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McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
C H A P T E R P L A Y L I S T S O N G :
“ F o r t h e L o v e o f M o n e y ” b y T h e O ' J a y s
Investment Basics
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11-2
Learning Objectives
LO 11-1 Distinguish between savings and investments.
LO 11-2 Analyze the risk and return on varying investment products.
LO 11-3 Interpret the hierarchies of the investment pyramid.
LO 11-4 Examine the importance of varying your investments.
LO 11-5 Compare portfolio asset allocations for the different personal finance life stages.
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11-3
Savings vs. Investments
Who is rich? He that is content. Who is that? Nobody.”
~ Benjamin Franklin
How much money should you have in savings vs. investments?
What is the difference?
“Savings is not to make you rich, but it is to keep you from being poor.” ~ J.B. Quinn
Savings – No or low-risk investments with low returns.
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11-4
Should You Save or Invest? Figure 11.1
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11-5
Impact of Inflation on Savings
Inflation is the overall increase in the price of goods and services over time
Savings - retain your purchasing power by having your interest rate remain the same or higher than the inflation rate
Investing - beat the inflation rate and grow your value in real terms
Bureau of Labor Statistics Consumer Price Index page
Consumer Price Index from 1913 – present
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11-6
BLS CPI Home Page
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11-7
Insured Savings
FDIC – Federal Deposit Insurance Corporation
NCUA – National Credit Union Association
United States Treasury Bills, Notes, and Bonds
Backed by the full faith and credit of the United States government
Risk Premium – The difference between the risk-free rate of return and the expected yield of an investment with risk.
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11-8
Making $en$e
How does an investment differ from savings?
How much money should you have in savings before you venture into investments?
What is a risk premium?
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11-9
Risk of Investing
Investing has risk – the chance of losing some or all of your investment
To compensate for risk and entice an investor, investments with risk must pay a premium
Risk premium – compensation for taking on the risk
“Zero” risk – FDIC, NCUA, U.S. Treasury bills, notes, and bonds – risk-free rate
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11-10
Types of Risk
Default Risk or Credit Risk – Risk that the company invested in may declare bankruptcy
2009 Chrysler bankruptcy: bondholders received $0.26 for every dollar they invested
Bondholders could lose their entire investment
FDIC and NCUA will insure deposits up to $250,000
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11-11
Types of Risk
Interest Rate Risk – Risk taken on when you lock into a fixed-rate investment for a specific length of time
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11-12
Types of Risk
Interest Rate Risk – Risk taken on when you lock into a fixed-rate investment for a specific length of time
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11-13
Types of Risk
Market Risk – The risk that the value of your investment will decrease due to changes in the market
Gold prices
Housing market
Oil prices
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11-14
Liquidity Risk – The
risk that you will not be able to cash out your investment quickly enough to either meet cash flow needs or to prevent a loss.
Types of Risk
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11-15
Analyzing Your Risk Tolerance
How much can you afford to lose?
Rule of thumb: The higher the risk, the higher the potential return and the less likely you are to achieve the higher return
Risk tolerance quizzes
Rutgers University’s Investment Risk Tolerance Quiz
money.msn.com
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11-16
Investment Pyramid
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11-17
Diversification of Assets
Diversification – Spreading out the risk across multiple investments
Why is diversifying your investments important?
Portfolio – Holding more than one investment
Asset Allocation – The types of assets you are holding in your portfolio
Diversified Balanced Funds – Both equities and bonds
Targeted and automatic asset allocation mutual funds
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11-18
Asset Allocation for Target Date Funds
T. Rowe Price Balance Fund (RPBAX)
Vanguard Target Retirement Fund Asset Allocation Tool
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11-19
Portfolio Evaluation
Re-evaluate your investment goals, risk tolerance, portfolio returns, and asset allocation at least once a year and rebalance your portfolio
Pick an easy date to remember to rebalance your portfolio
Birthday
January 1st
Other special days
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11-20
Independent (16-24)
529 College Savings Account
Retirement Savings
Roth IRA
401(k)
Early Family (25-44)
Roth IRA, 401(k)
529 College Savings Account
House Down Payment
Auto Down Payment
Life Stages and Accounts How Should the Assets Be Allocated?
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11-21
Empty Nest (41-65)
Retirement funds
Investment funds
Funds used within the next 10 years
Retirement (66+)
Retirement funds
Investment funds
Funds used within the next 10 years
Life Stages and Accounts How Should the Assets Be Allocated?
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11-22
Learn
LO 11-1 Distinguish between savings and investments.
LO 11-2 Analyze the risk and return on varying investment products.
LO 11-3 Interpret the hierarchies of the investment pyramid.
LO 11-4 Examine the importance of varying your investments.
LO 11-5 Compare portfolio asset allocations for the different personal finance life stages.
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11-23
Plan & Act
To assess your risk tolerance, take the Market Psych Questionnaire (Worksheet 11.1)
Given your risk tolerance and current goals, draw up your own investment pyramid (Worksheet 11.2)
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11-24
Evaluate
Are you making the appropriate allocations in building your emergency fund?
Outline your investment strategy.
Does this support your overall SMART goals?
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11-25
Continuing Case
Blake bought into a stock mutual fund as a retirement investment 6 months ago. Ever since then, he has watched the prices slowly drop each month. He is afraid that it will soon be worthless. He is tempted to cash in the stock and move what funds are left to another instrument. What advice would you give him?