Chapter 13 Investing Fundamentals Chapter 13 Investing Fundamentals.

Chapter 13

Investing Fundamentals

Chapter 13

Investing Fundamentals

Chapter 13Learning ObjectivesDescribe why you should establish an

investment programAssess how safety, risk, income, growth and

liquidity affect your investment decisionsExplain how asset allocation and different

investments alternatives affect your investment plan

Recognize the importance of your role in a personal investment program

Use various sources of financial information that can reduce risks and increase investment returns

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Preparing for an Investment Program Objective 1: Describe why you should

establish an investment programESTABLISHING INVESTMENT GOALS

-- accumulating retirement funds

-- enhancing current income

-- saving for major expenditures

-- sheltering income from taxes

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Preparing for an Investment ProgramObjective 1: Describe why you should

establish an investment program

ESTABLISHING INVESTMENT GOALSFinancial goals should be specific and

measurable. To develop your goals ask yourself. . . What will you use the money for?How much 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?

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Preparing for an Investment Program (continued)

What possible economic or personal conditions could alter your investment goals?

Given your economic circumstances, are your investment goals reasonable?

Are you willing to make the sacrifices necessary to meet your investment goals?

What will the consequences be if you don’t reach your investment goals?

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PERFORMING A FINANCIAL CHECKUPWork to balance your budget

Do your regularly spend more than you makePay off high interest credit card debt firstStart an emergency fund you can access

quicklyThree to nine months of living expenses

Have access to other sources of cash for emergenciesLine of credit is a short-term loan approved

before the money is neededCash advance on your credit card

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GETTING THE MONEY NEEDED TO START AN INVESTMENT PROGRAM

How badly do you want to achieve your investment goals

Are you willing to sacrifice some purchases to provide financing for your investments

What do you valueParticipate in elective savings programs

Payroll deduction or electronic transferMake extra effort to save one or two months each yearTake advantage of gifts, inheritances, and windfalls

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The value of long term investment program

After graduation, you plan to invest $200 per

month in the stock market. If you earn 6% per

year on your stocks, how much will you have

accumulated after 10 years?

Use time value of money calculation:

pmt = 200, I = 6/12 = 0.5, n = 10*12 = 120 FV = ?

FV = $32,775

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The value of long term investment programAfter graduation, you plan to invest $400 per

month in the stock market. If you earn 6% per year on your stocks, how much will you have accumulated after 15 years?


pmt = 400, I = 6/12 = 0.5, n = 15*12 = 180 FV

= ?

FV = $116,327

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month in the stock market. If you earn 12% per year on your stocks, how much will you have accumulated after 15 years?


pmt = 400, I = 12/12 = 1, n = 15*12 = 180 FV

= ?

FV = $199,832

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month in the stock market. If you earn 12% per year on your stocks, how much will you have accumulated when you retire in 30 years?


pmt = 400, I = 12/12 = 1, n = 30*12 = 360 FV

= ?

FV = $1,397,985

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Comparison:

$200, 6%, 10 years 32,775

$400, 6%, 15 years 116,327

$400, 12%, 15 years 199,832

$400, 12%, 30 years 1,397,985

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Factors Affecting the Choice of Investments

Objective 2: Assess how safety, risk, income, growth, and liquidity affect your investment decisions

Safety and risk

Safety in any investment means minimal risk

of loss

Risk means a measure of uncertainty about

the outcome

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14

Company A

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

0.45

0.5

4 8 12

Company B

0

0.02

0.04

0.06

0.08

0.1

0.12

0.14

0.16

0.18

0.2

-10 -5 0 5 10 15 20 25 30


To get a general idea of a stock’s price

variability, we could look at the stock’s price

range over the past year.

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52 weeks Yld Vol NetHi Lo Sym Div % PE 100s Hi Lo Close Chg134 80 IBM .52 .5 21 143402 98 95 9549 -3

115 40 MSFT … 29 558918 55 52 5194 -475

Factors Affecting the Choice of InvestmentsInvestments range from very safe to very risky

Annual Rates of Return 1926-2002 Standard Deviation Real Average

ReturnSmall- 33.2% 13.8% Stock Large- 20.5 9.1 StockLong-term 8.7 3.1 Corp-bond Long-term 9.4 2.7 Gov-bond U.S. Tre-bill 3.2 0.7

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The potential return on any investment should

be directly related to the risk the investor

assumes

Speculative investments are high risk

The Risk-Return Trade-Off

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Factors Affecting the Choice of Investments (continued)

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Calculate return on an investmentRate of return: income you receive on an

investment over a specific period of time divided by the original amount invested

Buy 1000 shares of Microsoft at $25, sell it at $30 a year later, and you receive $1 dividend per share. What is the rate of return for this investment?

