What Do You Know About Investment Risk?
All investing entails some risk. There’s always the chance, for instance, that you’ll lose money. In some cases, the returns on “safe” investments might be so low that they can’t keep up with inflation. Fortunately, there are ways to minimize several types of investing risk. Check your knowledge of investment risk and strategies to manage it with this 10-question quiz.
START QUIZ
Q1
You buy a stock or other investment when its average price reaches a targeted range
B.
How does the risk-minimizing investment strategy “dollar-cost averaging” work?
Question 1 of 10
You invest a set sum on a regular basis, no matter the investment’s price
A.
Let’s say you routinely invest $100 every paycheck. If you invest in a company or fund at $5 per share, you will buy 20 shares. But if the share price is $10, you will only purchase 10 shares. So, with dollar-cost averaging, you’ll end up buying more shares when the price is low and fewer shares when the price is high. This strategy can lessen the impact of market volatility — such as investing a lump sum just before the market falls. If you invest regularly in a 401(k) retirement plan, you’re already using this tactic.
Sorry, the correct answer is A.
Go to next question
You’re right, the correct answer is A.
Q2
The price of the bonds goes down
What happens to the price of existing bonds when interest rates rise?
Question 2 of 10
Investors earn more interest on their bonds, pushing up their price
Existing bonds are sensitive to interest-rate risk. If new bonds come onto the market paying a higher fixed rate of interest, older bonds will be less attractive to buyers. And that causes the price of the existing bonds to drop. Conversely, when rates fall, the price for existing bonds that pay a higher fixed interest rate will rise.
Sorry, the correct answer is B.
You’re right, the correct answer is B.
Q3
It spreads your money over different asset classes and types of investments
How does diversification help an investor manage risk?
Question 3 of 10
It promises a higher rate of return on your investments
Because you can’t know for sure which stocks or bonds will do well each year, you can protect your portfolio by spreading your money across a diverse group of investments. That way, if one or more of your investments lose money, the impact might be lessened by gains in others. Funds add another level of diversification because they can own hundreds of different stocks and/or bonds, as well as other assets, minimizing the impact of losses in a few securities.
It lowers the fees you pay on your investments
C.
Q4
When you’ll need the money
How much money you have to invest
What determines the best asset allocation (mix of stocks, bonds and cash) for you?
Question 4 of 10
When you plan to tap your portfolio is a key factor in asset allocation. You want to avoid investing too aggressively if you’ll need the money soon. A popular guideline to decide how much of your portfolio should be in stocks is to subtract your age from 120. So, a 60-year-old’s portfolio would be made up of 60% stocks, and the rest in bonds and cash. Risk tolerance also is a factor in choosing an asset allocation; some investors might want to further reduce their stock allocation if market swings keep them up at night.
Q5
10%
What is the approximate, average annual return of stocks over the past 50 years?
Question 5 of 10
5%
50%
D.
25%
As measured by the S&P 500 index, stocks actually gained 10.9% annually on average (excluding inflation) over the past 50 years. Stocks tend to be riskier and more volatile than bonds, but their rewards are potentially greater.
Q6
You buy more of the investments in your portfolio that have recently performed the best
Rebalancing is another strategy that can limit risk. How does it work?
Question 6 of 10
You buy and sell securities in your portfolio to maintain your desired asset allocation
Over time, some investments will perform better than others, and your asset allocation can veer off track. For instance, maybe you intend to have 60% of your total portfolio invested in stocks, but that allocation swells to 70%. You can rebalance quarterly or yearly, or do so when your allocation drifts, say, 10 percentage points off your target. Note: By rebalancing, you’ll be selling some of your winners and putting more money into your losers.
Q7
The chance that a bond issuer won’t pay interest or return the initial investment
What does credit risk mean for investors?
Question 7 of 10
The risk that thieves will steal your credit information to access your investment accounts
Bonds have something called “credit risk,” meaning the issuer might default on its promise to pay interest or return investors’ initial investment, or principal, when the bonds mature. Bonds are rated by their quality and risk of default (often ranging from D for the weakest to AAA for the strongest). U.S. Treasuries traditionally have earned the highest possible rating because they are backed by the federal government.
Q8
What is the biggest risk for young investors?
Question 8 of 10
A bear market
The big advantage young investors have is time. Even small sums regularly invested over many years can turn into a significant nest egg. Bear markets also can benefit young investors because they allow them to buy stocks at a discount, and again, they have time to see those depressed shares recover. Funds designed for young investors often hold 90% or more of their assets in stocks because of their long-term growth potential. And waiting to invest until your student loans are paid off means you could be losing 10 or more valuable years of investment growth.
Sorry, the correct answer is C.
Investing more than 90% of their portfolio in stocks
Delaying investing for retirement
Not paying off student loans before investing
You’re right, the correct answer is C.
Q9
What is one of the biggest risks newly retired investors face?
Question 9 of 10
Rising interest rates significantly decreasing the value of long-term bonds
A bear market just as you enter retirement and start withdrawing money from your portfolio can deplete your nest egg more quickly. That’s because you’re forced to sell more of your investments (which have shrunk in value) to meet living expenses. A series of bad returns early in retirement is called “sequence of returns” risk. One way to protect against this is to have enough of a cash cushion to cover your living expenses for a year or two, so you can wait out the bear market and give your portfolio time to recover.
Q10
False
I’m not sure I can handle every task on my own. Can I use the estate’s assets to pay outside experts to help?
Question 10 of 10
True
Retirees will still need stocks in their portfolio to counter “inflation risk”: the chance that the price of goods and services rises faster than what their money earns in savings accounts or through investments. For instance, if inflation is 3% and your investments earn only 2%, you’re losing purchasing power. Stocks can reduce this risk because their returns tend to outpace inflation over the long haul.
get your results
True or False? Retirees should invest only in bonds and cash to reduce risk.
© December 2021 The Kiplinger Washington Editors, Inc.
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This is only an overview of key aspects of investment risk. Consult with a financial professional before making any investing decisions.
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