the fundamentals of investing chapter 8. 8.1 preparing for an investment program establishing your...

The Fundamentals of Investing

Chapter 8

8.1 Preparing for an Investment Program

• Establishing Your Investment Goals– Plan carefully and practice discipline• Sacrifices will be worth it in the long run

– Starts with a measurable goal (saving for a car, college, or a down payment on a house)


• Performing a Financial Checkup– Balance your budget: spend less than you make– Have enough insurance to cover financial losses– Start an emergency fund (money that you can

access quickly for an immediate need)– Have access to other sources of cash• Line of credit or credit card cash advance


• Obtaining the Money You Need to Get Started– Pay yourself first – consider it a monthly bill– Take Advantage of Employer-Sponsored

Retirement Plans – many employers match part or all you put in and it isn’t taxed until you withdraw it, usually at retirement


• Obtaining the Money You Need to Get Started– Participate in an Elective Savings Plan –

automatically taken from your check and put into savings or from your account and invested

– Make a Special Savings Effort One or Two Months Each Year – cut back sharply at a specific time of year

– Take Advantage of Gifts, Inheritances, and Windfalls


• The Value of Long-Term Investment Programs– Some people don’t invest because they only have

a small amount or they think they are too young• Even small amounts add up because of the time value

of money (the increase in an amount of money as a result of interest or dividends earned)


• Factors That Affect Your Choice of Investments– Safety and Risk• Safety – the chance of losing your money in an

investment is fairly small; rate of return will be low• Risk – you cannot be certain about the outcome of your

investment; speculative investment (high risk investment in the hope of earning a relatively large profit in a short time)


• Factors That Affect Your Choice of Investments– Five Components of the Risk Factor

1. Inflation Risk – general rise in prices that affects everybody– Try to stay ahead of inflation by investing– Example on page 246

2. Interest Rate Risk– Government or corporate bonds have a fixed rate of return; if

the interest rate rates go up then the value of your investment will go down and vice versa, but if you wait until maturity to cash in you would get your full amount

– Examples on page 247



3. Business Failure Risk – applies to common stock, preferred stock, and corporate bonds; you face the possibility that the company you invested in will be less profitable than you had hoped– Research, research, research to protect against this

4. Financial Market Risk – the value of stocks, bonds mutual funds, and other investments go up or down depending on the overall state of financial markets (social and political conditions)– Example: price of oil stocks may be affected by the political situation

in the Middle East



5. Global Investment Risk – investing in companies in other countries


• Factors That Affect Your Choice of Investments– Investment Income – source of income

• Safest investments – savings accounts, certificates of deposit (CDs), U.S. Savings Bonds, and U. S. Treasury bills

• Government bonds, corporate bonds, preferred stock, utility stock, or certain common stocks

• Mutual funds and real estate rental

– Investment Growth – “growth” means that investments will increase in value• Growth companies reinvest their profits rather than pay

dividends (retained earnings – the profits that are reinvested)


• Factors That Affect Your Choice of Investments– Investment Liquidity – the ability to buy or sell an

investment quickly without substantially affecting its value• May have to accept a lower price for a house to sell it

quickly

8.2 An Overview of Investment Alternatives

• Types of Investments1. Stock or Equity Financing• Equity capital – money that a business gets from its

owners in order to operate• Sole proprietor – sole business owner• Partnership – share in the equity capital• Corporation – gets it money from stockholders

– Corporations do not have to repay you what you paid and they don’t have to pay you dividends (distributions of money, stock, or other property that corporation sometimes pays to stockholders)


• Types of Investments1. Stock or Equity Financing Continued• Common Stock – most basic form of corporate

ownership; entitles you to voting privileges and can provide a source of income if the company pays dividends

• Preferred Stock – gives the owner the advantage of receiving cash dividends before common stock holders


• Types of Investments2. Corporate or Government Bonds• Corporate bonds are a corporation’s written pledge

to repay a specified amount of money along with interest.

• Government bonds are a written pledge of a government or a municipality to repay a specified sum of money with interest

• “Buy a Bond” – you are lending money to a corporation or government agency for a certain period of time


• Types of Investments2. Corporate or Government Bonds Continued• Factors that affect the value of a bond:

– Whether the bond will be repaid at maturity– Whether the corporation or government agency will be able

to pay interest until maturity

• Maturity dates – 1 to 30 years• Paid – every 6 months


• Types of Investments3. Mutual Funds – an investment alternative in

which investors pool their money to buy stocks, bonds, and other securities based on the selections of professional managers who work for an investment company• So, if one of the stocks does poorly it can be made up

by the gains of another in the fund


• Types of Investments4. Real estate – goal is to have the property

increase in value so you can sell it at a profit or receive rental income• When buying property consider:

– Why are the present owners selling? Is the property in good condition? What is the condition of other properties in the area? Is there a chance that the property will decrease in value and you lose money?


