To test your investment knowledge, answer true or false to the statements in bold. There are no prizes for a right answer or penalties fora wrong answer.

1. A mutual fund’s past results can give a good idea of its futureperformance.

False. You can’t predict future returns by looking at past investmentperformance. Last year’s great results have no impact on this year’sperformance. Still, a long-term history of excellent performance maysuggest that the fund managers are investors who may be capable of earning good returns.

2. The Standard & Poor’s 500 Stock Index is a good indicator of the overallperformance of the U.S. stock market.True. The S&P 500 Stock Index is an index of 500 common stocks of largeU.S. companies. The index represents about 75 percent to 80 percent ofthe total market value of all companies traded on the New York Stock Exchange. It is commonly used a benchmark representative of the overallU.S. stock market.3. Investing in different asset classes (large company stocks, governmentbonds, international stocks, etc.) can help to reduce overall risk to aportfolio.

True. If you invest all of your money in just one asset class, you couldsuffer a big setback if that asset class drops sharply in value. You canreduce risk by creating a portfolio that incorporates stock funds, bond funds, and money market funds. This approach is known as diversification. The idea behind diversification is that the strong performance of one asset class can offset the weak performance of another.

4. A fund is a poor performer if its returns are lower than the benchmarkindex it is measured against.

False. A stock index like the S&P is an unmanaged index that measures theperformance of a certain group of stocks. Since an index does not buy andsell stocks, it has no trading costs. A mutual fund, on the other hand, isactively managed. That means its managers buy and sell stocks and have topay trading costs, recordkeeping expenses, and various other fees. Thesecosts, which are paid with fund assets, can reduce a fund’s performance figures. Whereas an index does not hold cash, fund managers have to keepsome mutual fund assets in cash to pay for shares that investors redeem to avoid having to sell other shares. Fund managers also need to keep somecash on hand to buy stocks or bonds they want to add to their portfolios.

It’s not hard to see why a fund that’s only 90 percent to 95 percent invested in stocks (or bonds) may underperform an index that’s 100 percent “invested.”Of course, it’s also important to consider the duration that the fund has underperformed its benchmark as well as its performance relative to its peers. Underperformance of either for and extended time may be anindication of larger underlying issues.

In general, the riskier an investment, the greater its potential for gains.

True. The potential to lose some or all of their initial investment is therisk investors pay for the possibility of a greater reward. Investmentswith little risk generally offer low returns.

(Alan S. Moore is a financial advisor with Legg Mason Wood Walker, Inc., adiversified securities brokerage and financial services firm that is a member of the New York Stock Exchange, Inc. and SIPC.)

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