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

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

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

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

 Interest  Dividends  Rent  Capital gain/loss  Rate of return or yield Preparations for Investing 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

Handling risk Ultraconservative strategies Conservative Moderate Aggressive Personal Investment Philosophy

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 Growth  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

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

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

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

 Random or unsystematic  Diversification  Market or systematic INVESTMENT RISK: 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

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

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

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 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 (continued)

Investment Alternatives 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 (continued)

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

Calculating Return on Investment Assume you invest $3,000 in a mutual fund. Also assume the mutual fund pays you $50 dividends this year and that the mutual fund is worth $3,275 at the end of one year. Your rate of return is 10.8%, as illustrated below: Step 1 Subtract the investment’s initial value form the investment’s value at year end $3,275 - $3,000 = $275 Step 2 Add the annual income to the amount calculated in step 1. $50 + $275 = $325 Step 3 Divide the total dollar amount of return in Step 2 by the original investment. $325/$3,000 = = 10.8%

Components of the Risk Factor Inflation Risk  Assume you deposited $10,000 in a bank at 3% interest. At the end of year one, your money will have earned $300 in interest. Assuming an inflation rate of 4%, it will cost you an additional $400, or a total of $10,400 to purchase the same amount of goods you could have purchased for $10,000 a year earlier.

Components of the Risk Factor Interest Rate Risk Suppose you purchase a corporate bond with a face value of $1,000 issued by AMR Corp, that matures in 2016 and pays 9% interest until maturity. Using the following formula, you can calculate the dollar amount of annual interest for the AMR bond: Dollar amount of annual interest = Face value x Interest rate $1,000 x 9% = $90

Components of the Risk Factor Interest Rate Risk If bond interest rates for comparable bonds increase to 10%, the market value of your 9% bond will decrease as follows: Approximate market value = Dollar amount of annual interest Comparable Interest Rate $90 = $900 10%

Components of the Risk Factor Market Risk Global Investment Risk

Investment Philosophies

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