1. Understanding Personal Finances and Investments
Chapter Twenty
Understanding Personal Finances and Investments

2. Learning Objectives
Explain why you should manage your personal finances and develop a personal investment program.
Describe how the factors of safety, risk, income, growth, and liquidity affect your investment decisions.
Understand how securities are bought and sold.
Identify the advantages and disadvantages of savings accounts, bonds, stocks, mutual funds, and real estate.
Describe high-risk investment techniques.
Use financial information to evaluate investment alternatives.
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3. Chapter 20 Outline Preparing for an Investment Program
Managing Your Personal Finances
Investment Goals
A Personal Investment Program
Important Factors in Personal Investment
How Securities Are Bought and Sold
The Primary Market
The Secondary Market
The Role of an Account Executive
Regulation of Securities Trading
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4. Chapter 20 Outline (cont’d)
Traditional Investment Alternatives
Portfolio Management
Asset Allocation, the Time Factor, and Your Age
Bank Accounts
Corporate and Government Bonds
Common Stock
Preferred Stock
Mutual Funds
Real Estate
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5. Chapter 20 Outline (cont’d)
High-Risk Investment Techniques
Selling Short
Buying Stock on Margin
Other High-Risk Investments
Sources of Financial Information
The Internet
Financial Coverage of Securities Transactions
Other Sources of Financial Information
Security Averages
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6. Preparing for an Investment Program
Managing Your Personal Finances
The use of your personal funds to earn a financial return
Personal budget is a specific plan for spending income
Investment goals
Personal investment goals must be
Specific and measurable
Tailored to individual needs
Focused on the future
Realistic in terms of economic conditions and opportunities
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7. Preparing for an Investment Program (cont’d)
Questions to consider when establishing goals
What financial goals do you want to achieve?
How much money will you need, and when?
What will you use the money for?
Is it reasonable to assume that you can obtain the amount of money you will need to meet your investment goals?
Do you expect your personal situation to change in a way that will affect your investment goals?
What economic conditions could alter your investment goals?
Are you willing to make the necessary sacrifices to ensure that your investment goals are met?
What are the consequences of not obtaining your investment goals?
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8. Preparing for an Investment Program (cont’d)
A personal investment program
Involves a careful evaluation of different investment opportunities
Financial planner
Begin by accumulating an emergency fund
Invest funds according to your plan
Monitor the plan
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9. Preparing for an Investment Program (cont’d)
Suggestions to help you accumulate the money needed to fund an investment plan
Learn to balance your budget
Make savings a higher priority
Take advantage of employer-sponsored retirement programs
Participate in an elective savings program
Make a special savings effort one or two months each year
Take advantage of gifts, inheritances, and windfalls
Source: Jack R. Kapoor, Les R. Dlabay, and Robert J. Hughes, Personal Finance, 9th ed. Copyright © 2009 by The McGraw Hill Companies, Inc. .
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10. Important Factors in Personal Investment
Match potential investments with your goals in terms of several factors
Safety and risk
Investment income
Investment growth
Investment liquidity
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11. Surviving a Financial Crisis
To survive a financial crisis, many experts recommend that you take action before the crisis to make sure your financial affairs are in order
Seven steps you can take
Establish a larger than usual emergency fund
Know what you owe
Reduce spending
Pay off credit cards
Apply for a line of credit at your bank, credit union, or financial institution
Notify credit card companies and lenders if you are unable to make payments
Monitor the value of your investment accounts
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12. How Securities Are Bought and Sold
Securities are usually exchanged with the help of an account executive or stockbroker
The primary market
A market in which an investor purchases financial securities (via an investment bank) directly from the issuer of those securities
Investment banking firm
High-risk investment
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13. How Securities Are Bought and Sold (cont’d)
The secondary market
A market for existing financial securities that are traded between investors
Securities exchange
Over-the-counter (OTC) market
Nasdaq
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14. How Securities Are Bought and Sold (cont’d)
The role of an account executive
An individual, sometimes called a stockbroker or registered representative, who buys and sells securities for clients
Full-service broker
Discount broker
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15. How Securities Are Bought and Sold (cont’d)
The mechanics of a transaction
Market order
Limit order
Discretionary order
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16. How Securities Are Bought and Sold (cont’d)
