Introduction to Investing "Take Charge of Your Finances" Analyze factors affecting the rate of return on investments. PF.SI.6

Saving and Investing Once an appropriate amount of liquid assets are reached Remember: The purpose of savings is to develop financial security Recommend refocusing goals from saving to investing

What is Investing? Purchase of assets with the goal of increasing future income Focuses on wealth accumulation Appropriate for long-term goals What are examples of long-term goals that can be accomplished by investing?

Investments usually earn higher rates of return than savings tools Rate of Return Total return on investment expressed as a percentage of the amount of money invested Total Return Amount of Money Invested Rate of Return Remember: Return is the profit or income generated by savings and investing Investments usually earn higher rates of return than savings tools

What is Mandy’s Rate of Return? Mandy saved $2,200 in a money market deposit account. After one year, she has a return of $110. What is Mandy’s rate of return? $110 $2,200 .05 = 5% Mandy’s rate of return on investment is 5%

What is Derek’s Rate of Return? Derek invested $900. When he withdrew his money from the investment, he had a total of $1,050. What is Derek’s rate of return? $150 $900 .167 = 16.7% Derek’s rate of return on investment is 16.7%

All investment tools carry some level of risk POTENTIAL RETURN RISK Risk- uncertainty regarding the outcome of a situation or event Investment Risk- possibility that an investment will fail to pay the expected return or fail to pay a return at all What is the risk level of savings tools? All investment tools carry some level of risk

Inflation Rise in the general level of prices Strive to have the rate of return on investment be higher than the rate of inflation Inflation Risk The danger that money won’t be worth as much in the future as it is today Inflation risk is usually not a concern with savings since the goal of savings is to provide current financial security

Types of Investment Tools Stocks Bonds Mutual Funds Index Funds Real Estate Speculative Investments

A share of ownership in a company Stocks Stock Stockholder or shareholder A share of ownership in a company Owner of the stock Usually a stockholder owns a very small part of a company

Return on Stocks Dividends Market Price Definition What is received? Share of profits distributed in cash to stockholders Current price that a buyer is willing to pay for stock Definition If stock is sold for a market price higher than what was paid If stock is sold for a market price lower than what was paid Stockholder may or may not receive dividends- depends on company profit What is received? Stockholder will receive a return Stockholder will lose money

Annual interest is paid to investor Bonds Form of lending to a company or the government (city, state, or federal) Definition Bonds are less risky than stocks but usually do not have the potential to earn as high of a return Annual interest is paid to investor Return Once the maturity date is reached, the principal is repaid to the bondholder

Reduces investment risk Mutual Funds Advantage Disadvantage Mutual fund- when a company combines the funds of many different investors and then invests that money in a diversified portfolio of stocks and bonds Reduces investment risk Make sure to research the fees charged by a mutual fund Saves investors time Fees may be high

Index Fund Index Index Fund A group of similar stocks and bonds- Standard and Poor 500 A mutual fund that invests in the stocks and bonds that make up an index

Usually charge lower fees than mutual funds Index Fund Advantage Disadvantage High diversification What is the difference between a mutual fund and an index fund? Still charge fees Usually charge lower fees than mutual funds

Real Estate Any residential or commercial property or land as well as the rights accompanying that land A family home is usually not considered an investment asset Can be risky and more time consuming but has potential for large returns Examples of real estate investments include rental units and commercial property

Speculative Investments High risk investments Have the potential for significant fluctuations in return over a short period of time Commercial Paper Futures Options Collectibles

Financial Risk Pyramid The risk level for specific investment tools may vary Speculative Investment Tools Futures Commercial Paper Increasing potential for higher returns Increasing risk Options Collectibles Stocks Real Estate Investment Tools Mutual Funds Index Funds Bonds Money Market Deposit Account Savings Tools Checking Account Savings Account Certificate of Deposit Savings Bonds

Investment Philosophy Everyone has a tolerance level for the amount of risk they are willing to take on The greater the risk a person is willing to make on an investment, the greater the potential return will be Investment Philosophy- an individual’s general approach to investment risk Generally divided into three categories: conservative, moderate, aggressive

Portfolio Diversification Portfolio Diversification- reduces risk by spreading investment money among a wide array of investment tools Creates a collection of investments that will provide an acceptable return with an acceptable exposure to risk Referred to as “Building a Portfolio” Assists with investment risk reduction

Buying and Selling Investments Brokerage firm acts as a buying and selling agent for an investor (except for real estate and certain speculative investments) Full service general brokerage firm Discount Broker Offer investment advice and one-on-one attention from a broker Offer no advice to investors but charge 40-60% less Complete investment transactions Only complete investment transactions

Taxation Profits earned on investments are unearned income Taxes are often owed on unearned income Taxes are due on most investment returns in the year the unearned income is received

