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Inflation, the rise in prices over time, can erode your investment return. Long-term investors should be aware that, if portfolio returns are less than the inflation rate, their ability to purchase goods and services in the future might actually decline. However, portfolios with long-term returns that significantly exceed inflation are associated with a higher degree of risk.
   1. Which of the following portfolios is most consistent with your investment philosophy?

  a. Portfolio A will most likely exceed long-term inflation by a significant margin and has a high degree of risk.
  b. Portfolio B will most likely exceed long-term inflation by a moderate margin and has a high to moderate degree of risk.
  c. Portfolio C will most likely exceed long-term inflation by a small margin and has a moderate degree of risk.
  d.

Portfolio D will most likely match long-term inflation and has a low degree of risk.



Portfolios with the highest average returns also tend to have the highest chance of short-term losses. The table at right provides the average dollar return of four hypothetical investments of $100,000 and the possibility of losing money (ending value of less than $100,000) over a one-year holding period.

Data supplied by Ibbotson Associates.
   2. Please select the portfolio with which you are most comfortable.

Probabilities After 1 Year
   
Possible
Average Value
at the End of
One Year
Chance of
Losing Money
at the End of
One Year
a.  Portfolio A
$106,000
16%
b.  Portfolio B
$107,000
21%
c.  Portfolio C
$108,000
25%
d.  Portfolio D
$109,000
28%

Investing involves a trade-off between risk and return. Historically, investors who have received high long-term average returns have experienced greater fluctuations in the value of their portfolio and more frequent short-term losses than investors in more conservative investments have.
   3. Which statement best describes your investment goals?
  a. Protect the value of the account. In order to minimize the chance for loss, I am willing to accept the lower long-term returns provided by conservative investments
  b. Keep risk to a minimum while trying to achieve slightly higher returns than the returns provided by investments that are more conservative.
  c. Balance moderate levels of risk with moderate levels of returns.
  d.

Maximize long-term investment returns. I am willing to accept large and sometimes dramatic fluctuations in the value of my investments.


Historically, markets have experienced downturns, both short-term and prolonged, followed by market recoveries. Suppose you owned a well-diversified portfolio that fell by 20% (i.e. $1,000 initial investment would now be worth $800) over a short period, consistent with the overall market.
   4. Assuming you still have 10 years until you begin withdrawals, how would you react?

  a. I would not change my portfolio.
  b. I would wait at least one year before changing to options that are more conservative.
  c. I would wait at least three months before changing to options that are more conservative.
  d.

I would immediately change to options that are more conservative.



The graph at right shows the hypothetical results of four sample portfolios over a one-year holding period. The best potential and worst potential gains and losses are presented. Note that the portfolio with the best potential gain also has the largest potential loss.
   5. Which of these portfolios would you prefer to hold?

  a. Portfolio A
  b. Portfolio B
  c. Portfolio C
  d.

Portfolio D



 
   6. I am comfortable with investments that may frequently experience large declines in value if there is a potential for higher returns.

  a. Agree
  b. Disagree
  c. Strongly Disagree
     

 



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