Chapter 14 Methods of Investing © 2010 Pearson Education, Inc.

Learning Objectives Explore the reasons for investing
Describe the process of investing in stock Describe the process of investing in bonds Describe the process of investing in mutual funds Explore other options for investing © 2010 Pearson Education, Inc. All rights reserved

Why Invest? Investment is something that you acquire with the goal of making money You should save a cash reserve that is placed in liquid investments These include checking accounts, certificates of deposit (CDs) , and savings accounts This is money that you should use for emergencies or unexpected expenses Explain that before investing, you should make sure your emergency fund is in place and in highly liquid accounts. © 2010 Pearson Education, Inc. All rights reserved

Why Invest? Why not just choose these guaranteed and liquid options for all the money you set aside? Highly liquid, lower-risk investments generally offer low interest rates and don’t account for inflation There are investments that offer hope of outpacing inflation over time, such as stocks, bonds, and mutual funds Emphasize the importance of yielding higher returns than possible inflation rates. © 2010 Pearson Education, Inc. All rights reserved

Why Invest? With the promise of higher returns comes higher risk
These types of investments do not produce steady, even results Investments may go up and down in value unpredictably Inform students that there is risk involved in investing. Students must find the level of risk that is comfortable with them keeping in mind the length of time the investment is needed for. The longer the timeframe, the higher the level of acceptable risk. © 2010 Pearson Education, Inc. All rights reserved

Why Invest? The stock market has generally produced much higher long-term returns than more liquid investments It also tends to have major up and down price swings Consider riskier investments to be long-term investments Understand that a risk of these longer-term investments is the total loss of the investment © 2010 Pearson Education, Inc. All rights reserved

Check Your Financial IQ
Why is it a good idea to invest money in something like stocks or bonds? © 2010 Pearson Education, Inc. All rights reserved

Investing in Stocks Stocks are certificates that represent pieces of ownership in a company If a company has issued 100 shares of stock that represents the entire ownership of the firm, then each share of stock would be equivalent to 1 percent of the firm’s value Companies, such as Apple, have issued millions of shares Stock ownership also carries voting rights Explain that if the company is successful, you share in the rewards by your stock increasing in value and likewise, if the company performs poorly your stock value will suffer. Explain that for a company like Apple that has issued millions of shares, each of these share represents a much smaller fraction of the firms' ownership © 2010 Pearson Education, Inc. All rights reserved

Stock Exchanges Initial public offering (IPO) is when a company chooses to “go public” and has the first sale of stock The IPO occurs in what is called the primary market Companies issue and sell stock as a way to raise money for business operations, expansion, and other needs. This initial sale is when the company receives money (shares) Later, the shares may be bought and sold by many different investors Explain that those later transactions involving those same shares of stock do not provide the company with any more money © 2010 Pearson Education, Inc. All rights reserved

Stock Exchanges These stock sales occur in the so-called secondary market, which includes the organized stock exchanges such as the New York Stock Exchange (NYSE) or the National Association of Security Dealers Automated Quotation system (NASDAQ). The transactions that take place after the IPO are the ones we are more familiar with They are the ones reported in the newspapers, such as the Wall Street Journal or on the financial news on TV © 2010 Pearson Education, Inc. All rights reserved

Stock Exchanges Publicly traded is when a company begins trading on one of the organized stock exchanges Many investors buy and sell stocks on the organized stock exchanges through stock brokers such as: Merril Lynch Internet accounts such as E*TRADE © 2010 Pearson Education, Inc. All rights reserved

Stock Exchanges The New York Stock Exchange may look chaotic on TV
It works remarkably well as a system for buying and selling stocks When you place an order to buy stock in a company that is “listed”—bought and sold—on the NYSE, that order flows through that chaotic market, and your order is carried out © 2010 Pearson Education, Inc. All rights reserved

Stock Exchanges The NASDAQ is also a stock exchange, but it does not have a central location where dealers gather It is an electronic network of dealers who buy and sell stocks Each day that trading occurs, the stock exchanges publish the prices at which stocks trade Emphasize NYSE and NASDAW—companies list on one and might be hard to find. Just because you can find them on NYSE doesn’t mean they are not publicly traded. © 2010 Pearson Education, Inc. All rights reserved

The Behavior of Investors
Institutional investors are investors who trade large volumes of stocks on behalf of large institutions (pension funds) There are many types of investors who trade stocks Individual investors are well represented in the stock market Investors trade stocks to make a profit Most investors attempt to buy a stock at a low price with the expectation of selling it later at a higher price Explain that individual investors can mean them (the students!) © 2010 Pearson Education, Inc. All rights reserved