Tax-Sheltered Investments Government tries to encourage certain types of investments by making them tax-sheltered Tax-sheltered investments are usually not tax-free! Tax-sheltered investments- eliminate, reduce, defer, or adjust the current year tax liability Retirement Child/dependent care Education expenses Health care expenses

When are taxes for tax-sheltered investments usually paid? Money is invested and taxes are paid Money grows untaxed with help from compounding interest Money is withdrawn Money is invested Money grows untaxed with help from compounding interest Money is withdrawn and taxes are paid OR What is the benefit of a tax-sheltered investment if taxes still have to be paid? There are often limits to the amount that can be invested

Employer-Sponsored Investment Accounts Type of tax-sheltered investment Money is automatically taken out of employee’s paycheck Employers often contribute a portion of money to the investment with no additional cost from the employee Employee contributes 7% of paycheck to investment account Example: Employer contributes the same amount of money to the employee’s investment account Employee benefits from having double the amount of money invested!

Advantages to Employer-Sponsored Investments Makes investing automatic Reduces tax liability It is recommended that a person utilize these investment tools as much as possible if they are offered Possibility for employer to match investment

Number of years needed to double the principal investment Rule of 72 Allows a person to easily calculate when the future value of an investment will double the principal amount 72 Interest Rate Number of years needed to double the principal investment

“It is the greatest mathematical discovery of all time.” Albert Einstein Credited for discovering the mathematical equation for compounding interest, thus the “Rule of 72.” At 10% interest rate, money doubles every 7.2 years, T=P(I+I/N)YN “It is the greatest mathematical discovery of all time.”

What Can the “Rule of 72” Determine? How many years it will take an investment to double at a given interest rate How long it will take debt to double if no payments are made The interest rate an investment must earn to double within a specific time period How many times money (or debt) will double in a specific time period

“Rule of 72” FYI Only an approximation Interest rate must remain constant Interest rate is not converted to a decimal Equation does not allow for additional payments to be made to the original amount Interest earned is reinvested Tax deductions are not included

Doug’s Certificate of Deposit Doug invested $2,500 into a Certificate of Deposit earning a 6.5% interest rate. How long will it take Doug’s investment to double? Invested $2,500 Interest Rate is 6.5% 72 6.5 11 years to double

Jessica’s Credit Card Debt Jessica has a $2,200 balance on her credit card with an 18% interest rate. If Jessica chooses to not make any payments and does not receive late charges, how long will it take for her balance to double? $2,200 balance on credit card 18% interest rate 72 18 4 years to double

Jacob’s Car 18% interest rate 4 years 72 $5,000 to invest Jacob currently has $5,000 to invest in a car after graduation in 4 years. What interest rate is required for him to double his investment? $5,000 to invest Wants investment to double in 4 years 72 4 years 18% interest rate

Future Value Wanna know what your investment will be worth in 30 years? Here’s how FV = PV ∙ (1 + i)t PV = Present Value i = Interest Rate T = Time (Number of payments)

What’s it gonna be worth? Mark parents invested $300 at his birth with an interest rate of 10%. What will their investment be worth when Mark is 36? FV = 300 (1+.10)36 Solve = $9,273.80

Your Turn Mark has invested $300 at age 16 into a money market account earning 6% What will his investment be worth when he is 52? Hint – figure out how many payments he will earn on the investment by taking 52 and subtracting 16!

Mark’s Investment 300 is the Present Value 6% interest rate 36 Payments FV = 300 (1+.06)36 Solve = 2444.18

The Perks of Interest Saving for long-term goals is easier when money grows through investments Interest allows money to grow even if you stop adding to it!

You invest $100 dollars with 5% interest for 3 years. Simple Interest Interest calculated on the original investment only Year 1 $100 X .05 = $5 Year 2 Year 3 Final $115 Earned Example You invest $100 dollars with 5% interest for 3 years.

What is Derek’s total amount? Derek invested $900 for three years at 5% simple interest. Year 1 $900 X .05 = $45 Year 2 Year 3 Final $135 Interest Earned

Earns interest on the investment and the interest earned Compound Interest Earns interest on the investment and the interest earned Year 1 $100 X .05 = $5 Year 2 $105 X .05 = $5.25 Year 3 $110.25 X .05 = $5.51 Final $ 115.76 Interest Earned Example You invest $100 dollars with 5% interest for 3 years w/ Compound Interest

What is Derek’s total amount? Derek invested $900 for three years at 5% compound interest. Year 1 $900 X .05 = $45 Year 2 $945 X .05 = $47.25 Year 3 $992.25 X .05 = $49.61 Final $1041.86 Interest Earned

Simple VS Compound Simple $900 $945 $990 $1035 Compound $992.25 $1041.86

It Adds Up You may not think so, but the longer you leave your money in there the larger your investment becomes! Especially when you use compound interest!

Summary What is the relationship between risk and return? How can a person reduce investment risk? Who should a person contact to purchase investment tools? What are the six main investment tools? What is a tax-sheltered investment? What is the Rule of 72?