Advanced Diploma of Financial Planning (ADFP) Practice Test

Which statement is true about equity mutual funds compared to bond funds?

1. They are generally less volatile.

2. They have a lower historical return over time.

3. They are generally more volatile.

4. They have minimal risk of loss.

The correct answer is: They are generally more volatile.

Equity mutual funds are generally considered to be more volatile than bond funds due to the nature of the underlying investments. Stocks represent ownership in a company and are subject to market fluctuations based on economic conditions, company performance, and investor sentiment. This inherent exposure to market dynamics leads to greater price swings, making equity funds more susceptible to rapid increases and decreases in value. In contrast, bond funds are typically made up of fixed-income securities, which provide more predictable returns and are often seen as safer investments. While bonds can also fluctuate in value, especially in response to interest rate changes, they generally exhibit less volatility compared to equities. Therefore, the statement identifying equity mutual funds as being more volatile accurately reflects the risk-return profile of these investment vehicles.