The Fundamentals of Investing Chapter 8

8.1 Preparing for an Investment Program Establishing Your Investment Goals Plan carefully and practice discipline Sacrifices will be worth it in the long run Starts with a measurable goal (saving for a car, college, or a down payment on a house)

8.1 Preparing for an Investment Program Performing a Financial Checkup Balance your budget: spend less than you make Have enough insurance to cover financial losses Start an emergency fund (money that you can access quickly for an immediate need) Have access to other sources of cash Line of credit or credit card cash advance

8.1 Preparing for an Investment Program Obtaining the Money You Need to Get Started Pay yourself first – consider it a monthly bill Take Advantage of Employer-Sponsored Retirement Plans – many employers match part or all you put in and it isn’t taxed until you withdraw it, usually at retirement

8.1 Preparing for an Investment Program Obtaining the Money You Need to Get Started Participate in an Elective Savings Plan – automatically taken from your check and put into savings or from your account and invested Make a Special Savings Effort One or Two Months Each Year – cut back sharply at a specific time of year Take Advantage of Gifts, Inheritances, and Windfalls

8.1 Preparing for an Investment Program The Value of Long-Term Investment Programs Some people don’t invest because they only have a small amount or they think they are too young Even small amounts add up because of the time value of money (the increase in an amount of money as a result of interest or dividends earned)

8.1 Preparing for an Investment Program Factors That Affect Your Choice of Investments Safety and Risk Safety – the chance of losing your money in an investment is fairly small; rate of return will be low Risk – you cannot be certain about the outcome of your investment; speculative investment (high risk investment in the hope of earning a relatively large profit in a short time)

8.1 Preparing for an Investment Program Factors That Affect Your Choice of Investments Five Components of the Risk Factor Inflation Risk – general rise in prices that affects everybody Try to stay ahead of inflation by investing Example on page 246 Interest Rate Risk Government or corporate bonds have a fixed rate of return; if the interest rate rates go up then the value of your investment will go down and vice versa, but if you wait until maturity to cash in you would get your full amount Examples on page 247

8.1 Preparing for an Investment Program Factors That Affect Your Choice of Investments Five Components of the Risk Factor Business Failure Risk – applies to common stock, preferred stock, and corporate bonds; you face the possibility that the company you invested in will be less profitable than you had hoped Research, research, research to protect against this Financial Market Risk – the value of stocks, bonds mutual funds, and other investments go up or down depending on the overall state of financial markets (social and political conditions) Example: price of oil stocks may be affected by the political situation in the Middle East

8.1 Preparing for an Investment Program Factors That Affect Your Choice of Investments Five Components of the Risk Factor Global Investment Risk – investing in companies in other countries

8.1 Preparing for an Investment Program Factors That Affect Your Choice of Investments Investment Income – source of income Safest investments – savings accounts, certificates of deposit (CDs), U.S. Savings Bonds, and U. S. Treasury bills Government bonds, corporate bonds, preferred stock, utility stock, or certain common stocks Mutual funds and real estate rental Investment Growth – “growth” means that investments will increase in value Growth companies reinvest their profits rather than pay dividends (retained earnings – the profits that are reinvested)

8.1 Preparing for an Investment Program Factors That Affect Your Choice of Investments Investment Liquidity – the ability to buy or sell an investment quickly without substantially affecting its value May have to accept a lower price for a house to sell it quickly

8.2 An Overview of Investment Alternatives Types of Investments Stock or Equity Financing Equity capital – money that a business gets from its owners in order to operate Sole proprietor – sole business owner Partnership – share in the equity capital Corporation – gets it money from stockholders Corporations do not have to repay you what you paid and they don’t have to pay you dividends (distributions of money, stock, or other property that corporation sometimes pays to stockholders)

8.2 An Overview of Investment Alternatives Types of Investments Stock or Equity Financing Continued Common Stock – most basic form of corporate ownership; entitles you to voting privileges and can provide a source of income if the company pays dividends Preferred Stock – gives the owner the advantage of receiving cash dividends before common stock holders

8.2 An Overview of Investment Alternatives Types of Investments Corporate or Government Bonds Corporate bonds are a corporation’s written pledge to repay a specified amount of money along with interest. Government bonds are a written pledge of a government or a municipality to repay a specified sum of money with interest “Buy a Bond” – you are lending money to a corporation or government agency for a certain period of time

8.2 An Overview of Investment Alternatives Types of Investments Corporate or Government Bonds Continued Factors that affect the value of a bond: Whether the bond will be repaid at maturity Whether the corporation or government agency will be able to pay interest until maturity Maturity dates – 1 to 30 years Paid – every 6 months

8.2 An Overview of Investment Alternatives Types of Investments Mutual Funds – an investment alternative in which investors pool their money to buy stocks, bonds, and other securities based on the selections of professional managers who work for an investment company So, if one of the stocks does poorly it can be made up by the gains of another in the fund

8.2 An Overview of Investment Alternatives Types of Investments Real estate – goal is to have the property increase in value so you can sell it at a profit or receive rental income When buying property consider: Why are the present owners selling? Is the property in good condition? What is the condition of other properties in the area? Is there a chance that the property will decrease in value and you lose money?

