1. Chapter 13 Investing Fundamentals

2. Chapter 13 Learning Objectives
Describe why you should establish an investment program
Assess how safety, risk, income, growth and liquidity affect your investment decisions
Explain how asset allocation and different investments alternatives affect your investment plan
Recognize the importance of your role in a personal investment program
Use various sources of financial information that can reduce risks and increase investment returns

3. Preparing for an Investment Program
Objective 1: Describe why you should establish an investment program
ESTABLISHING INVESTMENT GOALS
-- accumulating retirement funds
-- enhancing current income
-- saving for major expenditures
-- sheltering income from taxes

4. Preparing for an Investment Program
Objective 1: Describe why you should establish an investment program
ESTABLISHING INVESTMENT GOALS
Financial goals should be specific and measurable. To develop your goals ask yourself. . .
What will you use the money for?
How much will you need for your goals?
How will you obtain the money?
How long will it take you to obtain the money?
How much risk are you willing to assume in an investment program?

5. Preparing for an Investment Program (continued)
What possible economic or personal conditions could alter your investment goals?
Given your economic circumstances, are your investment goals reasonable?
Are you willing to make the sacrifices necessary to meet your investment goals?
What will the consequences be if you don’t reach your investment goals?

6. Preparing for an Investment Program (continued)
PERFORMING A FINANCIAL CHECKUP
Work to balance your budget
Do your regularly spend more than you make
Pay off high interest credit card debt first
Start an emergency fund you can access quickly
Three to nine months of living expenses
Have access to other sources of cash for emergencies
Line of credit is a short-term loan approved before the money is needed
Cash advance on your credit card

7. Preparing for an Investment Program (continued)
GETTING THE MONEY NEEDED TO START AN INVESTMENT PROGRAM
How badly do you want to achieve your investment goals
Are you willing to sacrifice some purchases to provide financing for your investments
What do you value
Participate in elective savings programs
Payroll deduction or electronic transfer
Make extra effort to save one or two months each year
Take advantage of gifts, inheritances, and windfalls

8. Preparing for an Investment Program (continued)
The value of long term investment program
After graduation, you plan to invest $200 per month in the stock market. If you earn 6% per year on your stocks, how much will you have accumulated after 10 years?
Use time value of money calculation:
pmt = 200, I = 6/12 = 0.5, n = 10*12 = FV = ?
FV = $32,775

9. Preparing for an Investment Program (continued)
The value of long term investment program
After graduation, you plan to invest $400 per month in the stock market. If you earn 6% per year on your stocks, how much will you have accumulated after 15 years?
Use time value of money calculation:
pmt = 400, I = 6/12 = 0.5, n = 15*12 = FV = ?
FV = $116,327

10. Preparing for an Investment Program (continued)
The value of long term investment program
After graduation, you plan to invest $400 per month in the stock market. If you earn 12% per year on your stocks, how much will you have accumulated after 15 years?
Use time value of money calculation:
pmt = 400, I = 12/12 = 1, n = 15*12 = FV = ?
FV = $199,832

11. Preparing for an Investment Program (continued)
The value of long term investment program
After graduation, you plan to invest $400 per month in the stock market. If you earn 12% per year on your stocks, how much will you have accumulated when you retire in 30 years?
Use time value of money calculation:
pmt = 400, I = 12/12 = 1, n = 30*12 = FV = ?
FV = $?

12. Preparing for an Investment Program (continued)
Comparison:
$200, 6%, 10 years  32,775
$400, 6%, 15 years  116,327
$400, 12%, 15 years  199,832
$400, 12%, 30 years  1,397,985

13. Factors Affecting the Choice of Investments
Objective 2: Assess how safety, risk, income, growth, and liquidity affect your investment decisions
Safety and risk
Safety in any investment means minimal risk of loss
Risk means a measure of uncertainty about the outcome

14. Factors Affecting the Choice of Investments
Company A
Company B

15. Factors Affecting the Choice of Investments
To get a general idea of a stock’s price variability, we could look at the stock’s price range over the past year.
52 weeks Yld Vol Net
Hi Lo Sym Div % PE s Hi Lo Close Chg
IBM
MSFT …

16. Factors Affecting the Choice of Investments
Investments range from very safe to very risky
Annual Rates of Return
Standard Deviation Real Average Return
Small % %
Stock
Large
Long-term
Corp-bond
Long-term
Gov-bond
U.S. Tre-bill

17. Factors Affecting the Choice of Investments
The potential return on any investment should be directly related to the risk the investor assumes
Speculative investments are high risk
The Risk-Return Trade-Off