Share prices for a company tend to go up when the company succeeds at its business Skilled investors carefully research the companies and industries they want to invest in Check out figure 14.1 to see what factors drive stock prices up or down © 2010 Pearson Education, Inc. All rights reserved

Keep in mind that the stock market can go up or down “Bull market” is a term used for markets that are treading upward “Bear market” is a term for markets that are trending down Bull and Bear are examples of some common jargon you hear investors use Explain that bull market means most stock values on rising. Bear market means the values are trending downward. Also, bear markets are not a bad thing, necessarily, as they offer opportunities for buy. They are only bad for those needing to sell. © 2010 Pearson Education, Inc. All rights reserved

Shareholders are the people who own stock in the company Dividends are the distribution of profits Many companies distribute a portion of their profits to shareholders Companies pay dividends in cash, or sometimes, in additional stock Dividends are another way some stockholders make money in the stock market © 2010 Pearson Education, Inc. All rights reserved

Math for Personal Finance
Jennifer bought 900 shares of stock for $45 a share in a company’s IPO. Not counting commissions, what was her dollar return if she sold the stock two weeks later for $56 a share? © 2010 Pearson Education, Inc. All rights reserved

Solution: 900 x $45 = $40,500 that Jennifer paid for the stock. She sold the stock for $56 x 900 = $50,400. Her return is the difference or $50,400 - $40,500 = $9,900 © 2010 Pearson Education, Inc. All rights reserved

Not all companies give out dividends A company that is trying to grow rapidly may opt to use all profits to expand the business Whether a company pays dividends or seeks to maximize growth is one factor an investor should consider when purchasing a stock Both types can be good investments, but only if they match the investor’s goals Make sure to do your research when deciding where to invest. How will it affect your financial plan? © 2010 Pearson Education, Inc. All rights reserved

Securities and Exchange Commission (SEC) is a government agency that regulates and monitors the stock market Security is a widely used term for investments issued by corporations or governments in which the investor receives proof of ownership The stock markets do not have insurance on your money The SEC regulates and monitors the stock market Look at figure 14.2 to see your own tolerance for the kind of risk investing in stocks involves Explain what it means by the stock markets not having insurance on your money. It is not protected! © 2010 Pearson Education, Inc. All rights reserved

The SEC makes sure companies that offer stock for public sale provide accurate information to investors and obey established rules designed to make the stock market a “fair” game The government needs the economy to have an active stock market Explain why it is important for the economy to have an active stock market. The stock market provides investors who buy the stock in the primary market with a way to sell their ownership shares at a later date Without the liquidity that active stock markets offer, few investors would buy the initial public offerings (IPOs) This would cut off a major source of funding that companies need to start and grow their business © 2010 Pearson Education, Inc. All rights reserved

Example of a Stock Transaction
Brokerage is a firm that provides you access to the stock markets full service brokerage firms provide advice and execute your trades Commission is a fee for carrying out a transaction Buying or selling stocks will require you to open an account at a brokerage. You can open an account at one of many full service brokerage firms Such firms offer a high level of service and charge customers a commission Do research when deciding what brokerage to use. Make sure it fits your needs. © 2010 Pearson Education, Inc. All rights reserved

Discount brokerage offers a reduced level of service, lower costs, and often the ability to make your trades yourself online Some investors decide to go with a discount brokerage Examples of discount brokerages are Scottrade and E*TRADE Take a look at figure 14.3 to see a flowchart outlining the process of selling a stock © 2010 Pearson Education, Inc. All rights reserved

Solution: ($38 - $32)/32 = or percent. Keep in mind this return is not an annualized return and may be good or bad depending on how long Evelyn held the stock © 2010 Pearson Education, Inc. All rights reserved

Stock investors must be prepared to evaluate their holdings regularly They may opt to sell poor performing stocks in hopes of finding a better investment Investors are generally wise to own a number of different stocks As risky as stocks can be, it is even riskier to depend on a single stock © 2010 Pearson Education, Inc. All rights reserved

Investing in Bonds Many investors place some of their money in bonds
Companies, nonprofit organizations, and government agencies issue bonds as a way of taking a loan Investors buy the bonds, effectively lending money to the bond issuer In return, the investor earns interest A bond is a promissory note, or a promise to repay a certain amount of money at some point in the future Explain that bonds are a loan an individual makes to a company or government entity in return for interest payments. When investing in bonds, you get to be the bank loaning others money. You receive interest payments until the time the loan is due in full. © 2010 Pearson Education, Inc. All rights reserved

