PERSONAL  FINANCIAL  MANAGEMENT  INVESTING  FUNDAMENTALS    Investment  program  creates  wealth  which  provides   financial   security   and  a   safety  net   against  emergency.   It   is   advisable   to   start   an   investment   program  early,   let   the   time   value   of  money  works,  make  sound  investments  and  your  finances  will  be  stable  upon  your  retirement.    PREPARING  FOR  AN  INVESTMENT  PROGRAM    Establishing  Investment  Goals    Investment   goals   must   be   written,   specific,   measurable,   and   should   be   classified   as   short,  intermediate  or  long-­‐term.    Investors  are  more  motivated  to  work  toward  goals  that  are  stated  in  terms  of  particular  things  they  desire  and  tailored  to  one’s  particular  future  needs.    The  following  questions  help  you  to  develop  your  investment  goals:    How  much  money  will  you  need  for  your  goals?  How  will  you  obtain  the  money?  How  long  will  it  take  you  to  obtain  the  money?  How  much  risk  are  you  willing  to  assume  in  an  investment  program?  What  possible  economic  or  personal  conditions  could  alter  your  investment  goals?  Are  you  willing  to  make  the  sacrifices  necessary  to  meet  your  investment  goals?  What  will  the  consequences  be  if  you  do  not  reach  your  investment  goals?  Given  your  economic  circumstances,  are  your  investment  goals  reasonable?    Before  beginning  an  investment  program,  make  sure  your  personal  financial  affairs  are  in  order,  you  are   living  within  your  mean.  Next  you  have  to  accumulate   fund   for  emergency.  Only   then  you  can  save  money  needed  for  investment  and  eventually  start  your  investment  program.    Performing  a  Financial  Checkup    Do  a  financial  checkup  to  make  sure  your  financial  affairs  are  in  order.    1. Work  to  Balance  Your  Budget   -­‐  make  effort  not   to  spend  more  than  you  make.  Reduce  or  

eliminate  your  debt  and  interest  first.  Your  consumer  credit  purchases  should  be  limited  to   20%   of   your   after   tax   income.  Make   effort   to   increase   your   cash   availability   to   be  saved  and  invested.  

2. Manage  Your  Credit   Card  Debt   –   credit   card   carries   a   high   rate  of   interest   i.e.   the   annual  percentage   rate   (ARP).     Five   prudent   ways   of   managing   credit   card   are   (1)   pay   your  balance  in  full,  (2)  do  not  use  credit  card  to  make  small  purchases  that  add  up  to  a  big  sum,   (3)   do   not   use   its   cash   advance   facility  which   is   costly,   (4)   limit   the   numbers   of  credit  cards  to  two  maximum  and  (5)  get  help  if  you  get  into  credit  card  problems.  

3. Start   an   Emergency   Fund   –an   investment   program   should   start   with   an   accumulation   of  emergency   fund   which   can   be   obtain   quickly   for   immediate   use.   The   amount   of  emergency   fund   varies   with   individual   but   the   common   sum   should   equal   to   3   to   9  months’  living  expenses.  

4. Have   Access   to   Other   Sources   of   Cash   for   Emergency   Needs   –   establishment   of   a   line   of  credit  with  a  bank  (overdraft  facility)or  cash  advance  from  credit  card.  Line  of  credit  is  a  short-­‐term  loan  that  is  approved  before  the  money  is  actually  needed.    

     Managing  a  Financial  Crisis    To  manage  a  financial  crisis,  many  experts  recommend  that  you  take  action  to  make  sure  your  financial  affairs  are  in  order.  The  eight  steps  that  you  can  take  are:    1. Establish  larger  than  usual  emergency  fund  –  you  may  want  to  increase  the  emergency  fund  

amount  higher  than  the  equivalent  3  to  6  months  living  expenses.  2. Know  what  you  owe  –  list  all  your  debts  and  the  amount  of  the  required  monthly  payment  

and  identify  the  debts  that  must  be  paid.  3. Reduce  spending  –  reduce  spending  to  basic  necessity  in  order  to  save  money  for  investing  

or  emergency  funds.  4. Pay  off  credit  card  –  high  interest  rate  and  expensive  credits.  5. Apply  for  a  line  of  credit  –  access  to  credit  during  emergency  e.g.  overdraft  facility.  6. Notify  credit  card  companies  and  lenders  if  you  are  unable  to  make  payments  –  you  may  get  

relieve  in  term  of  lower  interest,  lower  monthly  payment  or  extension  of  payment  time.  7. Monitor   the   value   of   your   investment   and   retirement   accounts   –   tracking   such   account  

helps   you   to   decide   which   investments   to   sell   for   cash   for   emergency   or   re-­‐allocate  investments  to  reduce  risk.  

