Selecting and Monitoring Your Investments

Dr. Barbara O’Neill, CFP® Rutgers Cooperative Extension oneill@aesop.rutgers.edu

Your Questions?

Types of Investments All investments fall into two major categories: Loanership (Fixed-Income) Lend money to a debt issuer (e.g., a city) Receive a pre-set interest rate Receive original principal back (assuming no default)

Ownership (Equity) Full or partial owner of investment Values fluctuate Potential higher return

Asset Allocation Models

What are Bonds? Why Own Them? IOUs issued by corporations or government entities “Cushions” a stock portfolio (adds diversification)

Addresses short- and intermediate-term goals

Provides predictable income stream in retirement

Affordable: face values as low as $100 (e.g., U.S. Treasury securities)

Some pay interest semi-annually (corporate and government bonds)

Others pay interest at maturity (e.g., EE and zero-coupon bonds)

Some offer tax advantages (municipal bonds)

Capital gains potential (if interest rates go down after purchase and you sell)

Bond Investment Risks

Credit risk

Interest rate risk

Inflation risk

Call risk

Bond Investor Decisions Decide on risk level

Investment grade bonds: top 4 grades (BBB, A, AA, AAA)

Junk bonds (a.k.a., high yield bonds): lower rated and higher risk

Decide on maturity Match to financial goals

Determine the after-tax return Taxable versus tax-exempt

Bond Ratings Measure Default Risk

U.S. Treasury Securities Considered safest fixed-income investment

Sold at periodic auctions; secondary market

Earnings exempt from state and local tax (principle of “reciprocal immunity”)

$100 minimum with $100 increments

Resource: http://www.treasurydirect.gov

U.S. Treasury Securities Types of Treasury Securities: Bills: Maturities up to 12 months; buy at discount Notes: 2-, 3-, 5-, 7-, and 10-year maturities Bonds: 30-year maturities (“long bonds”)

Can purchase through Treasury Direct Guided Tour: http://www.treasurydirect.gov/indiv/TDTour/default.htm

Interest is credited electronically

TIPS: Treasury Inflation Protected Securities

5-, 10-, and 30-year maturities

Interest rate fixed for term of bond

Principal adjusted twice a year for CPI

Protection against deflation (will get principal back)

Lower interest than regular Treasuries

Resource: https://www.treasurydirect.gov/indiv/products/prod_tips_glance.htm

U.S. Savings Bonds Two types: EE bonds and I bonds

EE Bonds: Buy at 50% of face value I Bonds: Partly indexed for inflation; buy at full face value

Denominations from $50 to $5,000 Maximum of $10,000 of each type per year (electronic) Interest compounds semi-annually; no state taxes Can cash in after 12 months; lose 3 months interest if cash in

within 5 years; mature in 30 years Resources: https://www.treasurydirect.gov/indiv/products/prod_eebonds_glance.htm

and https://www.treasurydirect.gov/indiv/products/prod_ibonds_glance.htm

Corporate Bonds A corporation’s pledge to repay principal and periodic interest

Considered safer than company stocks

Face Value Dollar amount bondholder receives at bond’s maturity date Usually $1,000

Coupon rate Stated interest rate Interest payments made every six months Example: $1,000 x 5.8% = $58 (in two $29 payments)

Maturity Date = Date that face value is repaid; generally 1 to 30 years

Resource: https://www.sec.gov/investor/alerts/ib_corporatebonds.pdf

Zero-Coupon Bonds Pay no (zero) periodic interest

Sold at a deep discount from face value

Eventually grows to face value at maturity

Very volatile as interest rates change (if sold prior to maturity)

Advantages: Low up-front cost Predictable return

Disadvantage: Annual increase in value is taxable (“phantom income”)

Can put in an IRA or buy tax-exempt “zeros” to avoid this problem

Resource: http://www.sec.gov/answers/zero.htm

Classifications of Stock Common and preferred stock

Preferred Stock- a cross between a stock and a bond (income oriented); no voting rights

Market capitalization (“cap”) Share price x number of outstanding shares

Defensive and cyclical

Cyclical Stocks – stock from a company whose profits are greatly influenced by changes in the economic business cycle.

Countercyclical (or Defensive) Stocks – stock from a company that performs well even in an environment characterized by weak economic activity

Growth and value Value Stock- Stock that is selling for < the true worth of company assets.

Common Stock Share of ownership in a company

Elect directors

Voting rights on other matters

Proxy – written authorization given by shareholder to someone else to represent him or her and vote his or her shares at a stockholder’s meeting.

Two ways to earn money value of stock increases (capital gain)

stock pays dividends

Historically, common stocks have out-performed all other types of investments, over longtime periods BUT…it has not been a smooth ride!

Historical Perspective

Time-Tested Stock Strategies Buy what you know or get to know (research)

Buy and hold quality stocks

Diversify among industry sectors

Dollar-cost average

Reinvest dividends and capital gains

Don’t invest > 10% of total portfolio in your own employer’s stock

Analyzing Stock Performance Earnings per share (EPS)

Formula: Corporation’s after-tax income divided by number of outstanding shares of common stock

Example: $5,000,000/10,000,000 = $0.50

EPS increase = generally a healthy sign

Analyzing Stock Performance Price-Earnings Ratio (P/E Multiple)

Price per share of stock ÷ firm’s earnings per share (EPS) Example: $10 price/0.50 EPS = a PE ratio of 20 Tells how much investors are paying for a company’s

earning power P/E of 15 long-term average P/E Need to compare P/E of stock to firms in same industry

Projected Earnings EPS and P/E based on historical data Future expectations more relevant

