bonds and mutual funds savings accounts and credit scores – the future of your savings!
TRANSCRIPT
Bonds and Mutual FundsBonds and Mutual FundsSavings Accounts and Credit Scores – The future of your savings!
What is a bond?
• A bond is an IOU to a government or to a corporation.
• When you loan your money to a corporation, government or a government agency the ISSUER promises to pay you back with INTEREST .
Bonds
• Issuers promise to pay you back a specific rate of interest called the COUPON RATE.
• You are usually paid interest then on a quarterly time rate for the life of the bond.
Life of the bond?
• The period of time the issuer has to pay back the investor.
• The issuer also promises to pay back the FACE VALUE of the bond when the bond MATURES.
Why invest in bonds?
• USUALLY doesn’t take much money to start.
• “Safer” investment– Tax-free and risk-free
return.• THAT IS THE CHEERY
PICTURE
Opportunity Costs of Bonds
• What happens if INFLATION goes higher than the value of your bond?– Interest on bond is 4%
but inflation goes to 6%.
• What happens if the rating on your bond goes south?
How do you know if a bond is a good one?
• Seek Investment Grade Bonds – Highest rated by
MOODY’S – a service that rates companies and government bonds.
– Investment Grade – least chance of missing interest payments
• Other good rating services for bonds include Fitch and Standard & Poor.
Grading Bonds
• AAA – PRIME BONDS.
• AA+ or AA or AA- or Aa1, Aa2 or Aa3 = HIGH GRADE BONDS.
• A+ to BBB- = UPPER GRADE TO MID GRADE BONDS
ANYTHING BB rated or below
•JUNK BONDS– These are high risk
bonds.• More chance of
DEFAULTING – not paying you back!
– Often called HIGH-YIELD offering higher interest rates at the same maturity of Investment Grade Bonds.
• Also sometimes called Subprime bonds.
Corporate Bonds
• Major source of corporate borrowing
• Debentures – most common type of bond, backed by the general credit of the corporation.
• Asset Based – backed by specific property or equipment of the corporation.
What are the best corporate bonds?
• According to Moody’s– AAA+ =
• ZERO!
– AAA = • JNJ• GE• PFE• MRK• UPS• XOM• ADP
WORST Corporate Bonds?
• Downgrades of investment-grade companies shot up by 153 percent from the year-ago quarter to a record 96, while downgrades of junk-rated companies surged by 147 percent to 287. – Moody's downgraded $1.76
trln U.S. corp debt in Q1– Wed Apr 1, 2009
• SBUX is now rated BB• BRK-A is now just AA
Municipal Bonds
• Issued by states and local governments to raise money.
• General Obligation: Backed by full faith and credit of the issuer.– Revenue Bonds: Based
on income produced by a specific project.
• Kearney’s Archway• Lincoln’s proposed $250-
million arena / convention center.
Municipal Bonds
• Why would Moody’s and Goldman Sachs urge people NOT to buy bonds in the highlighted states?– BTW: Nebraska Bond
Rating is downgraded to AA+
– Omaha – AAA– Lincoln – AA+– California - BBB
Municipal Bonds
• The minimum size of a municipal bond purchase is generally $5,000 of par value.
• Municipal bonds are sold and traded by dealers in an over-the-counter market; – there is no centralized
exchange where municipal bond transactions take place.
– Investors buy municipal bonds from licensed securities dealers that actually own the bonds they sell.
Agency Bonds
• Some government sponsored but privately owned corporations.– Freddie Mac / Fannie
Mae
• Sometimes specific projects that government wants to fund.
Agency Bonds
• Often issue bonds to raise funds either to make loan money available or pay off a new project.
• No! Not that bond either!
US Treasury Bonds
• Backed by full faith and credit of the US government.
• When government doesn’t collect enough in taxes it issues notes, bills, and bonds to make up the difference. – Bonds = at least ten years
to maturity– Bills= less than two years
to maturity.
Why have US Savings Bonds?