• Types of Investments4. Real estate continued• When you sell consider:

– Can you find an interested buyer? Can the buyer get the necessary financing to buy the property?


• Evaluating Investment Alternatives– When you make your choices to invest, it’s wise to

diversify• Diversification – process of spreading your assets

among several different types of investments to lesson risk


• Evaluating Investment Alternatives– Investment Pyramid

Level 4Speculation

Level 3Growth

Level 2Safety and Income

Level 1Financial Security


• Developing a Personal Investment Plan– Establish investment goals– Decide how much money you will need to reach those goals by

a certain date– List all the investment you want to evaluate– Evaluate the risks and potential return for each investment on

your list– Reduce the list of possible investments to a reasonable number– Choose at least two investments to give you some diversity– Recheck your investment program periodically…investment

goals will change over time

8.3 Reducing Investment Risk and Obtaining Investment Information

• The Role of the Financial Planner (specialist who is trained to offer specific financial help and advice)– Fee-only planners – charge and hourly rate from

$75 to $200 or a flat fee ranging from about $500 to several thousand dollars

– Fee-offset planners – charge an hourly or annual fee, but they offset or reduce it with commissions, or earnings they make by buying or selling investments


• The Role of the Financial Planner continued– Fee and commission planners – charge a fixed fee

for a financial plan and earn commissions from the financial products they sell

– Commission only planners – earn all their money through commissions they make on sales of insurance, mutual funds, and other investments


• Do You Need a Financial Planner?– Consider two things…• Your income – if you make less than $40,000 a year you

probably don’t need a planner’s advice• How willing are you to make decisions on your own – if

you take the time and effort to keep up-to-date on financial developments

– You can find a financial planner in the yellow pages, by contacting financial institutions, and by getting names from friends, coworkers, or professional contacts


• Do You Need a Financial Planner?– Selecting a Financial Planner• Help you assess your current financial situation• Offer a clearly written plan, including investment

recommendations, and discuss the features of the plan with you• Help you keep track of your progress• Guide you to other financial experts and services as

needed


• Do You Need a Financial Planner?– Certification of Financial Planners

• Requirements vary from state to state– Some require passing an exam– Others issue licenses to either individual planner or planning

companies– While others have no regulations at all

• Credentials may be Certified Financial Planner (CFP) or Charted Financial Consultant (ChFC)

• The federal government requires that the Securities and Exchange Commission (SEC) monitor the largest financial advisors


• Your Role in the Investment Process – it’s a continual process, even if you have a financial planner you shouldn’t ignore your money1. Evaluate Potential Investments2. Monitor the Value of Your Investments – helps you

to know if you’ve made money or not3. Keep Accurate and Correct Records - helps you

spot opportunities to increase profits4. Tax Considerations – investment income falls into

three categories:


• Your Role in the Investment Process continued4. Tax Considerations – investment income falls

into three categories:A. Tax exempt income – income that is not taxed; most

interest you receive from state and municipal bonds is exempt

B. Tax-deferred income – income taxed later; most common is on a traditional individual retirement account (IRA)

C. Taxable – all other investments


• Your Role in the Investment Process continued4. Tax Considerations continued• You have to pay tax on dividends, Interest income,

and rental income:– Cash dividends– Interest from banks, credit unions, and savings and loans

associations– Interest from bonds (unless tax exempt), promissory notes,

loans, and U. S. Securities– Rental property


• Your Role in the Investment Process continued4. Tax Considerations continued• Capital Gains and Capital Losses

– Capital gains –profit from the sale of an asset such as stock, bonds, or real estate. Taxed according to whether they are short term or long term.» Short term – owned for 12 months or less» Long term – owned for 12 months or more

– Capital loss – sale of an investment for less than its purchase price


• Sources of Investment Information– The Internet and Online Computer Services– Newspapers and News Programs – Wall Street Journal and

CNN Financial– Business Periodicals and Government Publications –

Barron’s, Business Week, Forbes, Fortune, Harvard Business Review, and the Federal Reserve Bulletin (much of it is free)

– Corporate Reports – businesses must provide investors with a prospectus (a document that discloses information about a company’s earnings, assets & liabilities, its products or services, and the qualifications of its managers)


• Sources of Investment Information– Statistical Averages – indicates whether the category it

measures is increasing or decreasing; won’t pinpoint the value of any specific investment but will show the general direction of stocks, bonds, mutual funds, and so on.• Dow Jones Industrial Average or Standard & Poor’s 500

Stock Index

– Investor Services – stockbrokers and financial planners periodically mail a free newsletter to their clients• Moody’s Investor Service sells subscription newsletters

the fundamentals of investing chapter 8. 8.1 preparing for an investment program establishing your...

Documents

investment program factors

investment goals plan

retirement slide

risk factor

risk safety

house slide

low risk

financial market risk