investing
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Investing
Capital Markets Program
Capital Markets Program
Saving Must Be a Priority• A little can really add up!
• Save $ per week at % interest in 10 years you’ll have$7.00 5% $4,720
14.00 5% $9,440
21.00 5% $14,160
28.00 5% $18,880
35.00 5% $23,600
• You can buy … a fast food meal or one movie ticket or … You can save $7.00 this week.
• You can buy … one large pepperoni pizza, delivered or one new CD or … You can save $14.00 this week.
• What will you give up to attain your financial goals?
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Capital Markets Program
The Rule of 72
How many years will it take to double my money?
72 DIVIDED BY = YEARS TO DOUBLE MONEY
INTEREST RATE
• A 6% rate of return will double my money every 12 years (72 / 6)
At what interest rate will my money double in a set number of years?
72 DIVIDED BY = INTEREST RATE REQUIREDYEARS TO DOUBLEA SUM OF MONEY
• To double my money in 9 years requires a rate of return of 8% (72 / 9)
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Capital Markets Program
Types of Savings AccountsPassbook Account• Depositor receives a booklet in which deposits, withdrawals, and interest
are recorded.• Funds are easily accessible.
Statement Account• Basically the same as a passbook account, except depositor receives
monthly statements instead of a passbook.• Accounts accessible through 24-hour automated teller machines
(ATMs).• Interest rates are the same as passbook account.• Funds are easily accessible.
Interest-Earning Checking Account• Combines benefits of checking and savings.• Depositor earns interest on any balances in his/her account.• Interest rates are typically lower than passbook and statement savings
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Capital Markets Program
Money-Market Accounts
What they are and how they work• Checking/savings account, where bank invests funds in high-quality,
liquid, short-term debt securities (i.e. money market securities).• Interest rate varies with size of balance and current level of market
interest rates.• Can access your money from an ATM, a teller, or by writing up to
three checks a month.
Benefits• Immediate access to your money.• Average yield (rate of return) higher than regular savings accounts.
Trade-offs• Usually requires a minimum balance of $1,000 to $2,500.• Limited number of checks can be written each month.
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Capital Markets Program
Certificates of Deposit (CDs)
What they are and how they work• Bank pays a fixed interest rate for a fixed amount of time.
Benefits• No risk (FDIC/FSLIC insured).• No fees.• Offers higher interest rates than savings and money market accounts.
Trade-offs• Restricted access to your money.• Withdrawal penalty if cashed before expiration date.
Special certificates of deposit• Indexed CDs – e.g. earnings based on stock market performance.• Promotional CDs – attempt to attract savers with gifts or special rates.
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Capital Markets Program
Bonds (Debt)
What they are and how they work• A bond is an “IOU,” certifying that you loaned money to a government
or corporation and outlining the terms of repayment.• Bond generally pay a fixed rate of interest (coupon) paid periodically
(e.g. semiannually) for a stated period of time (bond maturity).• When the time is up and the bond has “matured”, the bond is redeemed
for the full face (par) value (investor receives coupon and par amount).
Benefits• Senior claim on the issuer, often secured by assets (i.e. collateralized)• Potentially stable source of income
Trade-offs• Limited upside• Potential market risk (bond prices and market rates are inversely related)
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Capital Markets Program
Bonds (Debt)
Corporate• Sold by private companies to raise money.
• If company goes bankrupt, bondholders have first claim on the assets, before stockholders and even the IRS. Claims may be secured by specific assets of the firm.
Municipal• Issued by any non-federal government entity (e.g. state and local
governments, school districts, transportation authorities, etc).
• Interest paid comes from taxes or from revenues from special projects.
• Earned interest is exempt from federal income tax.
Federal government• The safest investment you can make. Default risk-free securities.
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Capital Markets Program
Stocks (Equity)
What they are and how they work• Stock represents ownership of a corporation. Stockholders are entitled to a
share of the profits as well as to a vote in how the company is run.• Company profits may be divided among shareholders in the form of
dividends. Dividends are usually paid quarterly.• Larger profits can be made through an increase in the value of the stock on
the open market (i.e. capital appreciation).
Advantages• If the market value goes up, the gain can be considerable.• Money is easily accessible (assuming publicly-traded shares).
Trade-offs• If market value goes down, the loss can be considerable.• Selecting and managing stock often requires study and the help of a good
brokerage firm or fund manager.
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Capital Markets Program
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Stocks (Equity)
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Capital Markets Program
Mutual Funds
What they are and how they work• Professionally managed portfolios of stocks, bonds, and other investments.
• Individuals buy shares, and the fund uses the money to purchase stocks, bonds, and other investments.
• Profits returned to shareholders monthly, quarterly, or semi-annually in the form of dividends and capital gains.
Advantages• Allows small investors access to professional account management, and
• Broad portfolio diversification, normally only available to large investors.
Trade-offs• Management fees can be high
• Liquidity may be limited (i.e. penalties for early withdrawal)
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Capital Markets Program
Mutual Funds• Balanced Fund includes a variety of stocks and bonds.
• Indexed Fund includes a variety of stocks designed to track the market.
• Global Bond Fund has corporate bonds from around the world.
• Global Stock Fund has stocks from companies in many parts of the world.
