A combination of instinct and knowledge differentiates short-term investors from those who invest for longer term. Know what you are:
1. When you buy a company’s stock…
a) You own a part of the company
b) You have lent money to the company
c) You are liable for the company’s debts
d) The company will return investment with interest
2. If you invest in a company’s bond or debenture or deposit...
a) You own a part of the company
b) You have lent money to the company
c) You are liable for the company’s debts
d) You can vote on shareholder resolutions
3. In general, if interest rates fall, bond prices…
a) Go down
b) Go up
c) Are not affected
4. Riskier investments generally provide higher returns than investments with less risk.
a) True
b) False
5. To ensure you are saving enough for retirement you should:
a) Contribute as much as possible to retirement plan
b) Diversify your investments
c) Know about asset classes
d) Begin investing early
e) All of the above
6. In the past 20 years the best returns have been generated by:
a) Stocks
b) Bonds
c) Corporate deposits
d) Money market accounts
e) Precious metals
7. What is a reasonable average annual rate of return to expect from an equity-diversified mutual fund over the long run?
a)5%
b)10%
c)15%
d)20%
e)25%
8. Understanding what kind of investment mix best suits your needs you should know:
a) Your investment goals
b) Your risk tolerance
c) Time horizon of your investments
d) You post-retirement financial needs
e) All of the above
9. Asset re-allocation means changes in your investment mix as your future needs and goals change
a) True
b) False
The correct answers are:
1. a
2. b
3. b
4. a
5. e
6. a
7. b
8. e
9. a
If you got most of the answers right you not only know the basics of investing, you are more likely to invest for the right reasons, in the right instruments and for the right term.
The three go hand in hand — if you know what you are investing for (the reasons) you are likely to pick the right instruments. Of course not all your investments will be and should be for the long term.
When you are young, majority of your savings should be invested in the longest-term instruments, especially the equity and equitylinked ones. These investments beat the inflation rate by the widest margin. As your age increases, the investment horizon should gradually shrink.
FILL THE KNOWLEDGE GAP
All that you know about investing in funds and stocks isn't right. Here's a 6-point check list.
WHAT YOU KNEW | WHAT'S THE FACT |
| For long-term investments returns from stocks, especially diversified portfolio of large-cap stocks, always exceeded the inflation rate | RIGHT. Between 1994 and 2006 the value of Sensex stocks rose by 3.51 times (over 250%) whereas wholesale price inflation increased by 1.8 times (83%) |
| The BSE 500 index is a measure of the average price of the stocks of 500 companies that comprise the index | WRONG. The BSE 500 does represent values of 500 stocks, but not in equal proportion. Different stocks have different weightages and influence the index differently |
| For investing in mutual funds, it is best to go for schemes that have delivered the highest return in the past year | NOT ALWAYS. Past performance of a fund is no guarantee of future returns; unlike a stock the price of which incorporates expectations of its future performance |
| The total return on an index fund has usually exceeded the return on most equity-based mutual fund schemes | RIGHT. Although index funds are never top performers, the best ones often outperform managed funds due to lower brokerage, research and management expenses |
| Equity mutual funds with a narrow focus, like sector funds, have lower price volatility than broader diversified funds | WRONG. The narrower the focus, the greater the volatility. A broad-based fund will resemble the market average better due to greater diversification |
| When interest rates rise, the market value of existing bonds and debt mutual funds rise | WRONG. When interest rates rise, the existing bonds with lower interest rate become less attractive relative to the new ones, causing their market price to fall |
