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1. All your colleagues are buying small-cap stocks to earn high returns. You strongly feel the fear of missing out, hence you decide to invest in small-cap stocks. Is it a practical investment decision?
Correct option is B - Simply following the actions of others is a common behavioral bias known as Herd Mentality. Investing in small-cap stocks just because your friends are doing so may not be a practical decision. Small-cap stocks are highly volatile and may not align well with your goals and risk tolerance. To overcome the Herd Mentality bias, it is important to have a goal-based investing approach. Identify your financial goals and choose investment products that align with the risk profile and time horizon of each goal. This will help you stay focused on your financial plan and prevent you from being swayed by the actions of others.
2. Which of the following investment behavior is correct?
Correct option is C - Let's understand it in detail. Our investment decisions are often influenced by Confirmation Bias, which is a common behavioral bias. Confirmation Bias leads us to seek out only information that confirms our existing beliefs while disregarding contradictory information. Option C, which involves conducting proper research on investment products and considering both positive and negative factors before making an investment, is the correct approach to overcome confirmation bias. This ensures a more objective and well-informed decision-making process.
3. A mutual fund has hugely outperformed its benchmark and other funds in the past three months. Based on this information, you are planning to invest in the fund. Is it the right decision?
Correct option is B - Your decision to invest should not be solely based on information based on recent events. This is because we often have biased ideas and beliefs that can influence us to take the wrong decisions. They are commonly known as behavioural biases. One such bias is the Recency Bias, in which we tend to place more information on recent information rather than historical data. In this scenario, while the fund may have outperformed its benchmark and other funds in the past three months but that can also be because of excessive risk taken by its fund manager. Ideally, you should look at how the fund has performed in the longer time frame say in the past 3-5 years. This would give you a better picture of the fund’s performance in different market cycles.
4. What does CAGR (Compounded Annual Growth Rate) mean in investing?
Correct option is A - CAGR is the annual rate at which investments have grown over a specific period. It takes into account the compounding effect of returns as well as the time period for which the money was invested. Below is the formula and example of the CAGR calculation.
CAGR = (End value/Beginning value)^ 1/n – 1
Let’s assume your investment of Rs 10,000 grows to Rs 20,000 in five years, the CAGR of your investment would be (20,000/10,000)^(1/5)-1 = 14.9%. In other words, your investment has given you an average return of 14.9% every year over the last five years.
Option B is the absolute return which measures simple growth without considering time. Continuing with the above example, the absolute returns on the investment is 100% (20,000/10,000-1).
5. Which investment product can give you the maximum tax benefits?
Correct option is A - Under section 80C of the Income Tax Act, an investment of Rs 1.5 lakh is eligible for tax deduction. The available options are PPF, ELSS, NPS Tier I, Tax savings fixed deposits, and certain small savings schemes. NPS comprises two account types: Tier I, which is mandatory and well-suited for retirement planning, and Tier II, which is for voluntary savings. Tier I in NPS is a contribution account for retirement corpus, offering annuity after age 60. In NPS Tier I, you gain an additional Rs 50,000 deduction under section 80CCD (1B). This makes NPS Tier I investments eligible for a total deduction of Rs 2 lakh. Tier II investments lack tax advantages. Please note that these tax-saving deductions aren't applicable in the new tax regime introduced in FY 2020-21 by the Indian government.
6. Ideally, when should you start saving for your retirement?
Correct option is A - The best age to start saving for your retirement is when you start earning. This is because the sooner you begin, the more time you will have to compound your money. For instance, if you begin investing Rs 10,000 per month from the age of 25, you can accumulate a corpus of Rs 3.83 crore by the time you reach 60 assuming a growth rate of 10% per annum. On the other hand, if you start investing at a later stage, the growth of your retirement fund will be comparatively lower. Investing from the age of 35 at a similar growth rate it will yield a corpus of around Rs 1.34 crore, while starting at 45 years will result in a corpus of only Rs 42 lakhs. Rising average life expectancy, increasing health costs, and improving standard of living make it crucial to plan for your sunset years sooner rather than later.
Correct option is B - Gold offers diversification to your portfolio. It has historically shown a negative correlation with equities. It means the price of gold rises when stock prices fall and vice-versa. As a result, adding gold to your portfolio reduces overall volatility. Gold also provides a hedge against inflation. Thus, you can invest in gold for stable long-term wealth creation.
8. Which product is best suited if your goal is to earn a regular flow of income?
Correct option is D - Bonds, fixed deposits with an interest payout option, and the SWP feature in debt funds are all suitable options for earning a regular flow of income. Bonds make interest payments on a monthly, quarterly, half-yearly, or annual basis, depending on the terms of the bond. Fixed deposits with an interest payout option also provide regular income. The interest earned on these fixed deposits is paid out on a periodic basis, as chosen by you at the time of deposit. Additionally, the SWP feature in debt funds offers investors the option to receive a fixed sum of money at regular intervals. With an SWP, investors can redeem a predetermined number of units from their debt fund investment on a periodic basis, such as monthly or quarterly, and receive the equivalent amount as a payout.
9. If wealth creation is your objective, which product is best suited for your goal?
Correct option is A - Equities have the potential for long-term wealth creation. Historically, equities have outperformed other asset classes over the long term. Due to the compounding effect of higher rates of return, equities are well-suited to meet long-term goals. Mutual funds can be the best way to invest in the equity asset class as they provide benefits such as expertise of professional fund manager, diversification, , etc. Savings accounts and PPF, on the other hand, are fixed income products that can provide secure and stable returns.
10. If your risk-taking ability is moderate, how much should you ideally allocate between equity and debt?
Correct option is C - Ideally, investors with a moderate risk appetite should have a balanced mix of equity and debt investments. Equity offers long-term wealth creation potential, while debt provides stability to the overall portfolio. Among the options, a 50% allocation to equity and 50% allocation to debt would be suitable for investors with moderate risk appetite.
11. Interest rates are declining, I think I should switch my investments from fixed deposits to equity funds. Is it the right investment decision?
Correct option is B - Switching investments from fixed deposits to equity mutual funds just because interest rates are declining is not the right investment decision. You should understand that fixed deposits offer relatively low risk and stable income. While equity mutual funds provide the potential for higher returns with a certain degree of risk assigned to equity products Ideally, your decision to invest in a fixed deposit or equity mutual fund should be based on your risk appetite, investment horizon and financial goal.
12. What are the options through which you can invest in fixed-income or debt asset class?
Correct option is D - Investing in the fixed income or debt asset class can be done through various options. Fixed deposits, which are offered by banks and other financial institutions. Fixed deposit provides a fixed interest rate over a specified period of investment. The Public Provident Fund (PPF) is a government-backed savings scheme that offers a fixed interest rate and tax benefits. Additionally, there are mutual funds that invest in debt securities, providing investors with exposure to the fixed-income market. All of these options allow individuals to invest in the fixed income or debt asset class. However, there are many other products such as various small savings scheme/post office saving schemes, direct non-convertible debentures (NCDs) of the company and other through which as well you can take exposure in the debt asset class.
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