Common Stock Price Quotes

Last trade price = $44.37 Annual dividend = $1.68

P/E = 15.41 (44.37÷ 2.88) Earnings per share = $2.88

Stock Splits Stock Split- when shares of stock owned by

existing shareholders are divided into a larger number of shares; done to change (lower) price

Example: 2:1- twice as many shares worth half as much

Reverse Stock Split- results in smaller number of shares; less common; often done to maintain listing on a stock exchange (to meet minimum share price)

Example: 1:2- half as many shares worth twice as much

What is a Mutual Fund? n Portfolio of stocks, bonds, or other securities

n Collectively owned by many investors

n Managed by professional investment company

Mutual Fund Advantages Full time professional money management

Reduced risk through diversification

Low minimum to get started and reinvest

Ready access to your money (liquidity) Shares issued and redeemed on demand

Automatic investment and withdrawal plans

Monitoring is easy

Mutual Fund Disadvantages

If broad market drops, so goes a fund

No guaranteed rate of return

Unwanted taxable distributions

High fund expenses erode returns

How Fund Investors Make Money Income Dividends

Earnings paid from dividend and interest income Taxed as ordinary income

Capital Gains Distributions Distributions when the fund buys and sells securities Taxed as long-term gains

Combination = Total Return

Capital Gains (or Losses) Capital gains (or losses) when fund investors sell shares at a price

different than price you originally paid Taxed as short- or long-term gains

Net Asset Value The NAV is the price your fund pays you

per share when you sell. Value of fund

Number of shares = NAV

Example: $52,500,000 3,500,000 = $15 per share

Mutual Funds Versus Individual Securities Individual securities (e.g., stocks and bonds)

Require time and expertise to analyze

Usually have higher transaction costs

Offer less probability of adequate diversification

OK if:

you have stock-picking expertise

you have $20-30K to buy 10-20 stocks to diversify

you are buying Treasury securities

Bonds vs. Bond Mutual Funds Individual bonds: Semi-annual income stream Return of principal at maturity Ability to “ladder” maturities

Bond mutual funds: Diversification-owns 100+ bonds Dividends paid out monthly Low minimum to purchase Liquidity Subject to interest rate risk

Actively Managed Funds Versus Index Funds Managed Fund fund manager makes

decisions regarding what securities are included in the fund’s portfolio

Index Fund securities held by the fund replicate those contained in a specific index like the Standard & Poor’s (S&P) 500

Stock Funds Long-term

Funds

Stock Funds Bonds Funds Other Funds

Growth

Equity income

Price growth vs. Dividend Income

Aggressive Growth

Socially responsible Invest in socially responsible firms

Economic SectorsSector funds

Company Size

Regional

Index funds Match index holdings

% U.S. vs. International

Small-cap

Mid-cap

Global

International

Large-cap

Source: Kapoor, Dlabay, & Hughes. Focus on Personal Finance (2008)

Bond Funds Long-term Funds

Stock Funds Bonds Funds Other Funds

High-yield

Intermediate Corporate bondsIntermediate U.S.

Gov't bondsLong-term

corporate bondsLong-term U.S.

gov't bonds

Municipal bonds

Short-term corporate bonds

Short-term U.S.gov't bonds

Source: Kapoor, Dlabay, & Hughes. Focus on Personal Finance (2008)

Other Funds Long-term

Funds

Stock Funds Bonds Funds Other Funds

Money Market Funds

Asset Allocation Funds

Balanced Funds

Lifecycle Funds

Fund of Funds

Source: Kapoor, Dlabay, & Hughes. Focus on Personal Finance (2008)

Balancing Risk and Return Source: Garman and Forgue. Personal Finance (2008)

Mutual Fund Fees Sales Charges/Loads- Charged to buy and sell shares

Operating Expenses

Management fee- Charged yearly (.25%-1.5% of average NAV) to pay fund manager

12(b)1 Fee- Annual fee to defray advertising and marketing costs; cannot exceed 1% of assets

Operating Expenses- Charged for shareholder services

Expense Ratio Total expenses associated with management fees and operating costs of the fund

Avoid above-average fund expense ratios

Stock funds > 1.4%

Bond funds > 1.00%

Money market funds > 0.5%

Typical Mutual Fund Fees Source: Kapoor, Dlabay, & Hughes. Focus on Personal Finance (2008)

Steps to Buying a Mutual Fund Identify type of fund that matches goal

Research specific funds Family of Funds: One investment company

manages a group of mutual funds portfolios

Get and read the prospectus Prospectus: Required legal document that states a

mutual fund’s investment objectives and policies

Make your purchase

Establish a schedule to buy more shares

Sources of Investment Information Stock and Mutual Fund Annual Reports Financial Publications

Business Week, Forbes, Kiplinger's Personal Finance, WSJ, and Money

Quality Ratings Bonds -- Standard & Poor’s, Moody’s

Annuities -- Standard & Poor’s, Moody’s, Duff & Phelps, Weiss Research,

A.M. Best Stocks -- Value Line Investment Survey, Standard & Poor’s Stock Guide

Mutual Funds -- Morningstar

Many of these are available at public libraries and/or online

Action Steps Get started now

Know your risk tolerance

Match investments to your goals

Know that the biggest risk in investing is not investing -- inflation is the real enemy

Reinvest dividends and capital gains

Compare results to market benchmarks

Take a long view and hold on

Questions and Comments? Barbara O'Neill, Ph.D., CFP®, CRPC

Extension Specialist in Financial Resource Management and Professor II Rutgers University Phone: 848-932-9126

E-mail: oneill@aesop.rutgers.edu

Internet: http://njaes.rutgers.edu/money/

Twitter: http://twitter.com/moneytalk1