8. Consider  converting  investments  to  cash  to  preserve  value  –  liquidate  investments  for  cash  to  weather  an  economic  crisis.  

 Getting  the  Money  Needed  to  Start  An  Investment  Program    Once   you   have   established   your   investment   goals   and   done   your   financial   checkup,   you   are  ready   for   your   investment  program  provided   you  have   the  money.  However,   you  have   to   ask  yourself  how  important  it  is  to  achieve  your  investment  goals.  Investing  requires  you  to  sacrifice  spending.   The   benefit   is   always   in   the   future.   Because   of   this,   most   people   begins   their  investment  through  employer  deduction  in  order  to  maintain  that  investing  discipline.    The  Value  of  Long-­‐term  Investment  Programs    There  is  no  better  time  to  begin  an  investment  program  than  when  you  are  young.    With  sound  investment   and   time   value   of   money   mechanism   will   ensure   you   are   well-­‐off   in   the   future.  People  do  not  start  young  because  they  have  only  small  sum  of  money  but,  even  small  sum  can  grow  over  a  long  period  of  time.    FACTORS  AFFECTING  THE  CHOICE  OF  INVESTMENTS    All   investors  must   consider   the   factors   of   safety,   risks,   income,   growth   and   liquidity.  Of  most  important  is  the  relationship  between  safety  and  risk.  Risks  are  associated  with  all  investments.  The   potential   return   for   any   investment   should   be   directly   related   to   the   risk   the   investor  assumes.  The  risk  factor  can  be  broken  down  into  five  components;   inflation  risk,   interest  rate  

risk,  business   failure   risk,  market   risk  and  global   investment   risk.  Next   factors   that  affect  your  choice  of  investment  are  income,  growth  and  liquidity.    Safety  and  Risk    Safety  in  an  investment  means  minimal  risk  of  loss  while  risk  in  an  investment  means  a  measure  of  uncertainty  about  the  outcome.  Investments  range  from  very  safe  to  very  risky.    A  very  safe  investment   attract   conservative   investors   because   they   know   there   is   very   little   chance   that  investments  will  become  worthless  e.g.  government  bonds,  CDs,  Mutual  funds,  corporate  bonds  etc.          The  other  end  is  speculative  investment  which  is  a  very  high-­‐risk  investment  made  in  the  hope  of  earning  a  relatively  large  profit  in  a  short  time.  They  have  a  potential  of  larger  return  but  also  if  unsuccessful,  lose  most  or  all  of  the  initial  investment.    The  Risk-­‐Return  Tradeoff    Two  types  of   risks  experience  by   investors  namely  a  risk   that  you  will  not  receive  the  periodic  payments  and  a  risk  that  an  investment  will  decrease  in  value.    When  investing,  not  everyone  has  the  same  tolerance  factor.  Those  who  have  higher  tolerance  for  risk  will  go  for  investments  with  higher  degree  of  risks  and  expect  larger  returns.  One  basic  rule  sums  up  the  relationship  between  the  factors  of  safety  and  risk:  the  potential  return  on  any  investment  should  be  directly  related  to  the  risk  the  investor  assumes.    Exhibit   13-­‐2   lists   a   number   of   factors   related   to   safety   and   risks   that   can   affect   an   investor’s  choice  of  investment.    

     Exhibit   13-­‐4   shows   typical   investments   for   financial   security,   safety   and   income,   growth   and  speculation.    Choosing  higher  risk  investments,  investors  expect  higher  return.    

             Rate  of  return   is   the  total   income  you  receive  on  an   investment  over  a  specific  period  of  time  divided  by  the  original  amount  invested.  The  rate  of  return  you  received  is  often  determined  by  the  amount  of  risk  you  are  willing  to  take.  It  is  possible  to  compare  the  projected  rate  of  return  for  different  investment  alternatives  that  offer  more  or  less  risk.    Example,    You  invest  $3,000  in  a  mutual  fund.  The  mutual  fund  pays  $50  dividend  this  year  and  the  fund  is  worth  $3,275  at  the  end  of  the  year.    Your  return  will  be  $275  ($3,275  -­‐  $3,000)  from  capital  gain  and  $50  from  dividend,  totaling  $325.  Your  rate  of  return  will  be  $325/$3,000  =  10.8%    If  an  investment  decreases  in  value,  the  steps  to  calculate  the  rate  of  return  is  the  same,  but  the  answer  is  negative.    The   key   is   to   determine   how   much   risk   you   are   willing   to   assume   and   then   choose   quality  investments  that  offer  higher  returns  without  an  unacceptably  high  risk.    Components  of  the  Risk  Factor    The   factor   of   risk   associated   with   a   specific   investment   does   change   from   time   to   time.   the  overall   risk   factor   can   be   broken   down   into   five   components   namely   inflation,   interest   rate,  business  failure,  market  and  global  investment  risk.    Inflation   Risk   -­‐   risk   from   a   rise   in   the   general   level   of   prices.   During   periods   of   high   inflation,  