How Bonds Work Each bond has a face value and a stated rate of interest This will be paid annually to the bondholder until the bond expires Bonds have maturity dates ranging from five to thirty years Look at figure 14.4 for a flowchart of the bonds process Maturity date the date when the bond expires (matures) Face value is the bond’s maturity value that is printed on the front of the bond Coupon rate is the bond’s interest rate © 2010 Pearson Education, Inc. All rights reserved

How Bonds Work Bonds offer investors more than one way to make money
Coupon payments are the regular interest payments Bonds offer investors more than one way to make money Bondholders can look to trade their bonds at a value higher than their face value A bond’s value moves up and down due to a number of factors Explain the types of factors that will cause a bond’s value to move up or down. such as interest rate changes or changes in investors’ beliefs in the bond issuer’s ability to repay a bond © 2010 Pearson Education, Inc. All rights reserved

How Bonds Work Some investors may elect to sell their bonds prior to the bond’s maturity date If the bond’s sale price is more than its face value, the investor will make a profit If the price is lower, the investor will have a loss on the sale of this bond © 2010 Pearson Education, Inc. All rights reserved

How Bonds Work Most bonds carry some risk
If the bond issuer has financial problems, you may not get the interest you are due or your money back There are rating services that rate bonds and help investors evaluate their risk Check out figure 14.5 for a sample of how bonds are rated Remind students that when you purchase a bond you are basically lending the bond issuer money Explain how the rating service works: The lower the rating, the higher the interest rate the bond pays © 2010 Pearson Education, Inc. All rights reserved

Kenneth held a bond for five years that had an 8.5 percent coupon rate and a $1,000 face value. How much did Kenneth receive in interest from the bond? © 2010 Pearson Education, Inc. All rights reserved

Types of Bonds Investors can choose from several types of bonds
These include: Treasury bonds Municipal bonds Federal agency bonds Corporate bonds © 2010 Pearson Education, Inc. All rights reserved

Types of Bonds Treasury bonds present no default risk since the federal government backs them There is an active secondary market where investors can sell Treasury bonds prior to maturity The interest earned on Treasuries is subject to federal tax It is exempt from state and local income taxes Treasury bonds are issued by the US Treasury to finance the debt of the United States government © 2010 Pearson Education, Inc. All rights reserved

Types of Bonds The United States Treasury offers a variety of bond options Maturity dates vary widely Some options, such as certain savings bonds, do not pay regular interest but are purchased at a discount © 2010 Pearson Education, Inc. All rights reserved

Types of Bonds Federal agency bonds are these types of bonds that encourage home ownership Federal agencies such as the Federal Housing Administration (FHA) and the Government National Mortgage Association (Ginnie Mae) may issue bonds in order to fund projects In these two cases, the bond proceeds are used to buy mortgages to encourage home ownership © 2010 Pearson Education, Inc. All rights reserved

Types of Bonds Municipal bonds are bonds issued by state and local governments to finance large public projects such as water and sewer systems Investors do not pay federal taxes on the interest from municipal bonds They may also escape state and local taxes if they live in the region where the bonds originate Municipal bonds do have a slight default risk Explain that municipal bond interest ins not taxed by the federal government and could be except from local and state taxes if you live in that state or municipality. © 2010 Pearson Education, Inc. All rights reserved

Types of Bonds Corporate bonds have all degrees of risk depending on the strength of the company Companies with a solid financial position will have a low risk of default The top four categories of bonds shown in figure 14.5 are considered investment grade bonds and reasonably safe Corporate bonds are bonds issued by large firms Junk bonds are bonds from companies with the highest risk Explain that corporate bonds have a greater likelihood of default than a government-backed bond © 2010 Pearson Education, Inc. All rights reserved

Buying Bonds Investors can buy and trade bonds in much the same way they buy stocks They may use a broker, including discount brokers to arrange transactions Investors can also buy treasury bonds directly from It is important to do your research when deciding what bonds to invest in. © 2010 Pearson Education, Inc. All rights reserved

Mutual Funds Mutual funds are another investment option
Mutual funds sell shares to investors in order to collect a pool of money that is then used to buy various investments Mutual funds are another investment option A team of professional fund managers oversee these investments The shareholders see an increase or decrease in the value of their shares in the mutual fund based on the overall performance of the fund’s investments. © 2010 Pearson Education, Inc. All rights reserved

