PRINCIPLES OF INVESTING

Thanks to: FCEE State Farm Ingham Foundation

Agenda TimeTopicElementsLEIPresenter 4:30-5:00Saving Behavior Bill 5:00-5:40IndexII9Brett 5:40-6:00DiversifyIII Bill 6:00-6:30Dinner 6:30-7:00DiversifyIII16Brett 7:00-7:30Keep It Simple V21Brett 7:30-8:00Save on Taxes Legally Appendix Bill 8:00-8:20Stock Market Challenge Bill 8:20-8:30Paperwork Bill

Why it is Hard to Save People have self-control problems. We are impatient!

Principles of Behavioral Economics Part A: Imagine you could choose between receiving $300 immediately, or another amount 6 months from now. How much would the future amount need to be to make it as attractive as receiving $300 immediately? Please write the dollar amount that would make the following options equally attractive: Receive $300 immediately Receive $________ in 6 months 5

Principles of Behavioral Economics Part B: Imagine you could choose between receiving $300 immediately, or another amount 1 year from now. How much would the future amount need to be to make it as attractive as receiving $300 immediately? Please write the dollar amount that would make the following options equally attractive: Receive $300 immediately Receive $________ in 1 year 6

What do your graphs look like? Does it decrease? Does it drop off fast, then flatten out?

How Humans Discount Future Values Exponential discounting: People value things less the further into the future they occur. Some people may discount the future by a lot – they are impatient. Present biased discounting: People discount anything received in the future relative to today by a constant amount. This type of discounting can result in people planning to do something in the future, but changing their mind when the time arises. In practice, both types of discounting are observed. 8

Exponential Discounting 9

Present-Biased Discounting 10

Total Savings and Investments Reported by Workers in Source: Employee Benefit Research Institute and Greenwald and Associates, Retirement Confidence Surveys

Total Savings and Investments Percentage By Age 12 AgeLess than $1,000 $1,000 - $9,999 $10,000- $24,999 $25,000- $49,999 $50,000- $99,999 $100,00 0- $249,00 0 Over $250, Source: Employee Benefit Research Institute and Greenwald and Associates, Retirement Confidence Surveys

How to Start to Save Agree to save now Pain is now, gain is discounted Agree to save in the future Both pain and gain are discounted Default bias We tend to stick with the default

Save More Tomorrow Savings Rates of Participants Who: Initiall y After First Pay Raise Second Pay Raise Third Pay Raise Fourth Pay Raise Declined Financial Advice

Save More Tomorrow Savings Rates of Participants Who: Initiall y After First Pay Raise Second Pay Raise Third Pay Raise Fourth Pay Raise Declined Financial Advice Took Consultant’s Recommende d Saving Rate

Save More Tomorrow Savings Rates of Participants Who: Initiall y After First Pay Raise Second Pay Raise Third Pay Raise Fourth Pay Raise Declined Financial Advice Took Consultant’s Recommende d Saving Rate Joined “Save More Tomorrow” Plan

Conclusions Acknowledge our human tendencies Know we are impatient Know we will agree to things in the future Know we go with defaults

And now, Brett…….Burkey.

Investing: Diversification Diversification A “stock” pays return of 100% half the time, 0% half the time. Experiment investing $5. People put all their money in one stock. Flip a coin. Heads 100%, Tails 0%. (Heads $10, Tails $5) People put $1 in five stocks. Flip a coin for each stock. Heads 100%, Tails 0%. (Heads $2, Tails $1)

No Diversification: My Results Flip 1Pay AVE 58

Diversification: My Results Flip 12345Pay AVE 5

Diversification - Lesson The average return is the same. Diversifying reduces the variance of the returns. You can also diversify across different markets!

Extension: If you had two stocks: Rain gear inc.:Pays 100% if heads, pays 0% if tails. Sunshine sunscreen:Pays 0% if heads, pays 100% if tails. If you could only buy 2 shares of stock (they are the same price of $10 each), how could you diversify so as to guarantee a 50% rate of return? Answer: One share of each company.

How to diversify in practice? Brett…Burkey

Tax Free Savings Why is there an advantage to tax-deferred savings accounts? Assume: Start with $2. Income tax is 50%. Capital gains tax is 25%. (Tax on gain in asset.) Savings will triple between time periods…

Taxed Savings Account: $6.25 Tax Deferred Savings Account: $9 Assume: Start with $2. Income tax 50%. Capital gains 25%. Savings Triple. 2 If no capital gains tax, the same: $9

Taxed Savings Account: $6.25 Assume: Start with $2. Income tax 50%. Capital gains 25%. Savings Triple. 2 Tax Deferred Savings Account with lower income tax rate of 33%: $12

Two Sources of Gains from Tax Deferred Accounts 1. The gains are not taxed along the way, so compounding on the gains adds to total savings! 2. For many people, the tax rate at retirement is lower than the tax rate during their working years, so this becomes a second source of gains. Plans: Differ on whether income tax is taken at beginning or end. Question is whether you expect to be in higher or lower income bracket early or later in life…