there   is  a  risk  that  the  financial  return  on  an   investment  will  not  be  able  to  keep  pace  with   the   inflation   rate.   You  may   get   the   same   amount   in   return   but   that   amount   has  gone   down   in   term   of   its   purchasing   power.   To   protect   from   inflation   risk,   some  corporations  are  issuing  inflation-­‐protected  bonds  i.e.  adjusting  the  interest  received.  

 1. Interest  Rate  Risk  -­‐  risk  associated  with  changes  in  interest  rate  in  the  economy.  The  value  of  

investments   with   a   fixed   rate   of   return   decreases   when   the   overall   interest   rate  increases  and  increases  when  the  overall  interest  rate  decreases.  

 Business  Failure  Risk  -­‐  the  risk  of  business  failure  is  associated  with  investments  in  stock,  bonds  

and   mutual   funds   which   invest   in   stocks   and   bonds.   Bad   management,   unsuccessful  products,   competition   etc  will   cause   the   business   to   be   less   profitable   than   originally  anticipated.   Lower   profit   may   result   in   lower   or   no   dividends.   The   best   to   protect  against   such   loses   is   to  carefully  evaluate   the  companies   that   issue   the  stocks  you  are  buying.  

 1. Market  Risk  -­‐  two  risk;  systematic  and  unsystematic,  can  affect  the  market  value  of  stocks,  

bonds,  mutual  funds,  real  estate  etc.  Systematic  risk  occurs  because  of  overall  risk  in  the  market  and  economy  e.g.  economic  crisis,   interest  rates,  purchasing  power.  This  affect  the   entire  market   as   such   diversification   cannot   be   done.   Unsystematic   risk   affects   a  specific  company  or  industry;  hence  diversification  can  eliminate  unsystematic  risk.  The  prices   of   stocks,   bonds,   mutual   funds   may   also   fluctuate   because   of   the   behavior   of  investors  in  the  marketplace.  They  perceived  on  certain  thing  and  that  may  affect  prices.  

 Global  Investment  Risk  -­‐  this  risk  is  associated  with  investing  in  foreign  stocks  and  bonds  which  

can  be  affected  by  changes  in  currency  and  exchange  rates.          

Investment  Income    

Investors   sometimes  purchase   certain   investments  because   they  want  a  predictable   source  of  income   from   their   investment.   The   safest   investments   are   saving   accounts,   certificates   of  deposits,  government  securities  are  also  the  most  predictable  sources  of  income.  If  income  is  a  primary   objective,   most   investors   choose   bonds,   preferred   stock.   Other   investments   that  provide   income  potential   are  mutual   funds   and   real   estate   rental   property.   The  downsides  of  rental  properties  are  they  are  vacant  or  incur  large  repair  bills.    When  purchasing  investments  for  income,  you  should  be  concerned  about  the  issuer’s  ability  to  make   periodic   income   or   dividend   payments   and   eventual   repayment   of   your   principal   sum  invested.  

 Investment  Growth    To  investors,  growth  means  that  their  investments  will  increase  in  value.  Companies  with  better  than  average  earnings  potential,  sales  revenue  that  are  increasing,  and  managers  who  can  solve  problems   associated   with   rapid   expansion   are   often   considered   to   be   growth   companies.  Growth   companies   may   not   declare   dividends   but   re-­‐invest   the   current   cash     to   generate  greater  growth  and  greater  value  in  the  future.  Mutual  funds.  government  and  corporate  bonds  and  real  estate  offer  growth  potential.    

