An Introduction to Investing Fin 302 Spring 2008 James Dow

2/11/08"An Introduction to Investing" Professor Dow, FIN Overview 1. Before You Invest 2. Some Basic Concepts 3. Asset Allocation 4. Investing Using Mutual Funds 5. Investing In Individual Securities 6. Good Habits For Investors

2/11/08"An Introduction to Investing" Professor Dow, FIN Before You Invest Have a Financial Plan Be Properly Insured Have Emergency Funds Determine Your Savings Goals

2/11/08"An Introduction to Investing" Professor Dow, FIN What Are Your Savings Goals? Short-Term Goals Down Payment on a House? Travel? Longer-Term Goals College Education for Children? Retirement?

2/11/08"An Introduction to Investing" Professor Dow, FIN Your Goals Can Affect Your Investing Decisions Short-Term Goals Usually easy to figure out what you need Invest in low-risk assets (more about this later) Long-Term Goals Harder to determine the amount you need Be less conservative with your investments

2/11/08"An Introduction to Investing" Professor Dow, FIN How Much to Save for Retirement Determine Expected Expenditures Sources of Retirement Income Social Security Pensions Individual Savings

2/11/08"An Introduction to Investing" Professor Dow, FIN Calculate Annual Savings Start with needed annual income when you retire. Calculate the amount of savings needed when you retire. Calculate the amount to save each year. Online calculators and FIN 303 can help you.

2/11/08"An Introduction to Investing" Professor Dow, FIN Employer-Sponsored Programs Defined Benefit: Amount paid is guaranteed by the company. It depends on salary and number of years with the company Defined Contribution: Individual makes contributions. Amount paid depends on how well the investments do.

2/11/08"An Introduction to Investing" Professor Dow, FIN Self-Directed Accounts Traditional IRA Roth IRA Keogh Plans Annuities

2/11/08"An Introduction to Investing" Professor Dow, FIN Now What? You know how much you need to save. You’ve signed up for a savings plan with your employer. How do you invest the money?

2/11/08"An Introduction to Investing" Professor Dow, FIN Some Basic Concepts What is Return? What is Risk? What is the Risk-Return Tradeoff? What is Diversification?

2/11/08"An Introduction to Investing" Professor Dow, FIN What is Return? Where do returns come from? Current Income Capital Gains Compounding: Interest earns interest. Returns are uncertain: Investors refer to “expected” or “average” returns.

2/11/08"An Introduction to Investing" Professor Dow, FIN What is Risk? How likely is it that your return will be higher or lower than you expect. Some assets (such as bank accounts) have little risk. Other assets (such as stocks) will have greater risk.

2/11/08"An Introduction to Investing" Professor Dow, FIN What is the Risk-Return Tradeoff? Assets with higher risk will generally offer a higher expected return. You can choose: investments with high risk and high return investments with low risk and low return but probably not low risk and high return

2/11/08"An Introduction to Investing" Professor Dow, FIN There are a range of assets Expected Return Risk Bank Accounts Short-Term Bonds Long-Term Bonds Small-Company Stocks Large-Company Stocks

2/11/08"An Introduction to Investing" Professor Dow, FIN What is Diversification? Don’t put all your eggs in one basket. You can reduce risk without hurting your expected return.

2/11/08"An Introduction to Investing" Professor Dow, FIN Asset Allocation What can you invest in? What is the right mix of investments? Who do you invest with?

2/11/08"An Introduction to Investing" Professor Dow, FIN What Can You Invest In? Bank Accounts Common Stock Bonds Real Estate Other Assets

2/11/08"An Introduction to Investing" Professor Dow, FIN Bank Accounts Are convenient Are insured Are low risk But do not offer the best returns Not the best choice for long-term investing

2/11/08"An Introduction to Investing" Professor Dow, FIN Common Stock A share represents ownership in the company. Stocks generate capital gains (or losses). Stocks may also pay dividends.

2/11/08"An Introduction to Investing" Professor Dow, FIN Bonds An “IOU” issued by companies and governments. Pay interest and can generate capital gains or losses. Less risk than stock but also a lower expected return.

2/11/08"An Introduction to Investing" Professor Dow, FIN Real Estate Income Properties Commercial Properties Residential Properties Single-Family Homes REITs

2/11/08"An Introduction to Investing" Professor Dow, FIN What is the right mix of assets? Asset allocation refers to how you allocate your wealth across different assets. For example: 60% Stocks 30% Bonds 10% Short-Term Assets (Cash)

2/11/08"An Introduction to Investing" Professor Dow, FIN How to determine the best allocation? The appropriate allocation depends on: Your investing horizon Your tolerance for risk You can find programs online that will suggest allocations for you.