18. Factors Affecting the Choice of Investments (continued)

19. Factors Affecting the Choice of Investments (continued)
Calculate return on an investment
Rate of return: income you receive on an investment over a specific period of time divided by the original amount invested
Buy 1000 shares of Microsoft at $25, sell it at $30 a year later, and you receive $1 dividend per share. What is the rate of return for this investment?
Capital gain: 1000 * (30-25) = $5,000
Dividend: $1*1000 = $5,000
Total income: = $10,000
Rate of return : 10,000 / (25* 1000) = 40%

20. Factors Affecting the Choice of Investments (continued)
COMPONENTS OF THE RISK FACTOR
Inflation risk - during periods of high inflation your investment return may not keep pace with the inflation rate
Interest rate risk - you may invest in a bond at a 6%, rates later go up to 8%; your bond price falls
Business failure risk - bad management or products affect stocks and corporate bonds and mutual funds that invest in stock
Market risk - prices fluctuate because of behaviors of investors
Global investment risk - changes in currency affect the return on your investment

21. Factors Affecting the Choice of Investments (continued)
INVESTMENT INCOME
Safest investments – predictable income
Savings accounts and certificates of deposit
U.S. savings bonds
United States treasury bills
Higher potential income investments include…
Municipal bonds
Corporate bonds
Preferred stocks and income common stocks
Income mutual funds
Real estate rental property

22. Factors Affecting the Choice of Investments (continued)
INVESTMENT GROWTH
Growth means investment will increase in value
Common stock
Growth companies pay little or no dividends, but reinvest in the company
Mutual funds, government and corporate bonds, and real estate offer growth potential
Gemstones and collectibles - more speculative
INVESTMENT LIQUIDITY
Ability to buy or sell an investment quickly without substantially affecting the investment’s value; e.g. Real estate is not a very liquid investment

23. Asset Allocation and Investment Alternatives
The process of placing your assets among several types of investments which lessens your investment risk
Types of assets
-- stocks of large corporations
-- stocks of medium-sized corporations
-- stocks of small companies
-- foreign stocks
-- bonds
-- cash

24. Asset Allocation and Investment Alternatives (contined)

25. Asset Allocation and Investment Alternatives (contined)

26. Asset Allocation and Investment Alternatives (contined)
Time Factor
The longer that you are invested the better your returns
Your Age
The type and style of your investments should change with your age

28. Asset Allocation and Investment Alternatives
Stock or equity financing
Equity capital is provided by stockholders who buy shares of a company’s stock.
Stockholders are owners and share in the success of the company.
A corporation is not required to repay the money obtained from the sale of stock.
The corporation is under no legal obligation to pay dividends to stockholders: they may instead retain all or part of earnings.

29. Asset Allocation and Investment Alternatives (continued)
CORPORATE AND GOVERNMENT BONDS
A bond is a loan to a corporation, the federal government, or a municipality
Bondholders receive periodic interest payments, and the principal is repaid at maturity (1-30 years)
Bondholders can keep the bond until maturity or sell it to another investor before maturity

30. Asset Allocation and Investment Alternatives (continued)
Mutual funds
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

31. Asset Allocation and Investment Alternatives (continued)
REAL ESTATE
The goal of a real estate investment is to buy a property and sell it at a profit. Nationally, 3% appreciation in price a year is average.
Location, location, location is important.
Before you buy real estate...
Is the property priced competitively?
What type, if any, of financing is available?
How much are the taxes?
What is the condition of the buildings and houses in the immediate area?
Why are the present owners selling?
Could the property decrease in value?

32. Asset Allocation and Investment Alternatives (continued)
OTHER SPECULATIVE INVESTMENTS
Speculative investments
A speculative investment is a high-risk investment made in the hope of earning a relatively large profit in a short time Typical speculative investments include:
Antiques and collectibles
Call and put options
Derivatives
Commodities
Coins and stamps
Precious metals and gemstones

33. A Personal Plan for Investing
Establish realistic goals
Determine the amount of money needed to meet your goals
Specify the amount of money available to fund your investments
List different investments you want to evaluate
Evaluate risk and potential return for each
Reduce possible investments to a reasonable number
Choose at least two different investments
Continue to evaluate your investment program

34. Factors that Reduce Investment Risk
Objective 4: Recognize the importance of your role in a personal investment program
YOUR ROLE IN THE INVESTMENT PROCESS
Evaluate potential investments
Seek the assistance of a financial planner (see Appendix at the back of the text)
Monitor the value of your investments
Keep accurate and current records
Consider the tax consequences of selling your investments

35. Sources of Investment Information
Objective 5: Use the various sources of financial information that can reduce risks and increase the investment returns
The Internet
A wealth of investment information is available
View sites such as and
Newspapers and news programs
Business periodicals such as Smart Money and government publications
Corporate Reports
Investor services and newsletters, such as ValueLine or Morningstar and financial calculators