©2012, College for Financial Planning, all rights reserved. Module 4 Investment Principles & Mutual Funds Foundations In Financial Planning SM Professional Education Program

Learning Objectives 4–1: Identify types of investment risk and their characteristics. 4–2: Identify factors affecting an investor’s risk tolerance. 4–3: Identify types and characteristics of investment return and how they relate to investor risk tolerance. 4–4: Define the concepts of asset allocation, diversification, and modern portfolio theory. 4–5: Describe methods of investment analysis and their characteristics. 4–6: Describe various approaches to investing. 4–7: Identify definitions or characteristics relating to mutual funds. 4–8: Describe types or styles of mutual funds. 4-2

Questions To Get Us Warmed Up 4-3

Basic Investment Objectives & Concepts Objectives o Income o Growth o Capital preservation Risk tolerance Time horizon Taxes 4-4

Systematic Risk Market risk Interest rate risk Reinvestment rate risk Purchasing power risk (inflation) Currency risk (exchange rate) 4-5

Unsystematic Risk Business risk Financial risk Credit risk Default risk Liquidity risk Marketability risk Event risk 4-6

Liquidity Risk & Marketability Risk 4-7 Investment VehicleLiquidityMarketabilityOther Main Sources of Risk Insured savings accountsHighN/A 1 P, R Money market accounts/fundsHighN/A 1 P, R EE and I bondsHighN/A 1 P, R Treasury billsHigh P, R Commercial paperHigh P, R Certificates of depositHighN/A 1,2 P, R Treasury notes and bondsModerate 3 HighP, I, R High-grade common stockModerateHighM, B High-grade corporate bondsModerate 3 High/moderateP, I, R, CR, E High-grade municipal bondsModerate 3 High/moderateP, I, R, CR, E High-grade preferred stockModerateHighP, I, R, CR Lower-grade common stockModerate/lowHighB, M, F High-yield corporate bondsModerate/low 3 High/moderateB, F, I, R, CR, D, E Puts and callsLowHighM, B Real estate investmentsLow M, B, F REITsModerateHighM, B, R Tangible (hard) assetsLow M Futures contractsLowHighM Mortgage-backed securitiesModerateHigh/moderateP, I, R Limited partnershipsLowLow 4 M, B, F 1 A secondary market does not exist. However, withdrawals or redemptions can be made. 2 Some brokerage firms sell CDs, as well as maintain a secondary market in them, providing a moderate/high degree of marketability. Most CDs are redeemed, however. 3 In general, the longer the period to maturity is, the lower the degree of liquidity is. 4 A small number of firms provide a secondary market for some limited partnerships. Also, some partnerships permit a limited number of units to be sold back to the general partner.

Risk Tolerance Factors Goals Time frame Experience Personality Market conditions Financial conditions Age Investment Advice 4-8

Methods of Measuring Risk Standard deviation Covariance Correlation coefficient Beta 4-9

Types of Return Growth Income o Dividends o Interest o Rent Balance: growth & income 4-10

Asset Allocation Two main decisions What assets? What proportion ? Strategic Passive Tactical Sector rotation Market timing Core/satellite 4-11

Diversification & MPT Asset classes MPT defined o Correlation coefficient o Efficient portfolios 4-12

Investment Analysis Technical o Indicators & Indexes Fundamental o Top-down o Bottom-up 4-13

Investment Approaches Buy-and-hold Market timing Dollar cost averaging Value averaging 4-14

Features of Mutual Funds Advantages Pooling Diversification Professional management Costs and Expenses Transaction (loads) Operating expenses Taxation Four types of basis 4-15

The Prospectus Minimum investment Investment objective Risk Investment policies Management Fees and sales charges Performance 4-16

Summary Prospectus A condensed version of the full, statutory prospectus Contains, in order, investment objective, fees and expenses, investment strategies, risks, and performance, fund management, brief information on purchase and sale of fund shares, brief tax information, and financial intermediary compensation (if applicable) 4-17

Stock Funds Value Large-cap Mid-cap Small-cap Blend Large-cap Mid-cap Small-cap Growth Large-cap Mid-cap Small-cap 4-18

Bond Funds Duration: short, intermediate, long High quality Medium quality Low quality 4-19

Other Fund Types Money market funds Index funds Growth funds Sector funds International and global funds Asset combination funds Closed-end funds 4-20

Other Fund Types Exchange-traded funds Exchange-traded notes Hedge funds 4-21

Question 1 Which one of the following is a type of unsystematic risk? a.business risk b.interest rate risk c.purchasing power risk d.market risk 4-22

Question 2 Diversification reduces a.systematic risk. b.unsystematic risk. c.market risk. d.purchasing power risk. 4-23

Question 3 Which one of the following is a measure of how much an investment’s returns vary from its average return? a.beta b.correlation coefficient c.standard deviation d.covariance 4-24

Question 4 With a core/satellite asset allocation approach, the core portion generally represents which percentage range of the portfolio? a.50% to 60% b.60% to 70% c.70% to 80% d.80% to 90% 4-25

Question 5 The broad category of expenses listed in a mutual fund’s prospectus are a.management fees and 12b-1 expenses only. b.management fees and other expenses only. c.12b-1 expenses and other expenses only. d.management fees, 12b-1 expenses, and other expenses. 4-26

Question 6 A type of fund with a net asset value that does not change is a a.bond fund. b.index fund. c.money market fund. d.stock fund. 4-27

Question 7 Correlations range from a.0 to b.–1.0 to 0. c.–1.0 to

©2012, College for Financial Planning, all rights reserved. Module 4 End of Slides Foundations In Financial Planning SM Professional Education Program