Investment  Liquidity      This   investment   focuses   on   its   liquidity   element   i.e.   can   be   converted   to   cash   without   a  substantial   loss   in   value   e.g.   current   and   saving   accounts,   certificate   of   deposits   (may   incur  penalty),  with  other  investments,  you  may  able  to  sell  quickly  but  depend  on  market  conditions,  economic  conditions,  selling  price  etc.    ASSET  ALLOCATION  AND  INVESTMENT  ALTERNATIVES    Asset  Allocation  and  Diversification    Asset   allocation   is   the   process   of   spreading   your   asset   among   several   different   types   of  investments   (asset  classes)   to   lessen  risk.  The  diversification  provided  by   investing   in  different  asset  classes  provided  a  measure  of  safety  and  reduces  risk,  because  a  loss  in  one  asset  class  is  usually   offset   by   gain   from   other   asset   class.   Typical   asset   classes   include   stocks   issued   by  corporations,  foreign  stocks,  bonds  and  cash.    Asset  allocation  is  the  most  important  factor  when  establishing  a  long-­‐term  investment  program  because   choosing   the   right   mix   of   assets   will   outperform   the   investment   selections   that  individual   investors  make  over  a  long  period  of  time.  Typically,  the  asset  allocation  will  change  and  become  more  conservative  as  you  get  older.    The  percentage  of  your  investment  that  should  be  invested  in  each  asset  class  is  determined  by  your  age,  investment  objectives,  your  risk  tolerance,  your  yearly  saving  for  investment,  value  of  your  current  investment  and  the  outlook  for  the  economy.    

 Exhibit  13-­‐4  above  suggest  that  an  investment  program  is  like  a  pyramid  which  trade-­‐off  risk  and  return.     The   investment   pyramid   has   four   levels.   The   foundation   or   level   1   is   conservative  investments  with   secure   and   stable   return.   Level   2   provides   safety   and   income  while   Level   3  provides  growth.    Level  4  which  is  the  apex  provides  the  most  speculative  yet  the  highest  return.        

   The  Time  Factor    The  amount  of  time  your  investments  have  to  work  for  you  is  an  important  factor  in  managing  your   investment   portfolio.     How   long   you   can   leave   your   investments;   for   a   long-­‐term  investment  you  can  choose  stock  and  mutual  funds.  If  you  need  quick  gain  on  investment,  you  should   go   for   high   rated   corporate   bonds,   certificate   of   deposits   or   short-­‐term   government  bonds.  The  longer  that  you  invest  in  a  particular  asset,  the  better  your  opportunity  for  increasing  returns.    Your  Age    A  final   factor  to  consider  when  choosing  an   investment   is  your  age.  Younger   investors  tend  to  invest  a  large  portion  of  their  assets  in  growth-­‐oriented  investments.  If  the  investments  do  not  perform,  they  have  time  to  recover.  Older   investors  tend  to  be  more  conservative  and  choose  safe   investment   such   as   government   bonds,   very   safe   corporate   stocks   and   mutual   funds.  

Experts   suggest   that   the   percentage   of   your   assets   in   growth   investment   should   equal   to  number   110   less   your   age   e.g.   If   your   age   is   50,   the   percentage   of   your   assets   in   growth  investment  should  be  60%  (110  –  50).    An  Overview  of  Investment  Alternatives    Once  you  have  considered  the  risk   involved,  asset  allocation,  the  time  factor  your   investments  can  work  for  you,  and  your  age,  it  is  time  to  consider  which  investment  alternatives  is  right  for  you.    Stock  or  Equity  Financing    Equity  capital  is  money  that  a  business  obtains  from  its  owners.  The  owner  or  investor  can  be  a  single   ownership   or   a   collective   ownership   such   as   shareholders.     Investor   should   consider   at  least   two   factors   before   investing   in   stock.   First,   a   corporation   is   not   obligated   to   repay   the  money   obtained   from   the   sale   of   stock   or   to   repurchase   the   stock   at   a   later   date.   Second,   a  corporation  is  under  no  legal  obligation  to  pay  dividends.  A  dividend  is  a  distribution  of  money,  stock  or  other  property  that  a  corporation  pays  to  stockholders.    There   are   two   types   of   stock;   common   stock   and   preferred   stock.   People   purchase   common  stock  because  (1)  as    a  source  of   income  if   the  company  pays  dividend,   (2)  growth  potential   if  the   value   of   stock   increases   and   (3)   potential   profit   if   the   company   splits   its   common   stock.  Preferred  stocks  are  purchased  because  it  pays  dividends  before  common  stock.    Corporate  and  Government  Bonds    There   are   two   types   of   bond   namely   government   bonds   and   corporate   bonds.   Government  bond   is   a   written   pledge   of   a   government   to   repay   a   specified   sum   of   money,   along   with  interest.   Corporate   bond   is   a  written   pledge   of   a   corporation   to   repay   a   specified   amount   of  money,   along   with   interest.   When   you   buy   bond   you   are   lending   money   to   corporations   or  governments  for  a  period  of  time.    The  maturity  date  is  the  date  in  which  the  face  value  of  the  bond  ill  be  paid.    The  value  of  a  bond  is  closely  tied  to  the  ability  of  the  corporation  or  government  entity  to  repay  the   bond   at   maturity   and   pay   interest   payment   until   maturity.     The   value   of   the   bond   may  increase   or   decrease   before   it   reaches   maturity   because   of   changes   in   interest   rates   in   the  economy.    Bondholders  can  keep  the  bond  until  maturity  and  receive  periodic  interest  payments  or  sell  it  to  another  investor  before  maturity.          Mutual  Funds    A   mutual   fund   is   an   investment   company   that   pools   the   money   of   many   investors   (its  shareholders)   to   invest   in   a   variety   of   securities.   Professional   management   is   an   important  factor  in  mutual  fund  investments.    Mutual  fund  is  also  chosen  for  its  diversification.    

