Investment Planning Flashcards

Which investment type typically offers the highest potential return over the long term?

Answer: Stocks

Historically, stocks have offered the highest potential for long-term growth and returns compared to other asset classes like bonds, certificates of deposit, or money market accounts. While they come with higher volatility and risk, their potential for capital appreciation and dividends makes them a key component for long-term wealth building.

What does diversification in a portfolio aim to reduce?

Answer: Unsystematic risk

Diversification is an investment strategy that involves spreading investments across various asset classes, industries, and geographies. Its primary aim is to reduce unsystematic risk (also known as specific or diversifiable risk), which is the risk inherent to a particular company or industry, by ensuring that poor performance in one area is offset by better performance elsewhere.

What is the primary objective of asset allocation in investment planning?

Answer: Balance risk and return

The primary objective of asset allocation in investment planning is to balance risk and return. By strategically dividing an investment portfolio among different asset categories like stocks, bonds, and cash, investors can create a portfolio that aligns with their risk tolerance, financial goals, and time horizon, optimizing the trade-off between potential gains and losses.

Which of the following is considered a fixed-income investment?

Answer: Bonds

Bonds are considered fixed-income investments because they typically pay investors a fixed rate of interest over a specified period. They represent a loan made by an investor to a borrower (such as a corporation or government), providing predictable income streams and generally lower risk compared to equities.

Which term best describes the risk of losing purchasing power due to rising prices?

Answer: Inflation risk

Inflation risk, also known as purchasing power risk, describes the risk of losing purchasing power due to rising prices over time. If the return on an investment does not keep pace with the rate of inflation, the real value of the investment and an investor's ability to purchase goods and services will decrease.

What is the main benefit of investing in index funds?

Answer: Broad market exposure at low cost

Index funds are designed to passively track a specific market index, such as the S&P 500, rather than actively picking stocks. This strategy provides investors with immediate diversification across numerous companies, offering broad market exposure. Their passive management approach also results in significantly lower operating expenses and management fees compared to actively managed funds.