Question

11. Research has shown that three factors can affect investors’ returns in their portfolios: Security selection, market timing, and asset allocation. Of these factors, which one has the greatest impact on the portfolio performance?

  

a. Asset allocation

  

b. Security selection

  

c. Market timing

  

d. They are all pretty much equal

12. Which of the following is not an advantage of index investing?

  

a. Index funds avoid behavioral biases

  

b. Index funds don’t suffer from survivorship bias

  

c. Index funds are cheaper to operate

  

d. Index funds tend to beat the market most of the time

Answer 1

11. Studies conducted previously by analysts show that investment policy or the allocation of assets is much more important than the investment strategy or market timing/security selection. The variance in portfolio return is 90% attributable to asset allocation.

Option a is the correct answer.

12. a - This statement is correct as there is no selection involved and funds are passively managed. So this is one of the advantages of index mutual funds.

b - Index funds do not suffer from survivorship bias. Survivorship bias occurs when only funds with good performance come to the forefront and funds with poor performance disappear. As there is no selection and funds are passively managed, index funds do not suffer from survivorship bias.

c - Index funds are cheaper to operate. This is correct and an advantage.

d - Index funds tend to replicate the market and not beat the market. They have historically provided better returns than actively managed funds but they tend to follow the index performance. So this statement cannot be an advantage.

Option d is the correct answer.