Online security transactions
Software can help investors evaluate potential investments, manage investments, monitor value, and place buy and sell orders online
Investors must still analyze the information and make decisions
Online trading generally has lower costs
Program trading—a computer-driven program that monitors the market value of particular stocks and enters buy or sell orders when those stocks reach specified prices
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17. How Securities Are Bought and Sold (cont’d)
Commissions
Most brokerage firms have a minimum commission
Additional commission charges are based on the number of shares and the value of stock bought and sold
Generally, online transactions are less expensive when compared to trading through a full-service brokerage firm
Full-service brokerages charge a percentage of the transaction amount (as much as 1.5 to 2.0%)
Commissions for bonds, commodities, and options are lower than for stocks
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18. Regulation of Securities Trading
A regulatory pyramid of four different levels exists to make sure investors are protected
1st level: Federal regulation by the U.S. Congress
2nd level: Securities and Exchange Commission (SEC)
3rd level: State regulation
4th level: Self-regulation by securities exchanges and brokerage firms
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19. Traditional Investment Alternatives
Portfolio management
Asset allocation, the time factor, and your age
Asset allocation
The time factor
Age
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20. Traditional Investment Alternatives (cont’d)
Bank accounts
Advantages
Disadvantage
Corporate bonds
Convertible bonds
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21. Traditional Investment Alternatives (cont’d)
Government bonds
Considered risk free; pay low interest
Treasury bills
Treasury notes
Treasury bonds
Savings bonds
Municipal bonds
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22. Traditional Investment Alternatives (cont’d)
Common stock
Dividend income
Stock dividend
Dividend payments
Increase in dollar value
Capital gain
Market value
Stock splits
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23. Traditional Investment Alternatives (cont’d)
Preferred stock
Stock in a corporation that has a claim on the dividends that supersedes common stock
Cumulative preferred stock
Convertible preferred stock
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24. Traditional Investment Alternatives (cont’d)
Mutual funds
A professionally managed investment vehicle that combines and invests the funds of many individual investors
Closed-end funds
Open-end funds
Net asset value (NAV)
Net asset value
Value of the fund’s portfolio – Liabilities Number of shares outstanding =
Current market value of a mutual fund’s portfolio minus the mutual fund’s liabilities and divided by the number of outstanding shares
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25. Traditional Investment Alternatives (cont’d)
Mutual funds (cont.)
Load funds
No-load funds
Yearly management fee
Managed funds
Index funds
Family of funds
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26. Traditional Investment Alternatives (cont’d)
Types of mutual fund investments
Aggressive growth stock funds
Global stock funds
Growth stock funds
High-yield (junk) bond funds
Income stock funds
Index funds
Long-term U.S. bond funds
Sector stock funds
Small-cap stock funds
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27. Traditional Investment Alternatives (cont’d)
Real estate
Advantages
Disadvantages
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28. High-Risk Investment Techniques
Buying long
Buying stocks expected to increase in value, which can then can be sold at a profit
Selling short
The process of selling stock that an investor does not actually own but has borrowed from a brokerage firm and will repay at a later date
Buying stock on margin
Buying stock by borrowing part of the purchase price, usually from a stock brokerage firm
Margin requirement
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29. High-Risk Investment Techniques (cont’d)
Other high-risk investments
Stock options
Commodities
Precious metals
Gemstones
Coins
Antiques and collectibles
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30. Sources of Financial Information
The Internet
Newspaper coverage of securities transactions
Common and preferred stocks
Bonds
Mutual funds
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31. Sources of Financial Information
Other sources of financial information
Investors’ services
Moody’s, Standard & Poor’s, Mergent, Value Line, Morningstar, Lipper Analytical Services, Wiesenberger Investment Companies
Brokerage firm analysts’ reports
UBS PaineWebber, Smith Barney, Merrill Lynch
Business periodicals
Business Week, Fortune, Forbes
Advertising Age, Business Insurance
U.S. News & World Report, Time, Newsweek
Money, Kiplinger’s Personal Finance Magazine, Consumer Reports
Corporate reports
A security average (security index) is an average of the current market prices of selected securities
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32. Sources of Financial Information (cont’d)
Security averages
An average of the current market prices of selected securities
Dow Jones Industrial Average
Standard & Poor’s 500 Stock Index
New York Stock Exchange Composite Index
American Stock Exchange Index
Nasdaq Composite Index
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