The   goals   of   investors   differ   as   such   mutual   funds   investments   can   be   tailor-­‐made   to   suit  individual   investor’s   need.   For   this   reason,   mutual   funds   are   excellent   choice   for   beginners’  investments,  retirement  accounts  etc.    Real  Estate    As  a  rule,  real  estate  increases  in  value  and  eventually  sells  for  a  profit,  but  this  is  no  guarantees.  Real  estate  investment  is  long-­‐term  in  nature.  Real  estate  investment  must  be  evaluated  and  the  key   evaluation   is   always   location.   Ask   yourself   questions   before   buying   real   estate;   is   the  property  priced  competitively?  what  type  of  financing  is  available?  How  much  are  taxes?  What  is  the  conditions  of  the  buildings  in  immediate  area,  why  are  the  present  owners  selling?  Could  the  property  decrease  in  value?    Other  Investment  Alternatives    Speculative  investment  is  a  high-­‐risk  investment  made  in  the  hope  of  earning  a  relatively  large  profit  in  a  short  time.  The  speculative  investments  include  antiques  and  collectibles,  call  and  put  options,  commodities,  coins  and  stamps  and  precious  metals  and  gemstones.    A  Personal  Plan  for  Investing    Safety,  risk,  income,  growth  and  liquidity  affect  investment  choice.  Exhibit  13-­‐6  ranks  alternative  investments  in  terms  of  factors  that  affect  investment  choices.    

 

 Individual   must   develop   an   investment   plan   and   implement   it   in   order   to   be   successful.  Individuals   begin   investment   planning   by   establishing   realistic   goals   and   then   adhere   to   the  eight  steps  of  personal  action  plan  to  be  effective  in  investment.    

   FACTORS  THAT  REDUCE  INVESTMENT  RISK    Your  Role  in  the  Investment  Process    Evaluation   of   an   investment   should   begin   before   purchasing   an   investment   and   after   it   is  purchased.  Some  basic  elements  include:    Evaluate  Potential  Investments  

When   choosing   an   investment,   the   work   is   the   time   needed   to   research   different  investments  so  that  you  can  make  informed  decision.  Successful  investors  evaluate  their  investments  and  continue  to  evaluate  their  investments.  

 Monitor  the  Value  of  Your  Investments  

Close   monitoring   of   your   investments   will   keep   you   informed   of   whether   your  investments   increases  or  decreases.   From   there   you   know  which   investments   to   keep  and  which  one  to  dispose.    

Keep  Accurate  and  Current  Records  Accurate  recordkeeping  can  help  you  spot  opportunities  to  maximize  profits  or  reduce  losses  when  you  sell  your  investments  or  in  making  decision  whether  to  add  or  minus  on  the  investments.    

Other  Factors  that  Improve  Investment  Decisions    To   achieve   financial   goals,   you   can   to   the   experts   for   advice   such   as   lawyers,   accountants,  bankers,   stockbrokers   or   insurance   agents   but   bear   in   mind   they   are   specialist   in   only   their  areas.  Financial  planner  is  also  a  source  since  they  are  trained  in  securities,  insurance,  taxes,  real  estates  and  estate  planning.  Tax  consequences  must  always  be  taken   into  consideration  when  selling  your  investments.    SOURCES  OF  INVESTMENT  INFORMATON  

 To  be  well   informed  when  making   investments  decisions,   you  must  be   guided  by   appropriate  information.   You   must   be   selective   in   the   type   of   information   that   you   use   for   evaluation  purposes.    The  sources  are   the   internet,  newspapers  and  news  programs,  business  periodicals  and  government  publications,  corporate  reports  and  investor  services  and  newsletters.