2/11/08"An Introduction to Investing" Professor Dow, FIN An Example The Hudsons 30 years until retirement Average tolerance for risk Recommended allocation is 55% stocks 30% bonds 10% real estate 5% cash Malkiel, Random Walk Down Wall Street, 2003

2/11/08"An Introduction to Investing" Professor Dow, FIN Who can you invest with? Mutual Funds Stock Brokers Through Your Employer

2/11/08"An Introduction to Investing" Professor Dow, FIN Investing Using Mutual Funds What are mutual funds? What is a mutual fund family? Why mutual funds? How to invest in mutual funds? What kind of fees are there?

2/11/08"An Introduction to Investing" Professor Dow, FIN What is a Mutual Fund? It is a financial company. Allows small investors to pool their money. Professional managers at the fund choose how to invest the money. They invest in stocks, bonds and other assets.

2/11/08"An Introduction to Investing" Professor Dow, FIN Why Mutual Funds? Advantages Can invest small amounts Easy to be diversified Convenient Professional management Disadvantages Less flexibility in choice of securities May have tax disadvantages

2/11/08"An Introduction to Investing" Professor Dow, FIN What is a Mutual Fund Family? Most mutual fund companies offer a number of different individual funds. Each fund will have it’s own specific investment goals and strategies. You will need to choose which specific funds to invest in.

2/11/08"An Introduction to Investing" Professor Dow, FIN How to Invest? Buy shares in the mutual fund. When you want to collect your return, you redeem your shares (sell them back to the mutual fund).

2/11/08"An Introduction to Investing" Professor Dow, FIN Net Asset Value (NAV) NAV = (value of all the securities in the fund’s portfolio)/(# of shares). Funds generally will sell and redeem shares at the NAV. If the value of the securities increases, the value of your shares will increase too. Holding shares in a mutual fund is just like owning the underlying assets.

2/11/08"An Introduction to Investing" Professor Dow, FIN Fees Fees reduce whatever return you earn – shop around. One-Time Fees Annual Fees

2/11/08"An Introduction to Investing" Professor Dow, FIN One-Time Fees (Loads) Loads are like sales commissions. Front-end loads are charged when you first buy the shares. Back-end loads are charged when you redeem the shares. No-load funds do not charge loads. Sometimes fees are charged if you redeem the shares soon after you buy them.

2/11/08"An Introduction to Investing" Professor Dow, FIN Annual Fees Management fees – The mutual fund company will take a percentage of the asset’s value each year – this is how they make their money. 12(b)-1 Fees – fees for marketing and promoting.

2/11/08"An Introduction to Investing" Professor Dow, FIN How to get information Online! A prospectus provides the details. What to look for: What does the fund invest in? Does it match your investing plan? What are the fees? How has it performed in the past?

2/11/08"An Introduction to Investing" Professor Dow, FIN Types of Funds Money Market Funds Low risk but low return You can write checks Bond Funds Corporate bond funds High-yield bond funds Municipal bond funds International bond funds

2/11/08"An Introduction to Investing" Professor Dow, FIN Types of Funds (cont’d) Stock funds Growth Income Value Sector International Mixed/Balanced

2/11/08"An Introduction to Investing" Professor Dow, FIN Types of Funds (cont’d) Index Funds Follows some index (S&P500) Stocks or bonds Low fees and highly diversified Good choice Asset Allocation Funds Real Estate Funds

2/11/08"An Introduction to Investing" Professor Dow, FIN Implementing your investment plan using mutual funds Start with an asset allocation. Choose 3-5 funds that match your asset allocation. Look for diversified funds (internationally too) Take advantage of index funds. Shop around for low fees.

2/11/08"An Introduction to Investing" Professor Dow, FIN Investing in Individual Securities What if you want to pick your own stocks? Go to a stockbroker Open an account Place an order for shares

2/11/08"An Introduction to Investing" Professor Dow, FIN Types of Brokers Full-Service Brokers Discount Brokers Online Brokers Differ in terms of cost, information provided and handholding.

2/11/08"An Introduction to Investing" Professor Dow, FIN Why brokers? You have a specific reason for buying a stock. You have a large amount of wealth and need specialized advice. Mutual funds are fine for the typical investor.

2/11/08"An Introduction to Investing" Professor Dow, FIN Stock Picking Judging whether a particular company’s stock is going to do well in the future. Can be fun and profitable. You’ll get lots of advice – be skeptical. If you take this approach, do your research.

2/11/08"An Introduction to Investing" Professor Dow, FIN Good Habits for Investors Have a plan. Save, save, save. Get the big picture right, don’t stress about the little things. Be diversified Have the right asset allocation

2/11/08"An Introduction to Investing" Professor Dow, FIN More Good Habits Avoid unnecessary taxes Avoid excessive fees Take a long-run approach Keep trading to a minimum Don’t obsess about the short-run fluctuations of the market.