1. Investment in Financial Capital

2. Objectives
Summarize reasons why people invest, what is required before beginning, how returns are earned, and some ways to obtain funds to invest.
Determine your own investment philosophy.
Recognize the variety of investments available.
Identify the major factors that affect the return on investment.
Specify some strategies of portfolio management for long-term investors.
List three guidelines to use when deciding the best time to sell investments.

3. Establishing Investment Goals
Financial goals should be specific and measurable.
Why are you accumulating these funds?
How much do you need?
How will you get it?
How long will it take you to reach your goal?
How much risk are you willing to assume?
Are you willing to sacrifice current consumption to invest for the future?
Is it realistic to try and save this amount?

4. Steps to Create a Personal Investing Plan
My investment goals are:
____________________
Step 2
By ___________, I will
have obtained $_______.
Step 3
I have $__________
available to invest.
Date _____________
Step 9
Continue evaluating choices.
Step 4
Possible investment alternatives:
1._________________
2._________________
3._________________
4._________________
Step 8
Final decision
1._______________
2._______________
Step 6
Projected return on each alternative
1.__________
2.__________
3.__________
4.__________
Step 5
Risk factors for each alternative
1.____________________
2.____________________
3.____________________
4.____________________
Step 7
Investment decision
1._______________
2._______________
3._______________

5. Definitions: Saving: setting money aside for future use
Investing: Putting the money to work for you or using your money to make more money
Borrowing: Using next year’s income this year.

6. Investment Fundamentals
ATTENTION!
Difference in return is a major distinction between savings and investing.
Successful investors begin to live off earnings, without spending wealth itself.

7. Investment in Financial Capital
Investment - use of economic resources to make a profit.
Financial Capital - liquid resources of a government, business, or individual

8. Preparations for Investing
WHY PEOPLE INVEST:
Achieve financial goals
Increase current income
Gain wealth and financial security
Have funds available for retirement

9. Preparations for Investing
PREREQUISITES TO INVESTING:
Live within means
Continue savings program
Establish lines of credit
Carry adequate insurance
Establish investment goals

10. Preparations for Investing
Interest
Dividends
Rent
Capital gain/loss
Rate of return or yield
INVESTMENT RETURNS:

11. Performing a Financial Checkup
Learn to live within your means
pay off high interest credit card debt
Provide adequate insurance protection
Start an emergency fund
three to nine months of living expenses
Have other sources of cash for emergencies
line of credit
cash advance

12. Getting Money to Start an Investing Program
Pay yourself first
Participate in elective savings programs
Payroll deduction
electronic transfer
Make a special effort to save one or two months a year
Take advantage of windfalls
Invest half of your tax refund

13. Value of Having a Long-Term Investing Program
Many people don’t start investing because they only have a small amount to invest but....
Small amounts invested regularly become large amounts over time

14. Personal Investment Philosophy
Handling risk
Ultraconservative strategies
Conservative
Moderate
Aggressive

15. Personal Investment Philosophy
Handling risk
Ultraconservative strategies
Conservative
Moderate
Aggressive

16. Investment Selection Lend or own Short-term or long-term
Choose a vehicle

17. Two ways to invest
Lend: Promise of repayment of loan (principal) and interest
Deposit money in bank
Lending money to the government
Lending money to a business
Own: Purchase an asset or equity
Buy stock
Buy mutual funds
Buy real estate
Buy collectibles

18. Factors That Affect Investment Decisions
Safety - minimal risk of loss
Risk - uncertainty about the outcome
inflation risk
interest rate risk
business failure risk
market risk

19. Factors that influence the investment decision: Risk Tolerance
Risk represents the uncertainty that the yield on an investment will deviate from what is expected.
The amount of risk a household can tolerate will determine:
The decision to invest
The type of investment
The investment strategy
The amount of investment

20. Types of Investment Risk
Inflation risk: investment returns will not keep up with inflation.
Default risk: the risk of losing a major portion of or all of your investment

21. Types of Investment Risk
Interest rate risk: market interest rates rise devaluing fixed rate investments
Marketability risk: having to sell a certain asset quickly; not being able to get the price you want. Also called liquidity risk.

22. Risk Tolerance Quiz Take the quiz listed in notes….

23. Income From Investments
Safest
CDs
savings bonds
T-bills
Higher potential income
municipal bonds
corporate bonds
preferred stocks
mutual funds
real estate

24. Commodities Junk bonds Options
Investment Pyramid
High risk
Commodities Junk bonds Options
Rental property
Utility stocks
Government
Securities
Corporate bonds
CDs
Money Market
Savings Accounts
Cash
High Quality
Stocks
Mutual funds
Low risk

25. Investment Growth and Liquidity
increase in value
common stock
growth stocks retain earnings
bonds, mutual funds and real estate
Liquidity
ease and speed to convert an asset to cash

26. Major Factors That Affect Rate of Return
INVESTMENT RISK:
Pure
Speculative
Risk pyramid

27. Major Factors That Affect Rate of Return
INVESTMENT RISK TYPES:
Financial
Market volatility
Political
Inflation
Deflation
Interest rate