8.2 An Overview of Investment Alternatives Types of Investments Real estate continued When you sell consider: Can you find an interested buyer? Can the buyer get the necessary financing to buy the property?

8.2 An Overview of Investment Alternatives Evaluating Investment Alternatives When you make your choices to invest, it’s wise to diversify Diversification – process of spreading your assets among several different types of investments to lesson risk

8.2 An Overview of Investment Alternatives Evaluating Investment Alternatives Investment Pyramid Level 4 Speculation Level 3 Growth Level 2 Safety and Income Level 1 Financial Security

8.2 An Overview of Investment Alternatives Developing a Personal Investment Plan Establish investment goals Decide how much money you will need to reach those goals by a certain date List all the investment you want to evaluate Evaluate the risks and potential return for each investment on your list Reduce the list of possible investments to a reasonable number Choose at least two investments to give you some diversity Recheck your investment program periodically…investment goals will change over time

8.3 Reducing Investment Risk and Obtaining Investment Information The Role of the Financial Planner (specialist who is trained to offer specific financial help and advice) Fee-only planners – charge and hourly rate from $75 to $200 or a flat fee ranging from about $500 to several thousand dollars Fee-offset planners – charge an hourly or annual fee, but they offset or reduce it with commissions, or earnings they make by buying or selling investments

8.3 Reducing Investment Risk and Obtaining Investment Information The Role of the Financial Planner continued Fee and commission planners – charge a fixed fee for a financial plan and earn commissions from the financial products they sell Commission only planners – earn all their money through commissions they make on sales of insurance, mutual funds, and other investments

8.3 Reducing Investment Risk and Obtaining Investment Information Do You Need a Financial Planner? Consider two things… Your income – if you make less than $40,000 a year you probably don’t need a planner’s advice How willing are you to make decisions on your own – if you take the time and effort to keep up-to-date on financial developments You can find a financial planner in the yellow pages, by contacting financial institutions, and by getting names from friends, coworkers, or professional contacts

8.3 Reducing Investment Risk and Obtaining Investment Information Do You Need a Financial Planner? Selecting a Financial Planner Help you assess your current financial situation Offer a clearly written plan, including investment recommendations, and discuss the features of the plan with you Help you keep track of your progress Guide you to other financial experts and services as needed

8.3 Reducing Investment Risk and Obtaining Investment Information Do You Need a Financial Planner? Certification of Financial Planners Requirements vary from state to state Some require passing an exam Others issue licenses to either individual planner or planning companies While others have no regulations at all Credentials may be Certified Financial Planner (CFP) or Charted Financial Consultant (ChFC) The federal government requires that the Securities and Exchange Commission (SEC) monitor the largest financial advisors

8.3 Reducing Investment Risk and Obtaining Investment Information Your Role in the Investment Process – it’s a continual process, even if you have a financial planner you shouldn’t ignore your money Evaluate Potential Investments Monitor the Value of Your Investments – helps you to know if you’ve made money or not Keep Accurate and Correct Records - helps you spot opportunities to increase profits Tax Considerations – investment income falls into three categories:

8.3 Reducing Investment Risk and Obtaining Investment Information Your Role in the Investment Process continued Tax Considerations – investment income falls into three categories: Tax exempt income – income that is not taxed; most interest you receive from state and municipal bonds is exempt Tax-deferred income – income taxed later; most common is on a traditional individual retirement account (IRA) Taxable – all other investments

8.3 Reducing Investment Risk and Obtaining Investment Information Your Role in the Investment Process continued Tax Considerations continued You have to pay tax on dividends, Interest income, and rental income: Cash dividends Interest from banks, credit unions, and savings and loans associations Interest from bonds (unless tax exempt), promissory notes, loans, and U. S. Securities Rental property

8.3 Reducing Investment Risk and Obtaining Investment Information Your Role in the Investment Process continued Tax Considerations continued Capital Gains and Capital Losses Capital gains –profit from the sale of an asset such as stock, bonds, or real estate. Taxed according to whether they are short term or long term. Short term – owned for 12 months or less Long term – owned for 12 months or more Capital loss – sale of an investment for less than its purchase price

8.3 Reducing Investment Risk and Obtaining Investment Information Sources of Investment Information The Internet and Online Computer Services Newspapers and News Programs – Wall Street Journal and CNN Financial Business Periodicals and Government Publications – Barron’s, Business Week, Forbes, Fortune, Harvard Business Review, and the Federal Reserve Bulletin (much of it is free) Corporate Reports – businesses must provide investors with a prospectus (a document that discloses information about a company’s earnings, assets & liabilities, its products or services, and the qualifications of its managers)

8.3 Reducing Investment Risk and Obtaining Investment Information Sources of Investment Information Statistical Averages – indicates whether the category it measures is increasing or decreasing; won’t pinpoint the value of any specific investment but will show the general direction of stocks, bonds, mutual funds, and so on. Dow Jones Industrial Average or Standard & Poor’s 500 Stock Index Investor Services – stockbrokers and financial planners periodically mail a free newsletter to their clients Moody’s Investor Service sells subscription newsletters