Investment Power2.1 THE POWER OF INVESTING

Objectives

Compare and contrast saving and investingDetermine how compounding worksDiscuss four basic rules for taking advantage of the long-term power of investing

Saving and Investing

Saving – Generally used to refer to putting money aside for a rainy day, whether in a savings bank or a piggy bank. (Savings bank is better)! The point is to have money on hand when needed. Everybody should have some money in an interest-bearing savings account.

Investing – Taking measures to make your money grow over time. Stocks, bonds, mutual funds, commodities, properties or anything you think will increase in value over time. With investing, you are not worried about the immediate accessibility (liquidity) of your money. You’re using money to make money.

The Rewards of Investing

1. A great way of making money2. Rewards can last a lifetime3. Time is on your side4. Can help you beat inflation5. A way of owning a piece of corporate America6. It’s fun!

The Growing Importance of Investing

Jobs are changing rapidly.One company for life and retire on a pension is no longer the case.Over your career, you’re likely to work for at least a half-dozen

employers.With no single life-long employer and no company pension, your

long-term security will reside in your own hands.Investing will not be a luxury, it will be a necessity.

The Magic of Compounding

Principal – The money you have on deposit on which interest is calculated.

Simple Interest – Interest paid once per year at the end of the year on the average balance in an account.

Compound Interest – Interest paid on the principal and on previously earned interest, assuming that the interest is left in the account. One of the reasons why investing over a long period of time is so profitable is the fact that your earnings compound and as a result, grow by larger and larger amounts.

The Magic of Compounding

Growth Rate Table (Page 39)

The Rule of 72

One of the easiest ways to calculate the effects of compounding is the Rule of 72.

This states that if an asset grows X% per year, its value will double in 72/X years. So in order to find how long it takes an investment to double, divide 72 by the annual rate of return.◦ Example: if you can earn 10% rate of return per year, it will take 7.2

years (72/10) for your money to double.

Four Basic Rules for Investors Four basic rules for taking advantage of the long-term power of investing are:

1. Invest on a regular basis over a long period of time2. Reinvest all earnings (dividends, interest, capital gains)3. Invest in common stocks or mutual funds of good

quality growth companies4. Diversify your portfolio

Investment Power2.2 THE CORPORATION

Objectives

Explain different forms of businessCompare primary and secondary capital markets

Organizing a Business All businesses offer products or services that satisfy customer wants and needs in order to earn a profit.

Before any business can begin to operate, it must meet two basic needs:◦ Labor: People who will do the work◦ Capital: Money to buy real estate, equipment, raw materials and

underwrite other start-up costs.

Generally, a new business needs more capital than a single owner or a small team of owners can provide and it must look to two primary sources of business capital: Lenders and Stockholders

Organizing a Business

Lenders – People who lend money to the business in return for a contracted rate of interest or return for their investment.

Stockholders – Those who buy shares of stock in a company and become part owners. Instead of receiving a fixed rate of interest, stockholders profit from the success of a business.

The dynamic process of creating and sustaining businesses through private investments is called Capitalism.

Legal Forms of a Business

Sole Proprietorships –

Partnerships –

Corporations -

Private and Public Corporations

The vast majority of corporations in the U.S. are private corporations.

Shares in private corporations are not sold on the stock market and can only be purchased from current stockholders (generally a pretty small group of people).

Private companies are a little like private parties – you have to be invited.

Shares in public corporations, however, can be purchased from dealers and other shareholders and traded openly on stock markets.

How Businesses Raise Money

When a corporation is raising new money for some venture, it may sell stocks or bonds directly to investors. This is called a primary capital market.

As a rule, however, the stock you buy will be sold in a secondary market. A secondary capital market is created when stockholders buy and sell shares from one another on a stock market with the help of brokers.

The New York Stock Exchange, the American Stock Exchange and the NASDAQ over-the counter market are predominantly involved in this secondary market.

The Securities and Exchange Commission (SEC)

The SEC is a federal agency which is considered the “policeman” of the securities industry (stocks and bonds).

The SEC is responsible for establishing and enforcing regulations which protect the investing public from unfair practices.

A publicly traded company is required to file registration information with the SEC. Company data, industry information, management and other important facts are included.

Severe penalties are imposed for violations of full disclosure rules.