28. Major Factors That Affect Rate of Return
INVESTMENT RISK:
Random or unsystematic
Diversification
Market or systematic

29. Major Factors That Affect Rate of Return
Leverage
Taxes
Marginal tax rate
Taxable vs. tax-free income
Buying and selling costs/commissions
Inflation

30. Risk Tolerance
., REVIEW BOOK: Personal Finance. Retrieved Oct 1, 2009 from .

31. Calculating Percentage Rate of Return

32. Major Factors that Affect Rate of Return
CALCULATE REAL RATE OF RETURN:
Identify before-tax return
Subtract marginal tax rate
Obtain net return after taxes
Subtract estimate of inflation
Obtain real rate

33. Real Rate of Return Example
1. You are in the 28 percent tax bracket.
= .72
If the yield on your investment is 6.25% then: x .72 = .045
Your after tax return is 4.5%
If inflation is 5%, your real rate of return after inflation is 4.75% (.05 x (1-.05) = .0475

34. Management Strategies — Long-Term Investors
Business-cycle timing
Dollar-cost averaging
Portfolio diversification
Asset allocation

35. Investment Alternatives
What is stock?
part ownership in a company
the money you pay for shares of stock provides equity capital for the business

36. An Example of Asset Allocation
., REVIEW BOOK: Personal Finance. Retrieved Oct 1, 2009 from .

37. Levels of Diversification
., REVIEW BOOK: Personal Finance. Retrieved Oct 1, 2009 from .

38. Investment Alternatives
(continued)
What is a bond?
a loan to a corporation, the federal government, or a municipality
The interest is paid twice a year, and the principal is repaid at maturity (1-30 years)
You can keep the bond until maturity or sell it to another investor

39. Investment Alternatives
(continued)
What is a mutual fund?
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

40. Monitor Your Investments
Read your account statements
Chart the value of your investments
Maintain accurate and current records
Calculate the current yield %
annual income from investment
market value of the investment

41. Sources of Investment Information
Newspapers
Business Periodicals
Government Publications
Corporate Reports
Statistical Averages
Investor Services and newsletters
Standard and Poor’s stock reports
Value Line
Moody’s investment service

42. Investment Philosophies

43. Best Time to Sell Take profits Cut losses
“If wouldn’t buy it now, sell it”

44. Mandatory Financial Investment for Retirement
Employer / Employee Social Security Contributions (15.3% of earnings up to a maximum taxable amount of $110,000 in 2012)
Defined Benefit Private Pension Plans

45. Discretionary Financial Investment for Retirement
Defined Contribution Pension Plans
401(k), 403(b), IRA
Roth IRA
Roth 401(k)

46. Income and Consumption Over the Life Cycle

47. Measures of Risk
Beta - measures the variability in the rate of return of a particular stock relative to the larger stock market.
Beta stock A = 3.0 means the variability in the rate of return of stock A is three times the market average
Bond ratings - Standard and Poor’s and Moody’s ratings of bonds for default risk only.

48. The Relationship Between Rate of Return and Risk
Risk and average rate of return are positively correlated.
Risk and variance of rate of return are positively correlated.

49. Measuring the Rate of Return
Typically think of rate of return in terms of interest paid per $1.00 invested. But, the timing of when you get this return varies depending on…
income return - situation where the principal that is invested remains the same but the investor periodically receives income based on this investment.
Certificates of deposit
money market funds
bond interest
stock dividends

50. Calculating the Return on an Investment
Rate of Return is the total income you receive on an investment over a specific period of time divided by the original amount invested.
For example:
Assume you invest $3,000 in a mutual fund. Also assume the mutual fund pays you $50 dividends this year and that the mutual fund is worth $3,275 at the end of the year.
Step 1: Subtract the investment’s initial value from the investment’s value at the end of the year: $3,275 - $3,000 = $275
Step 2: Add the annual income to the amount calculated in Step 1.
$50 + $275 = $325
Step 3: Divide the total dollar amount of return calculated in Step 2 by the original investment.
$325/$3,000 = = 10.8%

51. Measuring the Rate of Return
Capital gain - situation where you get your return only when you sell the investment.
stocks
Real Estate
collectibles
Sometimes, you get a combination of income and capital gains… makes it even more difficult to calculate the rate of return.

52. Measuring the Rate of Return
The risk-return trade-off can also be managed by having a variety of investments in your portfolio
BE DIVERSIFIED!
Statistically, you need between 6-15 stocks in different in different industries to be fully diversified in the market

54. Annual returns for stocks, T Bonds, T Bills from 1981 - 2011
Average
$100 invested in 1981 was worth___ in 2011:
Common Stocks-S&P 500
10.42%
$2,160.13
Small Company Stocks
9.55%
$1,690.38
Treasury Bills
5.20%
$481.38
Treasury Bonds
10.69%
2,330.02