Initial Assessment Review and Answers
Let's take these questions one by one!
Question: Which of the following is NOT considered a tax-advantaged account?
Answer: Brokerage
Explanation: There are a lot of different account types. In Section 2, Getting Your Accounts in Order, we'll go over all the different account type options out there and which one (or ones) are right for you.
Question: In order to have a diverse portfolio, you'll need to hold many different investments in your account.
Answer: False
Explanation: Diversification does mean being invested in a broad area of the market. There are ways to do this (like index funds) that will allow you invest in lots of different things with a single investment. In Section 3, Understanding Diversification, we dive into this question more.
Question: To maximize diversity, which type of investments should you favor?
Answer: ETFs / Mutual Funds
Explanation: ETFs and Mutual Funds (which are pretty much the same thing), are containers provided by investment companies that hold many stocks, bonds or other investments. When I say many, I mean MANY. Holding one index fund can be backed by over 10,000 different investments behind the scenes. Would you rather buy 10,000 different stocks, or 1 mutual fund? In Section 2, we'll go over ETFs/Mutual funds, then in Section 3, we'll talk about their huge benefit when it comes to diversity.
Question: One of the main advantage of a diverse portfolio is that your account balance will experience less dramatic swings in value.
Answer: True
Explanation: By diversifying your investments you'll never be the biggest winner, but you'll also never be the biggest loser. We'll look into how this impacts returns long-term in Section 3, Understanding Diversification.
Question: If you invest with a financial advisor that charges a 1% fee, and they choose a fund with a 1.5% fee, how much of your earnings could taken up by fees over 30 years (assuming 7% market growth)?
Answer: 50%
Explanation: This one is pure math. The problem is compound interest and how it works. Your interest in year 1 grows in year 1. In year 3, your interest from years 1+2 grow. Every little bit you take away from the compounding formula has a huge impact.
We'll dive into fees and how to reduce them in Section 4, All About Fees.
Here's a look look from the NerdWallet calculator on how a 2.5% fee could compare with a 0.04% fee.
Question: To lower taxes, you should put your funds with the largest growth potential in tax advantaged accounts (401k, Roth IRA, etc).
Answer: False
Explanation: When I started, I assumed this was true. After reading more and doing the math, I realized what you really want to do is put the funds with the most dividends in your tax-advantaged accounts. We'll dig into why this is the case in Section 5, Tax-Efficient Fund Placement.
Question: When should you invest in the market?
Answer: When you have money, or when you get paid
Explanation: Timing the market is a dangerous game. It's akin to betting in roulette based on the last spin. There are better ways of investing that favor "time in the market" rather than "timing the market". In Section 9, Pay Yourself First Mindset, we'll look into why this is the case.
Question: If you buy an investment and sell it within a year, how much tax will you pay on the gains of the transaction?
Answer: Whatever your ordinary income tax rate
Explanation: Taxes are a huge subject for investing. We'll look into short term capital gains taxes and long-term capital gains taxes in Section 10, Tax Implications.
Question: If you buy an investment, hold it longer than a year then sell it, how much tax will you pay on the gains of the transaction?
Answer: 0% or more, depending on your income bracket
Explanation: What you pay on investments held longer than a year is determined by your long-term capital gains rate. This can be $0 - that is you may not need to pay any taxes at all on your capital gains! We'll take a look into long-term capital gains rate in Section 10, Tax Implications.
Question: You should check your investments every day to make sure they're still correct.
Answer: False
Explanation: If you're a day trader then you'll want to check your investments everyday. If you're investing for retirement then this will be a waste of your time. In Section 11, Rebalancing Your Portfolio, I'll show some tips on how often you should check your portfolio and what you should do.
Question: You should listen to every word I say and do it exactly.
Answer: False
Explanation: This is a course on strategies that have worked for me as an investor. I'm also not a financial advisor, and I wouldn't want to give advice - only share what's worked for me. What works for you might be completely different! In Section 12, Create Your Own Rules For Investing, you'll take what you've learned and write your own rules for investing. I'll share my own rules as a starting point.
Whew! That's a lot of review of questions
It's time to start the course and begin understanding why these answers make sense.