), from Investor.gov
- Investment Products: Bank Products, from the Financial Industry Regulatory Authority
- Certificates of Deposit (CDs) vs. Savings Accounts: Which Is Better for You? from Investopedia
- CDs vs. High-Yield Savings Accounts: Which Should I Get? from SmartAsset
3.
d. approximately 25% more.
According to the Compound Interest Calculator on Investor.gov, a $10,000 investment earning an annual return of 7.0% (7.1% minus fees of 0.1%) compounding annually will grow to $76,123 in 30 years. The same investments with 1% higher fees, earning 6.0% a year (7.1% minus fees of 1.1%) compounding annually will grow to $57,435 in 30 years. That’s a difference of $18,688 ($76,123-$57,435) or 24.5% ($18,688 divided by $76,123).
Learn more
- How Fees and Expenses Affect Your Investment Portfolio – Investor Bulletin, from Investor.gov
- Understanding Fees, from Investor.gov
Mutual Fund Fees and Expenses, from Investor.gov
Fees and Commissions, from the Financial Industry Regulatory Authority
Making the most of mutual fund fees, a Money Talk Video with Isabelle Wiemero
4.
b. 12 years
The Rule of 72 is a shorthand formula for approximating how soon an investment will double in size. When the average annual return multiplied by the number of years equals 72, the initial investment will have doubled. Thus, 72 divided by 6 (the average annual return) is 12 years. Another example: If you wanted an investment to double within nine years, you would need an average annual return of 8% (72 divided by nine.)
Learn more
- The Rule of 72: Definition, Usefulness, and How to Use It, from Investopedia
- What is compound interest, from Investor.gov
- Rule of 72: What is it and how to use it, from Bankrate.com
- The power of compounding in investments, a Money Talk Video with Dave Sandstrom
5.
c. Diversifying portfolio assets.
A mind-numbing array of math and science went into the Modern Portfolio Theory developed by Nobel laureate Harry Markowitz. But the principle is simple: Spread out your investments to lower the risk that you’ll lose them. Generally, stocks rise in value in the long run but risk occasional backsliding along the way. Bonds tend to be steadier in the short term but are less likely to provide the appreciation needed to keep ahead of inflation. Markowitz found that allocating assets between growth-oriented investments and more stable fixed-income vehicles could be a reasonably successful approach for most investors.
Learn more
- Efficiently Allocating Assets, a Money Talk Video with Steve Giles
Talking Money: Modern Portfolio Theory, a Money Talk Video with Kyle Tetting - Getting the big stuff right, a Money Talk Video with Kyle Tetting
Compiled by Joel Dresang