Capital gain: 1000 * (30-25) = $5,000Dividend: $1*1000 = $5,000Total income: 5000 + 5000 = $10,000Rate of return : 10,000 / (25* 1000) = 40%

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COMPONENTS OF THE RISK FACTORInflation risk - during periods of high inflation

your investment return may not keep pace with the inflation rate

Interest rate risk - you may invest in a bond at a 6%, rates later go up to 8%; your bond price falls

Business failure risk - bad management or products affect stocks and corporate bonds and mutual funds that invest in stock

Market risk - prices fluctuate because of behaviors of investors

Global investment risk - changes in currency affect the return on your investment

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INVESTMENT INCOMESafest investments – predictable income

Savings accounts and certificates of depositU.S. savings bondsUnited States treasury bills

Higher potential income investments include…Municipal bondsCorporate bondsPreferred stocks and income common stocksIncome mutual fundsReal estate rental property

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INVESTMENT GROWTHGrowth means investment will increase in value

Common stockGrowth companies pay little or no dividends,

but reinvest in the company Mutual funds, government and corporate

bonds, and real estate offer growth potentialGemstones and collectibles - more

speculative

INVESTMENT LIQUIDITYAbility to buy or sell an investment quickly

without substantially affecting the investment’s value; e.g. Real estate is not a very liquid investment 22

Asset Allocation and Investment Alternatives Asset Allocation

The process of placing your assets among several types of investments which lessens your investment risk

Types of assets -- stocks of large corporations -- stocks of medium-sized corporations -- stocks of small companies -- foreign stocks -- bonds -- cash

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Asset Allocation and Investment Alternatives (contined)

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Time FactorThe longer that you are invested the

better your returns

Your AgeThe type and style of your

investments should change with your age

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Asset Allocation and Investment AlternativesInvestment alternatives

Stock or equity financingEquity capital is provided by stockholders

who buy shares of a company’s stock. Stockholders are owners and share in the

success of the company.A corporation is not required to repay the

money obtained from the sale of stock.The corporation is under no legal obligation

to pay dividends to stockholders: they may instead retain all or part of earnings.

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Asset Allocation and Investment Alternatives (continued)

CORPORATE AND GOVERNMENT BONDS

A bond is a loan to a corporation, the federal government, or a municipality

Bondholders receive periodic interest payments, and the principal is repaid at maturity (1-30 years)

Bondholders can keep the bond until maturity or sell it to another investor before maturity

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Mutual fundsInvestors’ money is pooled and invested by a

professional fund manager

You buy shares in the fund

Provides diversification to reduce risk

Funds range from conservative to extremely speculative

Match your needs with a fund’s objective

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REAL ESTATEThe goal of a real estate investment is to buy a

property and sell it at a profit. Nationally, 3% appreciation in price a year is average.

Location, location, location is important.Before you buy real estate...

Is the property priced competitively?What type, if any, of financing is available?How much are the taxes?What is the condition of the buildings and houses

in the immediate area?Why are the present owners selling?Could the property decrease in value?

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OTHER SPECULATIVE INVESTMENTSSpeculative investments

A speculative investment is a high-risk investment made in the hope of earning a relatively large profit in a short time Typical speculative investments include: Antiques and collectibles Call and put options Derivatives Commodities Coins and stamps Precious metals and gemstones

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A Personal Plan for Investing Establish realistic goalsDetermine the amount of money needed to

meet your goalsSpecify the amount of money available to fund

your investmentsList different investments you want to

evaluateEvaluate risk and potential return for eachReduce possible investments to a reasonable

numberChoose at least two different investmentsContinue to evaluate your investment

program 33

Factors that Reduce Investment RiskObjective 4: Recognize the importance

of your role in a personal investment program

YOUR ROLE IN THE INVESTMENT PROCESS

Evaluate potential investments

Seek the assistance of a financial planner (see Appendix at the back of the text)

Monitor the value of your investments

Keep accurate and current records

Consider the tax consequences of selling your investments

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Sources of Investment InformationObjective 5: Use the various sources of

financial information that can reduce risks and increase the investment returns

The Internet A wealth of investment information is availableView sites such as www.fool.com and

www.money.cnn.com Newspapers and news programsBusiness periodicals such as Smart Money and

government publicationsCorporate ReportsInvestor services and newsletters, such as

ValueLine or Morningstar and financial calculators35

Chapter 13 Investing Fundamentals Chapter 13 Investing Fundamentals.

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