Types of Retirement Accounts Individual Retirement Accounts (no tax now) Roth IRA (no tax later) 401k (employer plan, no tax now) 403b (employer plan for nonprofit organizations, no tax now)

Traditional v. Roth IRA TraditionalRoth IRA Who May ContributeUnder age 70 ½No age limit - MAGI Single below $116,000 Married below $169, Contribution Limit Individual: $5,500 Married (jointly): $11,000 Age 50+:$1,000 catch up Individual: $5,500 Married (jointly): $11,000 Age 50+:$1,000 catch up Federal Income Tax Deductible Deductible if part of employee plan No income tax deduction Tax-Advantaged Growth (5 year hold) No taxes on distributions until you withdraw Tax free growth and withdraws after age 59 ½ Required Distributions April 1 st of the year after turning 70 ½ No mandatory age for taking distributions.

COMPANY AND GOVERNMENT SPOSORED RETIREMENT PLANS 401 K A workplace savings plan that lets employees invest a portion of their paycheck before taxes are taken out. The savings can grow tax free until retirement, at which point withdrawals will be taxed as income. A large majority of employers will match an employee’s contribution – up to a point – thereby boosting the employee’s savings rate. Contribution cap: $18,000/yr. 403B The plan is a U.S. tax-advantaged retirement savings plan available for public education organizations, some non-profit employers, and cooperative hospital service organizations. It has tax treatment similar to a 401(k) plan. Employee salary deferrals into a 403(b) plan are made before income tax is paid and allowed to grow tax-deferred until the money is taxed as income when withdrawn from the plan.

What to teach kids? Details are not relevant to kids right now and may change. Concepts: Reason why tax free growth is beneficial. Idea of when to pay tax (now or at retirement). Remind of importance of matches…

Why Play Stock Market Challenge? Knowledge of stocks Risk vs. Return Even if they use mutual funds…

Overview Hypothetical $100,000 to invest. Stocks, Bonds, Mutual Funds Can borrow on the margin…

Registration Hints:Username will be the prefix for all your team names, so be creative “Sharkvestors” or “AtlanticHS” You should have 3 to 6 students on a team.

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Stocks Investing in Stocks: There are four basic ways to transaction stocks: buy (BO), sell (SC), short sell (SS), and short cover (CO). When buying a stock, you are taking a "long position" with the hope that the price per share will increase. When you sell a stock, you close or reduce that long position. Selling short is selling a stock that you don't own (you actually borrow the stock from the broker) with the hope that you can later buy the stock back at a lower price. When you buy the stock to pay back what you borrowed, it is called "covering" your short position. To buy or short sell a stock, specify how many shares you want, rather than how much money you wish to spend.You may not be long and short in the same stock at the same time. Day trading is not allowed. Duplicate transactions on the same day are not allowed.

Basics Selling Short: What is selling short? Short selling is a method of making money when a stock goes down. The team borrows a stock from the broker and sells it at today's price. The team hopes the stock will go down, so they may rebuy the stock at a lower cost and return it to the broker.

Basics Suppose the team wishes to sell short 200 shares of BAD company at a price of $20. The team borrows and sells the shares 200 x $20 =$4,000 Broker's Fee $25.00 =$ 25 $3,925 is made from sale. The $4,000 is listed in value of short positions.

Basics Short Cover: Suppose the stock BAD goes down to $5 the next week. The team decides to cash in on the stock's demise. The team buys back 200 shares for $1,000 (200 shares at $5). The broker's fee of $25 is subtracted from the team's balance. Profits = $3,975 – $1,025 = $2,950

Comparing… Buy a $20 stock, the most you can lose is? Short a $20 stock, the most you can lose is?

Bonds Investing in Bonds: Florida SMC allows you to buy or sell bonds. Bonds are notoriously difficult to research. A selection of Corporate Bonds, Treasury Bonds, Strips, and Bond Mutual Funds is listed on the bond transaction screen. All bonds have a par value of $1,000. When you buy a bond, you must pay the accrued interest on the bond. On your statement, the accrued interest and commission are added together. You cannot short a bond. Portfolios will be evaluated to see whether purchased mutual funds also contain bonds. If so, teams will be contacted by the program coordinator, Cheryl S. Geslani, via to notify them on an on-going basis of their true allocation.

Bonds

Mutual Funds Investing in Mutual Funds: Florida SMC allows you to buy or sell mutual funds. Mutual funds are transacted in dollar amounts not by number of shares. Mutual funds must be bought or sold in lots of $500. To sell off all of your mutual fund shares enter a “99999” in the box for dollar amounts. Like stocks, in order to buy or sell mutual funds you must have the ticker symbol. All mutual fund ticker symbols are five letters long ending in "X".

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Paperwork Palm Beach Broward participants will not get their in-service points unless they: 1. Sign in on the Attendance sheet we sent you. 2. Complete the Professional Learning Feedback found in MyLearningPlan (a Broward database). 3. Complete the Follow-Up assignment that Marie DiRito sent to you (it is due 30 days after the date of the workshop - which would be October 14.) We will this information to participants again, but if you could mention it, that would be great.