2.2.

1 Study: Building Wealth Study Guide

Personal Financial Name: Caleb J. Gonzalez
Literacy Date: Oct 28, 2022

Use this guide to take notes as you work through the activity. Taking good notes can
help you remember important ideas. Your notes on this guide will help you prepare
for quizzes and tests.

1. What are the three rules of wealth building?

1. Use Compound interest to your advantage

2. Invest for the long term
3. Diversify

2. How do people grow their wealth through the process of capital formation?
To accumulate additional capital, a country needs to generate savings and
investments from household savings or based on government policy. To produce
capital and a government that runs a surplus can invest the surplus in capital goods.

3. An investment balances __return__ against the potential __risk_.

4. Why is investing in a savings account less risky than investing in stocks?

Savings accounts allow your money to earn interest slowly and doesn’t offer a high
return on investment, but can grow over time.

Stocks can give a large return on investment, but if the company doesn’t do well, this
can cause the value of the stocks to fall below what you paid for them and can have
the risk of losing all that money.
 5. What is the risk of holding on to shares in a stock when the share price is falling?

Rise the risk of decline in price.

6. What is the relationship between risk and return in investments?

They’re directly related. The greater the risk that an investment may lose money, the
greater its potential for providing a substantial return, and vice versa. The smaller
the risk on investment poses, the smaller the potential return.

7. Fill in the table below to identify the key features of each type of investment.
A cash investment is a way for you to invest your money with low risk
but also a low return. A basic savings account, money market
account, or certificate of deposit is an example of a cash investment.
You might be willing to accept the low return if you know you will
Cash need ready access to your funds — in an emergency, for example.

Retirement accounts allow you to put money away for the future in a
way that earns interest. Common types of retirement accounts
include 401(k) plans, pension plans, and individual retirement
account (IRA) plans. Many retirement accounts are tax-deferred,
which means they earn interest while protecting your money from
Retirement accounts taxes as it grows.

A bond is a way of lending money to a government or business. You

get interest payments on the bond, and after a set time period, you
get the principal back as well. A bond is similar to a certificate of
deposit (CD), except that with a bond you can typically withdraw
money from it before the term expires. This is not usually possible
Bonds with CDs.

Stocks A stock is a share of the ownership stake in a company. Units of

stocks are called shares. Stocks are mostly bought and sold through
stock exchanges. The value of stocks can fluctuate quite a lot. A
 company's shares might be up one week and down the next. Stocks
often outperform other types of investments and investing in stocks
can involve more risk.

A mutual fund is a pool of money from a group of investors that is

invested in various securities such as stocks and bonds. Each

investor in the pool gets a share of the profits from the fund.

A hedge fund works in a similar way, but unlike a mutual fund, which

is regulated and public, a hedge fund is private and only available to

officially recognized investors. It is also generally a higher-risk form

of investment.
Mutual funds and hedge
funds

Real estate is an investment in which paying down the property gives

the value of the real estate, called equity, to the owner. If the real
estate increases in value, the owner can sell the property for a profit.
Although the value of real estate tends to go up over time, some real
estate investments — like land that has no buildings — are higher-risk
Real estate and can take a long time to make a profit.

8. How are strategies for long-term investments different from the strategies for
short-term investments?

Long-term investments are often considered to be less speculative and risky than short-term
investments, as they are less likely to fluctuate in value in the short-term. However, long-
term investments can also offer the potential for lower returns than short-term investments.

9. Complete the table by identifying whether each investment type is low- or high-
risk.

Low- High-
Investment Type risk risk
 ✓
Savings accounts

Certificates of deposit ✓
(CDs)

✓
Bonds

✓
Retirement accounts

✓
Mutual funds

✓
Hedge funds

10. Deciding how much money to invest in stocks is ____asset allocation___________,

and deciding which different stocks to buy is ___diversification____________.

11. What advantage does diversification offer to an investment portfolio?

Diversification lowers your risk by spreading money across and within different
asset classes.

12. How might an investment in a risky stock be diversified?

A diversified strategy includes a mix of both high- and low-risk investments. This strategy
balances the risk of your investments to achieve a higher return than a purely low-risk
strategy with less risk than a purely high-risk strategy.

After 10 years of investing in a combination of low-risk certificates of deposit and high-risk

stocks, a $10,000 initial investment could yield a 10 percent rate of return and be worth
 $25,937.42. That's less than half the value of the high-risk strategy of investing only in

stocks, but twice as much as the low-risk strategy of investing only in CDs.

Use this table to write definitions for the key terms from this activity in your own
words. If you're confident you know a term, put a check mark next to it and move on.

Key term Definition

asset allocation

bond

capital formation

certificate of deposit

diversification

hedge fund

individual retirement
account (IRA)
investment

mutual fund

portfolio

rate of return

risk

stock

If you noticed other unfamiliar terms in this activity, use the blank rows to list them
and their definitions.

   

   

   

   

   

I have answered all the questions on the

study guide and feel confident that I
understand the main ideas of the
☐ sections. I'm ready to move on!
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2.2.1 Study: Building Wealth