Week 4 - Financial Accounts & Intro to Investing Flashcards
(T/F) Actively trading common stocks is the best long-term investment strategy for most investors.
False
The potential advantages of index funds are
- Many, though not all, are well diversified.
- Many, though not all, have low fees
- Most, though not all, beat the market every year.
- Many, though not all, are well diversified.
- Many, though not all, have low fees
(T/F) It is surprisingly difficult to look up the fees for mutual funds?
False
When buying a mutual fund in a particular asset class, which of the following is most important?
a) Whether Jim Kramer likes the fund.
b) The fees the fund charges.
c) Whether or not the fund’s return the previous year was in the top 10% of similar funds.
b) The fees the fund charges.
(T/F) A mutual fund load is a commission you pay when you buy (or sometimes when you sell) a mutual fund.
True
(T/F) The fees charged by index funds vary with the types of assets the funds invest in.
True
(T/F) Exchange Traded Funds (ETFs) sometimes charge high fees, but they are always well diversified.
False
(T/F) If the market drops 30%, it is certain to recover during the next year.
False
If you buy a company’s stock,
you own a part of the company.
If you buy a company’s bond,
you have lent money to the company.
If a company files for bankruptcy, which of the following securities is most at risk of becoming virtually worthless?
The company’s stock.
Holding a diversified portfolio of stocks rather than an undiversified portfolio:
- increases the likelihood that you will someday be as rich as Bill Gates is today.
- increases the likelihood that you will own at least one stock that performs poorly.
- protects you from broad economy-wide risk.
- increases the variance of the entire portfolio.
- increases the expected (average) return of the portfolio.
- increases the likelihood that you will own at least one stock that performs poorly.
(T/F) Investments with higher risk always have higher expected returns
False
What are the investment basics?
- invest in Mutual Funds or ETFs
- choose low-cost index funds
- pick a mix of stock and bond funds
How much should you invest in bonds?
110 - age in equities
Should you buy mutual funds with load fees, why or why not?
No you should not. Loads are commissions usually charged when you buy and fund and shared by the mutual fund company with the advisor who sold the fund to you.
What are the pro’s of index funds?
- inexpensive
- well-diversified
- liquid
- relatively tax efficient
- work well in well-regulated markets that have lots of active management
What are the con’s of index funds?
- overweight overvalued stocks
- concentrate voting rights at mutual fund companies
- have potential tax disadvantages
- may contribute to mispricing in poorly regulated markets with insufficient active management
What are some factors that increase stock prices?
- improving economy: more demand for products
- improving production tech
- lower interest rates: cheaper borrowing for companies, bonds become less desirable
- increasing inflation: equities hedge inflation better than bonds
- increasing inflation: equities hedge inflation better than bonds
How is the cyclically adjusted price-to-earnings ratio calculated?
By dividing a stock’s current price with its average inflation-adjusted earnings from the previous 10 years.
How can you ensure you always pay on-time?
Enable auto-pay for the statement balance, enable paper statements
Always pay your _______ Balance by the __________
Statement….due date
What are some ways to lower your utilization?
- ask for a larger credit line
- make payments before your statement closes
- get another card
- use your debit card
Aspects of short-term funds (now –> 3 years)
- cash
- high-yield savings
- no loss of principal
Aspects of intermediate funds (3 –> 10 years)
- brokerage account
- moderately invested
- can withdraw with no penalty. Taxes, yes
Aspects of long-term funds (retirement)
- Roth/Trad IRA
- Roth/Trad 401(k)
- aggressively invested now, less so later
What is the retirement stool?
Retirement income composed of social security, employer pension, and personal savings
Aspects of an IRA
- $7,000 limit per year
- Funding window: Jan 1 – April 15
- can open it anywhere
- more withdrawal flexibility
- Roth or Traditional
- Income limits (x2)
- Nothing to do with employer
Aspects of 401(k)
- $23k limit per year
- Funding window: Jan 1 - Dec 31
- Must be with employer custodian
- Can loan against it
- Roth or Traditional
- No income limits
- Completely dictated by employer
What is the priority of saving?
1) Matching 401(k)
2) Rainy Day Fund
3) Pay down debt(s)
4) IRA / 401(k)
5) Brokerage account
6) Kid’s college
7) Exotics/ Alternative
Why do we invest and not just save?
Money loses its purchasing power over time. A $1 from 1980 would have lost 71% of its purchasing power if used in 2019.
What is the point of diversification?
Reduces the volatility of your portfolio without reducing the expected return. i.e. having lots of small bets is better than one bet because atleast some will pay off
Can broad economic risk be diversified away?
No, only company specific risks can be diversified away.
What is an all markets equity index fund?
Owns all the stocks
What should you do with your company stock?
Sell it!
(T/F) Low cost index funds are the best investment for most investors
True
What is an index fund?
A mutual fund that tracks an index
What are mutual funds?
Investment companies. It is the simplest and most economical way to own a diversified portfolio.
What are the 3 forms of a mutual fund?
- Open-ended
- ETF’s
- Closed-end funds
What are open-ended mutual funds?
Can be bought and sold directly from mutual fund companies (ex: Vanguard, Fidelity). Or you can purchase through financial advisor or brokerage (Charles Schwab, Morgan Stanley)
What are exchange traded funds?
A basket of securities. Bought and sold through financial advisor, brokerage firm, or mutual fund company
What is an index?
A list of stocks, bonds, or other securities
What is a passive investment?
When you’re not trying to beat the market
Why do active managers underperform?
too many people spending too much time and too much money trying to beat the U.S. market
What are the advantages of index funds over actively managed funds?
1) better-diversified
2) much lower fees
3) lower trading costs such as commissions
4) low trading rates on index funds
(T/F) You SHOULD focus on past performance when buying a mutual fund
False; focus on diversification, fees, asset allocation
What is spread?
The difference between price at which you can buy and sell a security, like a stock or ETF (small for S&P 500)
What shouldn’t you buy?
- index funds that track particular industries
- funds that track market in a single country
- funds that bet the market is going down
- funds that use borrowed money
Why is it hard to beat the market?
You have to beat the spread, or otherwise, find underpriced companies. Prices in the market adjust to make it very difficult for investors to find bargains. There are too many people spending too much time and money trying to beat the market.
(T/F) Mutual funds are actively managed
True
(T/F) Index funds are passive investments
True
What are examples of index funds?
An open-ended mutual fund or ETF constructed to track the market index
Do higher expected returns equal higher risks?
Yes, but higher risk doesn’t always mean higher returns
Why aren’t there investments with high expected returns and low risk?
Because of market forces
If market forces eliminate investments with high returns and low risk, why don’t they eliminate investments with low returns and high risk?
- the market adjusts prices for risks that investors can’t avoid through diversification
- there is no reward for taking unnecessary risks
What do we mean by expected return?
An average of all possible returns that you might get, with each outcome weighted by its probability. Probabilities are usually estimated from past returns.
Is the expected return the return you should expect to get?
No you’ll earn more or less
What are options?
Contracts bw 2 parties, in which one party sells the other party the right to buy or sell something
Futures
Agreements in which one party promises to buy and the other party promises to sell, a specified security (such as a stock) on a future date, in a specific location, for a price agreed on now.
What are commodities?
Agricultural products, natural resources, usually traded as futures
What are zero-sum games?
if the buyer of an option gains a dollar, the seller loses
