Presentation on theme: "Investments Overview Timothy R. Mayes, Ph.D. FIN 3600: Chapter 1."— Presentation transcript:
Investments Overview Timothy R. Mayes, Ph.D. FIN 3600: Chapter 1
Investing vs. Gambling Both investors and gamblers seek risk. But investing is not gambling: Gamblers create risk, while investors (speculators) deal with pre- existing risks. Investors (speculators) help to transfer this risk from those who don’t want it to those who do (much like insurance companies take your risk for a fee). Gambling is a zero-sum game, investing is not. Investing has a positive expected return, gambling has a negative expected return because the “house” must earn a profit and cover its costs. This means that in the long run, investors make money and gamblers lose money. Investing is a productive activity that provides benefits to society as a whole (channeling funds to those who need and want them most); gambling provides no benefits beyond the enjoyment of risk by the gambler.
Why Should We Invest? Investing is the process of delaying current consumption in favor of future consumption. We do this in exchange for an expected financial return, thereby increasing our future purchasing power. Investing also benefits society by providing a means for capital to flow from those who don’t currently need it to those that do, thereby increasing economic growth and prosperity.
Why Should We Invest? (cont.) Investment markets also provide pricing information (signals) which helps to evaluate which possibilities represent the “highest and best use of capital”
Getting Started in Investing Before making investments, we should first answer several questions: What’s already in my portfolio? What are the goals for my investments? What is my holding period? What return do I need to earn to meet my goals? How much risk am I willing to accept? What is my tax situation? How much time am I willing to devote to my investments?
What’s already in my portfolio? The first thing to do is to inventory all of your major assets. Only then can you know if all of your financial bases are covered. Additionally, this step can help in constructing a well-balanced portfolio of financial assets (diversification is vitally important).
What are my Investing Goals? Your goals will help to identify the types of investments that are appropriate. Categories of goals are: Stability of principal Current income Growth of income Growth of principal (capital appreciation) Funding a future asset or liability Pure Speculation
What is my Holding Period? Your investing goals help determine an appropriate holding period or vice versa: If you are saving to buy a house in a year, you have a short holding period and need to be conservative. If you are investing for retirement in 30 years, you have a long holding period and can afford considerably more risk.
What Returns Do I Need? The returns that you can earn are determined by the risk/return tradeoff that is available in the market. Taking more risk will, in all likelihood, lead to higher returns over long periods. So you don’t need to invest as much to meet your goals. Taking less risk generally leads to lower returns and you’ll need to invest more to meet your goals.
Realistic Annual Return Expectations Jeremy Siegel, in Stocks for the Long Run, studied very long-term, inflation-adjusted returns for various asset classes:
How Much Risk Can I Afford? Everybody is risk averse to one degree or another. How much risk you can tolerate will determine your investment returns over the long run. The goal is to balance risk tolerance with your need for return (if you can’t sleep comfortably at night, you are taking too much risk).
What is My Tax Situation? Depending on your tax status, you may prefer capital gains to income (dividends or interest) Generally, the higher your marginal tax bracket, the more you will prefer capital gains to income and tax-free investments to taxable investments
How Much Time Can I Spend? Managing a portfolio of investments can be time consuming. If you have time and a desire to invest on your own, individual stocks/bonds and a discount brokerage may be appropriate. If you don’t have much time or desire, hiring a professional (broker, financial planner, etc) and investing through mutual funds may be more appropriate.
Types of Investments Financial Assets: Stocks Bonds Money-market instruments Mutual funds Derivatives Real Assets Real estate Collectibles Diamonds Gold
Investment Truisms from History There is a positive relationship between risk and return Diversification is good International Investing is good Financial Markets are efficient Mistakes happen