Chapter 11: Investment Basics

Money needed in the next 5 years should be put into a _____, ____,____.

-Savings account

-Short-term certificate of deposit

-U.S. Treasury bill

Inflation is:

The increase of prices for goods and services over time

The value of a dollar is _________________.

its purchasing power, and it is inversely related to inflation

_________________ is money set aside for future use in a secure, no-risk instrument.

Savings

An _________________ is an outlay of money for a profit, where the risk exists that either some or the entire original amount may be lost.

An investment

The first question to ask when deciding whether to save or invest is:

When will I need the money?

Where should Elena put her graduation gift money of $5,000 if she plans to use it to help fund a European trip in four years?

In a short-term, safe, insured, guaranteed investment

What is the impact on a checking account's purchasing power if it is earning 2% APY and inflation is 3% for the past year?

Inflation outpaced savings by 1%

A household with an annual take-home pay of $120,000 a year needs how much in its emergency fund, if one month of emergency money is required based on annual income?

$10,000

The major types of risk are:

Default, interest rate, market, and liquidity

10 years ago, your grandparents gifted you a 20-year, $1,000 bond. The interest rate at the time of purchase was 5%. Today, similar bonds are paying 7%. About how much could you sell this bond for?

$714

_________________ is the risk you take when you lock into a fixed-rate investment for a specific length of time.

Interest rate risk

_________________ is the risk that the company you have invested in may declare bankruptcy.

deafult risk

________ is the risk that the value of your investment will decrease due to changes in the market

Market risk

________________ is the risk of not being able to cash out an investment quickly enough to either meet cash flow needs or to prevent a loss.

Liquidity risk

What proportion of your income should be in savings?

6-9 months of income

to entice investors to take on riskier investments, it must pay a(n) _______________ to offset the risk.

investment incentive

Risk tolerance for savings and investing _________________.

is dependent on individual

_________________ is the spreading of assets among different investment options to reduce risk.

diversification

You determine that the appropriate balance for your investment-risk tolerance is a 70-20-10 proportion (stocks, bonds & cash). After year 1, your $10k investment is now worth $20k, with $16,000 in stocks, $2,750 in bonds, and $1,250 in cash. How should your assets be allocated to retain your risk proportion?

Sell $2,000 in stocks, buy $1,250 in bonds, and add $750 in cash

_________________ is all the investments you hold.

a portfolio

________________ is the diversification of the portfolio.

asset allocation

If you are managing your own portfolio, you need to re-evaluate your investment goals, risk tolerance, portfolio returns, and asset allocation on at least _________________ basis.

an annual

The investment pyramid _________________.

is a guideline for invesing and saving

Over the past 75 years, inflation has grown on average _________________ /year, money in the bank has averaged a _________________ return, and the stock market has averaged _________________.

3.1%; 3.9%; 12.3%

Right after college graduation, you open a targeted retirement account, allocating 90% of the funds in domestic and international stocks and 10% in corporate bonds. You plan to shift these allocations to 50% stock and 50% bonds upon retirement. You are now ready for retirement with $8,000,000 in your fund. How much money should you allocate to stocks and bonds?

$4,000,000 to stocks and $4,000,000 to bonds

In which life stage is it the best time to invest in a Roth IRA and start building your retirement fund?

independent

f your tax liability is 30% of your $50,000 salary and you contribute $2,000 to your 401(k) and your employer matches $2,000, what is your immediate ROI upon contributing $2,000 to your 401(k)?

130%

If you contribute 4% of your salary of $50,000 (you contribute $2,000) to your company 401(k) and your employer matches 100%, how much free money are you getting from your employer match?

$2,000

The ________ stage is the life stage where you are typically in the prime earning years and have more disposable income than in the past. This is a good time to contribute the maximum amount to retirement accounts, which will help lower your taxable income and help you reach financial independence sooner.

empty nest

T or F- Saving your money in a low-risk account grows its purchasing power

false

T or F- investing is putting $ at risk

true

T or F- The higher the risk, the higher the potential return and the less likely you will achieve the higher return.

true

T or F- When allocations are made to each tier of the investment pyramid proportionally, you mitigate overall risks while continuing to grow wealth

true

T or F- A reason not to invest in a mutual fund is that you have a targeted retirement date and you would like to reduce your market risks gradually as you approach retirement.

false

T or F- With a 529 college savings account, there are no taxes on the account's earnings; anyone (your mom, dad, grandparents, uncles, aunts, etc.) can contribute to the account; and, in some state-sponsored plans, the contribution is deductible from state taxes.

true

T or F- A traditional IRA does not offer any tax advantage on the contribution, but it grows tax-free and all withdrawals are tax-free.

false

T or F- All 401(k) contributions are on a pretax basis and the earnings are tax-deferred.

true

T or F- A Coverdell Education Savings Account is similar to a Roth IRA in that the contributions to the accounts are after-tax and they grow free of federal income tax

true

T or F- important savings goals during the independent life stage are investing in your education and investing in your retirement.

true