Investment Test

moneyMy Comments: I have no idea where the following came from. I found them in my archives and decided the respective statements and explanation are still very relevant. And besides, today is Monday and that’s when I post stuff about investing money. My apologies for not being able to correctly attribute this post.

Which investment has the highest average annual returns, historically?

Since 1978, according to Morningstar, stocks have returned an average annual 11.6%, compared with 11.1% for real estate, 8.9% for bonds and just 5.2% for the shiny yellow metal.

When yields go down, bond prices go up.

If market interest rates fall, which means new bonds will be issued with lower yields, the prices of outstanding bonds will rise. It’s simple supply and demand. Say you purchase a $10,000, 10-year bond with a 2% yield. That gives you $200 a year in interest. Now imagine that rates fall and new 10-years are issued at 1%. A buyer can choose between your bond, yielding 2% and paying $200 annually, or a new bond paying just $100 a year. Naturally, your bond will command a premium price in the secondary market. Similarly, if new bonds are yielding 3%, your 2% bond will become less attractive and will have to sell at a discount to attract any interest. So while the yield of your bond remains fixed for the life of the security, the market will adjust the price you can get for it to reflect current market rates.

The higher the yield on a dividend-paying stock, the safer the investment.

In fact, the opposite might be the case. Find the yield by dividing the stock’s dividend per share by the share price. If the high yield reflects an overly generous dividend, you have to ask yourself whether the company has the cash to sustain it. Look for a positive free cash flow, which means a company has invested what it needs to maintain its business and has money left over to spend on dividends. Another measure is the stock’s payout ratio—the percentage of earnings paid out in dividends. The average payout ratio for the S&P 500 has been around 40% recently. A spiking yield likely indicates a sinking stock price. That’s a red flag that demands further investigation.

A company’s market capitalization is calculated by multiplying the stock price by the number of shares outstanding.

Although definitions vary, so-called large-capitalization stocks are generally considered to be those with a market value of $5 billion or more; mid-cap stocks fall within the $2 billion to $5 billion range; and small-cap stocks are classified as those with a market value of less than $2 billion. Slicing and dicing a little further gets you mega-caps, at $100 billion or more, and micro-caps, at $50 million to $300 million.

Stocks aren’t in a bear market until they lose 20% of their value.

The classic definition of a bear market is a 20% decline from the previous peak, although the average loss suffered in 13 bear markets since 1929 is nearly 40%, measured by losses in Standard & Poor’s 500-stock index (not including dividends). A stock market “correction” is generally considered to be a pullback of at least 10%. Since World War II, there have been 11 bear markets and 21 corrections.

The best time to buy stocks is at the start of an economic expansion. The best time to sell is when there’s a recession.

The stock market anticipates the economy, not the other way around, typically by six to nine months. By the time you know there’s a recession, your portfolio has most likely already taken a big hit, and by the time a recession is pronounced over, stocks have usually been off to the races for a while. The Great Recession began in December 2007, according to the National Bureau of Economic Research, the official arbiter of recessions and expansions. But stocks had already peaked in October. And if you missed the start of the bull market on March 9, 2009, because you were waiting for the recession’s end, which came in June of that year, you’d have missed a 64% rally.

A stock with a low price-earnings ratio is always a better bargain than a stock with a high P/E.

Context matters with P/Es, which are calculated by dividing a company’s stock price by its earnings per share, often estimated for the coming 12 months. What’s high for a mature utility company could be low for a fast-growing tech stock, for example. Stocks in the utilities and tech sectors recently sported average P/Es of 18 and 17, respectively. Based on historical norms, that implied that utilities were overvalued by 19%, while tech stocks were 17% undervalued. In the same way, analysts at S&P Global recently considered biotech drugmaker Regeneron Pharmaceuticals, with a P/E approaching 25, to be a better buy than blue-chip pharmaceutical firm Pfizer, with a P/E of 12. P/Es are most useful when comparing a company with its peer group, or comparing an industry with its long-term average.

A strategy that calls for investing a fixed amount at regular intervals is known as:

Dollar-cost averaging can lower the average cost of shares because you are spreading out your purchases, hopefully buying more when prices are lower and fewer when prices are high. If you invest all of your money at once, rather than at regular intervals, you might get unlucky and buy the stock at or near its peak price.

The strategy also helps curb harmful behavioral inclinations. If you’re apprehensive about investing, dollar-cost averaging makes it easier to take the plunge by spreading your risk over an extended period. Once you’re in the market, the strategy can help you stick to your plan. Putting everything into the market at once guarantees that you’ll know all too well how much you’ve lost if you happen to invest at the wrong time. Investing at intervals erases that fixed reference point, making it easier to keep your cool.

How many companies in Standard & Poor’s 500-stock index have a triple-A credit rating?

Microsoft and Johnson & Johnson are the only companies to sport Standard & Poor’s highest rating, after ExxonMobil lost its AAA rating in April 2016. In 1980, 32 S&P 500 companies carried the coveted triple-A rating. Apple, which has the largest weight in the S&P index, has an AA+ rating.

In investing, the pleasure of making money trumps the pain of losing.

Investors feel the pain of a loss about twice as much as they feel the pleasure of the same-size gain, say market behavior psychologists. This loss aversion can contribute to a number of investing mistakes. Investors who fear a loss, and especially those who have recently suffered one, can be reluctant to take risks that are entirely appropriate. For example, many investors shunned the stock market after the 2007-09 financial crisis, missing out on significant gains. Loss aversion can also cause an investor to sell what should be a long-term holding too soon, after a short-term hiccup. Conversely, an investor might hold on to a losing investment too long, reluctant to lock in the loss.