Chapter 13: Investment Fundamentals and Portfolio Management

Objectives Summarize reasons why people invest, what is required before beginning, how returns are earned, and some ways to obtain funds to invest. Determine your own investment philosophy. Recognize the variety of investments available. Identify the major factors that affect the return on investment. Specify some strategies of portfolio management for long-term investors. List three guidelines to use when deciding the best time to sell investments.

Establishing Investment Goals Financial goals should be specific and measurable. Why are you accumulating these funds? How much do you need? How will you get it? How long will it take you to reach your goal? How much risk are you willing to assume? Are you willing to sacrifice current consumption to invest for the future? Is it realistic to try and save this amount?

Steps to Create a Personal Investing Plan My investment goals are: ____________________ Step 2 By ___________, I will have obtained $_______. Step 3 I have $__________ available to invest. Date _____________ Step 9 Continue evaluating choices. Step 4 Possible investment alternatives: 1._________________ 2._________________ 3._________________ 4._________________ Step 8 Final decision 1._______________ 2._______________ Step 6 Projected return on each alternative 1.__________ 2.__________ 3.__________ 4.__________ Step 5 Risk factors for each alternative 1.____________________ 2.____________________ 3.____________________ 4.____________________ Step 7 Investment decision 1._______________ 2._______________ 3._______________

Investment Fundamentals ATTENTION! Difference in return is a major distinction between savings and investing. Successful investors begin to live off earnings, without spending wealth itself.

Preparations for Investing WHY PEOPLE INVEST: Achieve financial goals Increase current income Gain wealth and financial security Have funds available for retirement

Preparations for Investing PREREQUISITES TO INVESTING: Live within means Continue savings program Establish lines of credit Carry adequate insurance Establish investment goals

Preparations for Investing Interest Dividends Rent Capital gain/loss Rate of return or yield INVESTMENT RETURNS:

Performing a Financial Checkup Learn to live within your means pay off high interest credit card debt Provide adequate insurance protection Start an emergency fund three to nine months of living expenses Have other sources of cash for emergencies line of credit cash advance

Getting Money to Start an Investing Program Pay yourself first Participate in elective savings programs Payroll deduction electronic transfer Make a special effort to save one or two months a year Take advantage of windfalls Invest half of your tax refund

Value of Having a Long-Term Investing Program Many people don’t start investing because they only have a small amount to invest but.... Small amounts invested regularly become large amounts over time

Personal Investment Philosophy Handling risk Ultraconservative strategies Conservative Moderate Aggressive

Investment Selection Lend or own Short-term or long-term Choose a vehicle

Factors That Affect Investment Decisions Safety - minimal risk of loss Risk - uncertainty about the outcome inflation risk interest rate risk business failure risk market risk

Income From Investments Safest CDs savings bonds T-bills Higher potential income municipal bonds corporate bonds preferred stocks mutual funds real estate

Investment Growth and Liquidity increase in value common stock growth stocks retain earnings bonds, mutual funds and real estate Liquidity ease and speed to convert an asset to cash

Commodities Junk bonds Options Investment Pyramid High risk Commodities Junk bonds Options Rental property Utility stocks Government Securities Corporate bonds CDs Money Market Savings Accounts Cash High Quality Stocks Mutual funds Low risk

Major Factors That Affect Rate of Return INVESTMENT RISK: Pure Speculative Risk pyramid

Major Factors That Affect Rate of Return INVESTMENT RISK TYPES: Financial Market volatility Political Inflation Deflation Interest rate

Major Factors That Affect Rate of Return INVESTMENT RISK: Random or unsystematic Diversification Market or systematic

Major Factors That Affect Rate of Return Leverage Taxes Marginal tax rate Taxable vs. tax-free income Buying and selling costs/commissions Inflation

Major Factors that Affect Rate of Return CALCULATE REAL RATE OF RETURN: Identify before-tax return Subtract marginal tax rate Obtain net return after taxes Subtract estimate of inflation Obtain real rate

Management Strategies — Long-Term Investors Business-cycle timing Dollar-cost averaging Portfolio diversification Asset allocation

Investment Alternatives What is stock? part ownership in a company the money you pay for shares of stock provides equity capital for the business

Investment Alternatives (continued) What is a bond? a loan to a corporation, the federal government, or a municipality The interest is paid twice a year, and the principal is repaid at maturity (1-30 years) You can keep the bond until maturity or sell it to another investor

Investment Alternatives (continued) What is a mutual fund? 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

Monitor Your Investments Read your account statements Chart the value of your investments Maintain accurate and current records Calculate the current yield % annual income from investment market value of the investment

Sources of Investment Information Newspapers Business Periodicals Government Publications Corporate Reports Statistical Averages Investor Services and newsletters Standard and Poor’s stock reports Value Line Moody’s investment service

Investment Philosophies

Best Time to Sell Take profits Cut losses “If wouldn’t buy it now, sell it”