Category 1: Investing Basics & Behavior
How does investing differ from saving in a bank account?
Answer: Investing allows you to accumulate wealth for retirement (long-term), while saving is best for short-term purchases or emergencies.
How is a Bond different from a Stock?
Answer: A Bond is a loan to an organization (debt), while a Stock is partial ownership in a company (equity).
What strategy involves investing a fixed dollar amount (e.g., $100) every month, regardless of share price?
Answer: Dollar-Cost Averaging.
What is a 401(k)?
Answer: An employer-sponsored retirement plan where contributions are often made pre-tax and matched by the employer.
Identify two factors that can influence an individual company’s stock price.
Daniel has a savings account earning 0.5% interest, but inflation is 2%. What happens to his purchasing power?
Answer: It decreases because the interest rate is lower than the rate of inflation.
What are the two main ways to make money from stocks?
Answer: Selling for a higher price (Capital Gains) and Dividends.
Why is Diversification recommended?
Answer: It helps reduce risk by spreading investments across different assets.
Katrina earns $65k. Her company matches 3%. She has $150/month to save. What should she do?
Answer: Contribute the full $150 to the 401(k) to get the "free money" match.
Explain why it is important to start saving for retirement when you are young, even though retirement is decades away. Give at least two reasons.
What is Compound Interest?
Answer: Earning interest not only on the amount you saved (principal) but also on the interest you've already earned.
Which trades throughout the day like a stock but holds a basket of assets: a Mutual Fund or an ETF?
Answer: An ETF (Exchange Traded Fund).
You bought 10 shares for $45 and sold them for $80. What is your total profit?
Answer: **$350** profit. *($80 - $45 = $35 gain per share x 10 shares)*.
What is the main tax difference between a Roth IRA and a Traditional IRA?
Answer: Roth IRA = Pay taxes now, tax-free withdrawals later.
Traditional IRA = Tax deduction now, pay taxes on withdrawals later.
Jeff is 22 years old. He wants to divide his money between stocks and bonds.
Recommended Allocation: ______% Stocks / ______% Bonds
Jeff has more time to recover from market drops, so he can tolerate higher ____________ in exchange for higher potential returns. He can also take advantage of ____________ interest over time.
Generally recommend that Jeff invest a high percentage in stocks (about 80%) and a lower percentage in bonds (about 20%). Since Jeff is young, he has the advantage of time and can take more (risks). For this reason, he can allocate the majority of his investments into stocks as those have a greater chance of a higher return. To balance this allocation, he can put the remainder of his investments into bonds, as those are generally less risky investments and tend to have lower returns. Having more time also allows Jeff to take advantage of (compound interest), which will help his retirement savings grow even further!
Note: As Jeff grows older, he can adjust his portfolio accordingly to take less risk.
Why is understanding Risk Tolerance important?
Answer: You should tailor your portfolio to assume an amount of risk you are comfortable with (so you don't panic sell).
If interest rates rise, what happens to the price of existing bonds?
Answer: The price of existing bonds decreases. (Inverse relationship).
Fund A has a 7% return with a 1% fee. Fund B has a 6.5% return with a 0.1% fee. Which is better?
Answer: Fund B. (Net return: Fund A is 6.0%, Fund B is 6.4%).
Why is a Target Date Fund (TDF) good for a beginner like Sam?
Answer: It automatically adjusts the asset allocation (risk level) based on the retirement year he chooses.
Explain three key differences between index funds and mutual funds.
Answers:
What behavior often prevents people from making smart investing decisions during a market downturn?
Answer: Exiting the market (selling) because that is what everyone else is doing (herd mentality).
Explain the difference between an Actively Managed Mutual Fund and an Index Fund.
Answer: Active funds have a manager trying to beat the market (higher fees); Index funds passively track a market list (lower fees).
What is the general relationship between Risk and Return?
Answer: Investors expect to earn a higher return when they invest in a high-risk asset.
What is Social Security?
Answer: A government program that pools contributions from current workers to fund retirement benefits for those eligible.
Case Study - "Helping Jasmina"
Jasmina is new to investing. She says: "I know I should pick individual stocks to win big! My job offers a 401(k) with a match, but I don't know what that means. I'm scared I'll lose all my money if the market crashes."
1. Address her misconception about "picking stocks": Why is picking individual stocks generally not recommended for beginners compared to Index Funds?
2. Explain the "Match": If Jasmina puts money into her 401(k) and her employer "matches" it, what does that effectively mean for her investment return immediately?
3. Calming her fears: How does Diversification help reduce her fear of "losing everything" if one company crashes?