Investment Power2.3 THE INVESTMENT SUPERMARKET

Objectives

Describe the relationship between risk and returnIdentify different types of investments

Risk and Potential Return

Level 1 – Lowest Risk/Lowest Return

Loans to the Federal Government - (guaranteed by the federal government which has the power to tax and create money).Series EE Bonds – issued in small denominations and discounted to 50% of face value. Variable rate. Advantages include 1)Safety and 2) Deferred Taxes.Series HH Bonds – Sold in larger denominations and at face value. Interest is currently taxable.

Both types of bonds are non-marketable (cannot be sold and must be redeemed usually through bank).

Treasury Bills – Short term (mature in 3 -12 months). $10,000 minimum.Treasury Notes and Treasury Bonds – Longer maturities (notes 1-10 years and bonds more than 10 years). $1,000 minimum.

Level 1 – Lowest Risk/Lowest Return (cont.)

Insured Savings and Checking Accounts – FDIC insured up to $250,000 in commercial and savings banks. Low rate of interest. Suitable for short-term money.

Insured Certificates of Deposit (CDs)- Slightly longer term investments ranging from 3 months to several years. Also FDIC insured up to $250,000. Higher interest than savings and checking accounts since money is tied up longer.

Level 2 – Low Risk/Low Return

Money Market Accounts (or MM Mutual Funds) – low risk, relatively short term securities such as T-bills, large CDs and notes issued by large stable corporations.

High Quality Corporate Bonds (or Corp Bond Mutual Funds) – Loaning money to higher rated corporations. Riskier than loans to federal government. Bonds are rated by Standard & Poor or Moody’s.

High Quality Municipal Bonds (or Muni Bond Mutual Funds) – Similar to high quality corporate bonds but issued by federal, state and city government entities. Interest earned is TAX FREE.

Level 3 – Relatively Low Risk

High Quality Convertible Bonds – A corporate bond which pays a fixed rate of interest but can be exchanged for common stock. Rate of return is usually lower than the rate on “straight” (non-convertible) bonds.

High Quality Preferred Stock – Non-voting stock which pays a fixed dividend.

Balanced Stock/Bond Mutual Funds – Offer an opportunity to invest in a mixed bag of several companies’ stocks and bonds. Level of risk varies with the percentage of fund invested in stocks versus bonds. (More stocks means higher risk).

Level 4 – Intermediate Risk

Quality Growth Stocks (or Mutual Funds) – Shares of companies which are leaders in their industry and have demonstrated consistent growth rates for both earnings and revenues. Usually pay low dividends but offer opportunity to profit from rising stock prices.

Large Capitalization (Large Cap) Stocks (or Mutual Funds) – Shares in corporations with a total market value of outstanding stock of $10 Billion or more. These corporations are the largest in the world. Market value is calculated by multiplying the number of common shares outstanding by the current price per share.

Level 5 – Relatively High Risk

Medium Capitalization (Mid Cap) Stocks (or Mutual Funds) – Shares of corporations with a market value of between $2 Billion and $10 Billion. Large, but not enormous corporations.

Small Capitalization (Small Cap) Stocks (or Mutual Funds) – Shares of corporations with a market value of less than $2 Billion. Most numerous but smallest corporations.

Specific Industry Mutual Funds – Investing in several companies that are all in the same industry. (Health Care, Financial Services, Technology, etc.)

Low Quality Stocks (or Mutual Funds) – “low quality” is somewhat objective. Could be high risk for several reasons including small revenue and earnings base, erratic past performance, concentration on one product, company management.

Level 5 – Relatively High Risk (cont.)

Low Quality Bonds – Because these are non-investment grade bonds, there is a higher likelihood that they could default and not pay the interest due and/or the face value of the bond at maturity. At the bottom of this group are “junk bonds”.

Collectibles – Includes things like rare coins, art, sports cards, comic books and historical memorabilia. Considerations include proper insurance and storage.

Level 6 – High Risk Futures – Commodity futures are contracts to buy and sell items that are mined and grown at some time in the future. (Soy beans, coffee, cattle, orange juice, etc). The investor is betting on future movement of prices.

Options – A contract to buy or sell a stock at a certain price during a specified period of time. The investor is betting on the future direction of the price of that stock.

Penny Stocks – Stock of corporations which sell for under $1. These are generally small companies without a track record.