CHAPTER 13

Investing

•Describe why you should establish an investment program

•Assess how safety, risk, income, growth and liquidity affect your investment decisions

•Explain 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

Chapter 13 Learning Objectives

5 Important ?’s of Investing Fundamentals

1. How does money grow?

2. Why should I invest?

3. When should I invest?

4. What are the risks to investing?

5. What are the ways that I can invest my money?

Why establish an investment program….

Make your money work for you!Establish an investment program by establishing investment goals that are specific and measurable. Take into consideration:

Length of goal Personal conditions Economic circumstance Sacrifice

Perform a financial checkup Budget Cash Flow Net Worth (Refer to Chapter 3)

Cost of Waiting One Year

6

Preparing for an Investment Program

Objective 1: Describe why you should establish an investment program

ESTABLISHING INVESTMENT GOALS Financial 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?

7

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?

8

Preparing for an Investment Program (continued)

PERFORMING A FINANCIAL CHECKUP Work to balance your budget

Do you regularly spend more than you make Pay off high interest credit card debt first Start an emergency fund you can access quickly

Three to nine months of living expenses Have access to other sources of cash for

emergencies Line of credit is a short-term loan approved before the money is needed

Cash advance on your credit card

9

Preparing for an Investment Program (continued)

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 value? Participate in elective savings programs

Payroll deduction or electronic transfer Make extra effort to save one or two months each year Take advantage of gifts, inheritances, and windfalls

Obtaining Money to Establish an Investment Program

11

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 Investments range from very safe to very risky 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

Diversification - Investing in a variety of securities

Complete –Risk Tolerance Quiz (Text Page 434)

12

Factors Affecting the Choice of Investments (continued)

COMPONENTS OF THE RISK FACTOR

Inflation 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

13

Factors Affecting the Choice of Investments (continued)

INVESTMENT INCOME

Safest investments – predictable income Savings accounts and certificates of deposit U.S. savings bonds United States treasury bills

Higher potential income investments include… Municipal bonds Corporate bonds Preferred stocks and income common stocks Income mutual funds Real estate rental property

14

Factors Affecting the Choice of Investments (continued)

INVESTMENT GROWTH Growth means investment will increase in value

Common stock Growth companies pay little or no dividends, but reinvest in the company

Mutual funds, government and corporate bonds, and real estate offer growth potential

Gemstones and collectibles - more speculative

INVESTMENT LIQUIDITY Ability to buy or sell an investment quickly without substantially affecting the investment’s value; e.g. Real estate is not a very liquid investment

15

Asset Allocation and Investment Alternatives

Objective 3: Explain how asset allocation and different investment alternatives affect your investment plan

Stock or equity financing Equity 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.

16

Asset Allocation and Investment Alternatives (continued)

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

Time Factor The longer that you are invested the better your returns

Your Age The type and style of your investments should change with your age

17

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

18

Asset Allocation and Investment Alternatives (continued)

MUTUAL FUNDS Investors’ 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

19

Asset Allocation and Investment Alternatives (continued)

REAL ESTATE The 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?

20

Asset Allocation and Investment Alternatives (continued)

OTHER SPECULATIVE INVESTMENTS Speculative 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

21

A Personal Plan for Investing

Establish realistic goals Determine the amount of money needed to

meet your goals Specify the amount of money available to

fund your investments List different investments you want to

evaluate Evaluate risk and potential return for each Reduce possible investments to a reasonable

number Choose at least two different investments Continue to evaluate your investment

program

22

Factors that Reduce Investment Risk

Objective 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

Monitor the value of your investments

Keep accurate and current records

Consider the tax consequences of selling your investments

Factors Affecting the Choice of Investments

Investopedia.com videoInvestment Pyramid (Page 439)

Factors Affecting the Choice of Investments

Factors to Be Evaluated - Page 443

25

Sources of Investment Information

Objective 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 available View sites such as www.fool.com and www.money.cnn.com

Newspapers and news programs Business periodicals such as Smart Money and

government publications Corporate Reports Investor services and newsletters, such as

ValueLine or Morningstar and financial calculators

Pennies Make Dollars

PAY Yourself 1st

Enforce the 80 – 20 plan of savings Take into consideration making a sacrifice today for wealth tomorrow The Earl Crawly Story

Start Early – START NOW! Financial impact of giving up one soft drink daily

Calculate the Rate of Return

The total income you receive on an investment over a specific period of time divided by the original amount.

Steps:1. Subtract the investment’s initial value from

the investment’s value at the end of the year.

2. Add annual income to the amount calculated in Step 1.

3. Divide the total dollar amount of return calculated in Step 2 by the original investment.

Example Rate of Return Page 432

Assume that at the beginning of the year, you purchased an investment for $3,000 that pays you $50 annual income. Also assume the investment’s value has increased to $3,275 by the end of the year.1. Subtract the investment’s initial value from the

investment’s value at the end of the year.$3,275 - $3,000= $275

2. Add annual income to the amount calculated in Step 1.

$275 + 50 = $3253. Divide the total dollar amount of return

calculated in Step 2 by the original investment.$325/$3,000=10.8%

Your Rate of Return is: a Positive 10.8%