• Growth Fund emphasizes companies that are expected to increase in value (i.e. capital appreciation); also has higher risk.
• Income Fund features stock and bonds with high dividends and interest.
• Industry Fund invests in stocks of companies in a single industry (such as technology, health care, banking).
• Municipal Bond Fund features debt instruments of state and local governments; generates tax-exempt income.
• Regional Stock Fund involves stocks of companies from one geographic region of the world (e.g. Asia, Latin America, emerging markets, etc).
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Capital Markets Program
Real EstateWhat it is and how it works• Buy a house, live in it, and sell it later at a profit.• Buy income property (such as an apartment house or a commercial
building) and rent it.• Buy land and hold it until it rises in value.
Advantages• Provides protection against inflation.• Interest expenses are tax deductible.• Excellent means of investment portfolio diversification.
Trade-offs• Can be difficult to convert into cash (i.e. illiquid asset).• A specialized investment requiring study and knowledge of business.• Financing is critical.
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Capital Markets Program
Taxes
• Interest earned on savings accounts, CDs, bonds and any other debt securities is taxed as ordinary income (i.e. taxed at the personal marginal tax rate of up to 35.9%).
• Dividends earned on stock are taxed as ordinary income.
• Realized price appreciation of securities (i.e. when a security or real estate investment increases in market value and the investor sells) is called capital gains.
• If the security or real estate investment is held by the investor for at least 1 year prior to the sale, capital gains are taxed at the long-term capital gains rate of only 15%.
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Capital Markets Program
Retirement Plans
What they are and how they work• Tax-advantaged plans that help individuals save for retirement.
• Corporate pensions are largely a thing of the past.
• Today, corporations tend to encourage personal retirement savings by matching the employee’s contributions to their retirement plan (up to some limit).
• The individual saves while employed and self-directs the investments within the plan.
• Penalty charges apply if money is withdrawn before retirement age (usually 59.5 years old), except under certain circumstances, including:– account owner becomes disabled
– educational expenses
– purchase of a first home
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Capital Markets Program
Retirement PlansIndividual Retirement Account (IRA)• Allows a person to contribute up to $4,000 of “pre-tax” earnings per year.• Funds are taxable when withdrawn from account at retirement.
Roth IRA• While the $4,000 maximum annual contribution to this plan is not “tax
deductible”, the earnings on the account are tax-free after five years.
401(k)• Allows a person to contribute up to $15,000 to a savings plan from his or
her “pre-tax” earnings, reducing the amount of tax that must be paid.• Employer matches employee contributions up to a certain level.• Roth 401(k) plans are now available.
Keogh Plan• Allows a self-employed person to save up to 20% of “pre-tax” income
(but not more than $44,000 per year).
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Capital Markets Program
Retirement Plans – ExampleQ: How do you make a small fortune in the market?A: Start with a large fortune.
Day traders are in and out of investments very quickly. They look for one-off opportunities to make significant profits. While some prosper, most do not. Day trading is effectively gambling.
Investing, on the other hand, is a disciplined, long-term strategy built upon strong fundamentals. So a more serious answer to our question:
Q: How do you make a small fortune in the stock market?A: Commit to a disciplined, long-term investment strategy.
Let’s look at an example of such a strategy:Personal Wealth Calculator
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Capital Markets Program
Strategy
Diversification
• Investors can maintain their expected returns but eliminate about 40% of their risk via diversification.
• All rational investors diversify their portfolios.
Risk
# of Stocks40
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Capital Markets Program
Strategy
Management
• Efficient Market Hypothesis.
– Generating above market returns generally requires taking above market risks (the risk / return trade-off). There are no free lunches.
– Over 40,000 PhD, MBA and CFA finance professionals worldwide.
• Managed funds generally do not outperform the market over the long-run.
– Basic balanced funds can be an exception.
• Consequently, practical advice and guidance can be valuable, but paying large management fees does not usually lead to above market returns.
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Capital Markets Program
StrategyConclusion• Invest in mutual funds to attain diversification.
• Specifically, invest in index funds and “basic” balanced funds (low management fees).
• Include international stocks and bonds in your portfolio.
• Some portion of your portfolio should be in cash as well (e.g. T-bills, money market accounts, CDs, etc.).
• Moreover, you should consider including real estate in your investment portfolio (increased diversification).
• Do not make investment decisions driven primary by taxes, but understand the tax implications.
• Take advantage of all opportunities to save for retirement.
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Capital Markets Program
Appendix: Comparing Plans
instrument maturity risk yield minimum $ taxable?
Savings Account Immediate None if insured Low $5 Yes
CD 90 days or more None if insured Moderate Varies Yes
Bonds
Corporate 5–30 years Some Moderate $1,000 Yes
Municipal 1–20 years Some Moderate $5,000 No federal
U.S. Treasury
Bills 1 year or less None Moderate $10,000 Federal only
Notes 1–10 years None Moderate $1,000 Federal only
Bonds 10–30 years None Moderate $1,000 Federal only
Stocks Perpetuities Low to high Low to high Varies Yes
Mutual Funds Varies Low to high Low to high Varies Usually
Retirement Funds
When buyer is
59.5 years old
Low to high Low to high Varies Varies(Std vs. Roth)
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