Mutual Funds Diversification is the process of investing in multiple investments Mutual funds are attractive to investors for several reasons Mutual funds pool large amounts of money and own a wide range of investments Diversifying investments reduces risk because failure of one company will not significantly impact the entire amount invested Explain that mutual funds are just a bunch of investors putting their money together to invest. Explain that diversification is extremely important in investing—mutual funds allow a person to diversify without having to choose or buy the stocks of individual companies their own. © 2010 Pearson Education, Inc. All rights reserved

Mutual Funds Investors who buy individual stocks and bonds can achieve diversification on their own Investors with limited funds who want to diversify may choose a mutual fund Mutual funds are managed by experienced people Explain that investors can achieve diversification on their own, but it takes many purchases and a lot of money. Discuss how there are thousands of mutual funds that invest in stocks and bonds, with many specializing in certain types of securities For example, you can purchase shares in a mutual fund that only invest in Japanese companies or ones that invests in gold mining stocks © 2010 Pearson Education, Inc. All rights reserved

Mutual Funds Investors can purchase mutual funds through a brokerage
They can also buy funds directly from the companies that sell them Funds vary widely in the fees they charge shareholders It pays to research any fund purchase carefully © 2010 Pearson Education, Inc. All rights reserved

Mutual Funds One of your primary reason to invest is for retirement
Take advantage of the current tax laws that allow you to grow investments in a tax sheltered retirement account such as a r401 (k) or IRA These accounts provide the benefit a of allowing your money to grow tax free until you retire © 2010 Pearson Education, Inc. All rights reserved

Other Ways of Investing: Real Estate
Many people have used real estate as an investment Housing values move up and down over time depending on the supply and demand for homes in an area Investing in real estate offers tax benefits, or the ability to take advantage of rules in the tax code that may reduce your tax liability Explain that real estate can be used for income and as a long-term investment Explain that people invest in real estate by buying a home © 2010 Pearson Education, Inc. All rights reserved

Other Ways of Investing: Real Estate
Some people invest in real estate by buying rental property People own an apartment or other commercial property and rent it out on a monthly basis Profits will come form the real estate increasing in value over time Explain how using rental property as an investment is not unlike buying a stock that pays dividends or a bond-the regular income can be used for everyday operations but the potential for increased property value offers the growth © 2010 Pearson Education, Inc. All rights reserved

Other Ways of Investing: Owning a Business
Many people have a dream of owning their own business A large number of millionaires are small business owners Restaurants, and retail stores provide opportunities for someone who works hard to generate wealth Be careful with these types of opportunities though because many small ventures tend to fail © 2010 Pearson Education, Inc. All rights reserved

Summary Liquid investments are important, but it is important to aim for a return that will beat inflation This involves making riskier investments with a more long-term goal Stock is partial ownership in a company and a good way to seek a profit Brokerages, both full-service and discount, make it possible to trade stock © 2010 Pearson Education, Inc. All rights reserved

Summary Bonds are promissory notes from an issuer to an investor
The bond issuer pays interest and has to pay back the face value at the maturity date Types of bonds include Treasury bonds, federal agency bonds, municipal bonds, and corporate bonds Junk bonds are the highest risk bonds Bonds can be sold at a profit or loss before their maturity date © 2010 Pearson Education, Inc. All rights reserved

Summary Mutual funds are another investment option
Mutual funds provide diversification and professional management for a low initial investment Investors can purchase shares in mutual funds through a brokerage or directly from the companies that sell them People can also invest in real estate and small businesses © 2010 Pearson Education, Inc. All rights reserved

Key Terms and Vocabulary
Bond Brokerage Commission Corporate bond Coupon payment Coupon rate Discount brokerage Diversification Dividend Face value Federal agency bond Full-service brokerage Initial public offering (IPO) Institutional investor Investment Junk bond Maturity date Municipal bond Mutual fund National Association of Security Dealers Automated Quotations (NASDAQ) New York Stock Exchange (NYSE) Primary market Publicly traded Secondary market Securities and Exchange Commission( (SEC) Security Shareholder Stock Treasury bonds © 2010 Pearson Education, Inc. All rights reserved

Chapter 14 Methods of Investing © 2010 Pearson Education, Inc.

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Chapter 14 Methods of Investing © 2010 Pearson Education, Inc.

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