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Here’s a chance to put your financial knowledge to the test. Below are eight general (but not necessarily easy) questions that could be essential to your financial planning. The answers are provided below. While you can take pride in the questions you answer correctly, it is more important to look at the ones you may have missed. Of these, is the question significant to your finances or have you been structuring your finances using an incorrect assumption? Regardless of how many questions you get right or wrong, they can help add clarity to your financial decisions.
1. How much can a person increase his or her Social Security check by waiting until age 70 to begin taking benefits, rather than taking them at “full retirement” at age 66?
a. 10 percent
b. 16 percent
c. 24 percent
d. 32 percent
2. A husband and wife decide to begin saving for retirement at age 25. The wife starts funding her retirement account right away with $400 a month. She continues saving at this rate for 10 years. When she stops, her husband begins funding his retirement account at the same rate, but contributes for 30 years, at which point they retire. Both accounts grow tax free at a rate of 6 percent a year. We know the wife only saved one-third of what her husband saved, but which statement best describes the final value of the account?
a. The wife ended up with significantly more money
b. The wife ended up with slightly more money
c. The husband ended up with slightly more money
d. The husband ended up with significantly more money
3. True or False:
Annuities are a poor investment because they return less money than if the principal cost was invested directly.
4. For the 2017 tax year, what is the maximum amount an estate is exempt from taxation?
a. $1.49 million
b. $2.49 million
c. $5.49 million
d. No maximum on the exemption
5. Using the S&P 500 market index, what has been the average annual growth rate of large-cap stocks from 2007-2016?
a. 2 percent
b. 5 percent
c. 8 percent
d. 12 percent
6. What is the primary difference between mutual funds and exchange-traded funds (ETFs)?
a. ETFs are not actively managed by anyone, and therefore have lower management fees than most mutual funds.
b. Unlike mutual funds, ETFs are not regulated by the Securities Exchange Commission, allowing ETFs to use much riskier investment strategies.
c. Mutual funds are not allowed to invest in foreign bonds; ETFs can make use of any bonds available.
d. The average ETF comprises far more unique investment assets than mutual funds, which typically make use of less than 10 different assets.
7. Say you start your retirement with a target income of $50,000 a year. Assuming inflation continues at a modest 2 percent, how much money will you need by the 25th year of your retirement to maintain the same spending power as $50,000?
8. True or False:
Bonds are often considered safer assets than stocks; a safe portfolio is one that consists mostly of bonds.
Answers and Explanations
1. d. 32 percent
Your monthly social security benefit increases by 8 percent of its full retirement value for each year you defer, reaching its maximum at age 70.
This increase can make delaying your social security benefit extremely advantageous if you end up having a long retirement.
2. c. The husband ended up with slightly more money
This one was a bit of a trick question and would have been difficult to answer unless you got a calculator and did the math. In this scenario, the husband ended up with about 4 percent more than his wife did, but contributed 300 percent of what she did and only passed her value in the last four years of saving. The husband ended up with more in his account, but the extra $96,000 the wife got to use elsewhere makes her the better planner.
Like most things with retirement and investing, the usefulness of a strategy or investment comes down to the individual. Annuities can be extremely helpful for certain people. Only a comprehensive retirement plan can determine whether an annuity is right for a person.
4. c. $5.49 million
In 2011, the government allowed individuals to pass up to $5 million through their estate (married couples could pass $10 million). Since this value is adjusted for inflation, it increases each year; in 2017, this exclusion is now $5.49 million for an individual and $10.98 million for married couples. Any amount exceeding this exemption is taxed at 40 percent.
5. b. 5 percent
Though it has improved significantly since the Recession, the S&P 500 stock index has only climbed an average of about 5 percent per year for the past 10 years. It’s important to note that historical growth rates are no indication or guarantee of future changes in the market.
6. a. ETFs are not actively managed by anyone, and therefore have lower management fees than active mutual funds.
The lower fees associated with inactive management has made ETFs very popular in recent years; however, though mutual funds typically generate higher fees, their active management often allows them to survive market upheaval better than ETFs.
7. b. $80,000 (technically, $82,030)
After 25 years of 2 percent inflation, each dollar has lost about 40 percent of its buying power. It is absolutely vital to consider the significance of inflation when calculating your retirement plan.
“Safety” in investing is all relative to a person’s situation. Any portfolio that is overly committed to a single asset or type of asset is carrying extra risk. Additionally, safer assets produce lower returns. It is possible for a “safe” asset to be dangerous because it does not produce high enough returns for you to meet your goals.
Remember that past performance may not indicate future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, strategy, or product referenced directly or indirectly in this newsletter will be profitable, equal any corresponding historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. You should not assume that any information contained in this newsletter serves as the receipt of personalized investment advice. If a reader has questions regarding the applicability of any specific issue discussed to their individual situation, they are encouraged to consult with a professional adviser.
This article was written by Advicent Solutions, an entity unrelated to Guidestream Financial, Inc.. The information contained in this article is not intended to be tax, investment, or legal advice, and it may not be relied on for the purpose of avoiding any tax penalties. Guidestream Financial, Inc. does not provide tax or legal advice. You are encouraged to consult with your tax advisor or attorney regarding specific tax issues. © 2014-2017 Advicent Solutions. All rights reserved.