• $50, $75, $100, $200, $500, $1,000, $5,000 and $10,000.
• Series EE Savings Bonds are purchased at half their face value. – A face-value $100 EE
bond is purchased for $50.
Why have US Savings Bonds?
• These EE bonds will increase in value every month instead of every six months. Interest is compounded semiannually.
What happens if the US defaults?
• If new people – or countries – won’t buy our debt (bonds) – what then?
Final Note on Bonds
• Bonds are considered FIXED INCOME INVESTMENTS.– Fixed amount of
interest to the bondholder for the use of their money
Another type of purchase with the game – MUTUAL FUNDS
• A collection of stocks, bonds, and other securities owned by a group of investors and managed by a professional investment advisory firm.
Mutual Funds
• Help to DIVERSIFY a portfolio.– DIVERSIFICATION:
Reducing risk by combining different investments so they aren’t going to be in step with one another.
– Mutuals Cannot:• Buy on margin• Short-sell stock
Mutual Funds: Types
• Value Funds – Only invest in stocks that the managers believe are UNDERVALUED.
• Socially Responsible Funds – only invest in companies that have “social responsibility.”– www.socialfunds.com
Vocabulary with Mutuals
• Open-end Funds – – Funds that sell as
many shares as investors want to buy.
• If you sell your shares, you sell them back to the fund.
• Closed-end Funds – – You buy these as
shares, like stock.
Vocabulary for Mutuals
• Large-Cap– Generally a company with
at least $5-billion in value of market capitalization.
• Mid-Cap– $1-$5 billion in market
capitalization (value of the company or stock)
• Small Cap– $250-million to $1-billion
• MICRO-CAP: less than $250 million.
The Best of Mutuals
Large Cap Value Fund 1yr. 5yrs. Expenses (as % of assets) American Funds American Mutual A -20.3 -0.4 0.60 Sound Shore -25.3 -0.7 0.92 T. Rowe Price Equity Income -24.9 -1.7 0.71 Vanguard Windsor II -24.4 -1.4 0.39
Why do you save money?
• Major purchases• Annual or
semiannual bills• Unexpected
expenses• Major long-term
expenses.• Amass wealth
Types of Savings Accounts
• Regular Savings Account– OB: require only a
small deposit.– OB: LIQUIDITY: can
be converted to cash with little or no loss in interest payments.
– OC: Most banks charge fees if balance too low.
Types of Savings Accounts
• Money Market Deposit Accounts:– OB: Generally
higher interest rates offered. Depends on t-bill interest rates.
– OB/OC: Fairly easy to withdraw.
– OC: Interest rate might be lower than regular savings.
Time Deposits
• CDs (Certificates of Deposit) – required to leave money in account for a specific amount of time.
• Maturity – When you can have your money back.
Time Deposits
• USUALLY the longer in, the more interest earned. – Depends on interest
rates!
• Interest rate is established when the CD is purchased.
• Require minimum deposit.
QOD
• If you had $1000 – how would you save it? – CD?– Savings Account?– Money Market?– Bonds?– Stocks?
Terms to Know:
• Compound Interest: Interest added to the PRINCIPAL at regular intervals.
• Subsequent interest is based on the original principal and the interest!
• $1000 at 5% = $1005• Compounded: $1000 at
5% = $1157.63
Terms to Know
• Simple Interest: Interest calculated at regular intervals based SOLELY ON THE PRINCIPAL.
• $1000 at 5% = $1050 a year.
• 3 years, $1150
Terms to Know
• Rule of 72: A way to calculate how long it takes your investment to double in value IF the interest rate is constant.
• 72/ interest rate = time it takes to double.
• EXAMPLE: 12 years for money to double at 6%.
Terms to Know
• 401K – A retirement plan that has employees AND employers contributing. Funds grow TAX-FREE until you withdraw them!
TERMS TO KNOW
• IRA – Individual Retirement Account: A personal savings account for retirement that is tax-free until you withdraw from the account.
• Variety of ways to set up the account to save for you!– DIVERSIFY!