1. Investment Fundamentals
Chapter 13:
Investment
Fundamentals

2. Learning Objectives Explain how to get started as an investor.
Discover your own investment philosophy.
Identify the kinds of investments that match your interests.
Describe the major factors that affect the rate of return on investments.
Decide which of the five long-term investment strategies you will utilize.
Create your own investment plan.

3. 1. Starting Your Investment Program
Saving vs. Investing…What’s the difference?
Put Your Money to Work!
Build “real” wealth
Rate of return; Time
Sacrifices are necessary:
Start early, invest regularly
Delay 5: Double Down
We invest in securities [stocks, bonds, mutual funds]
Our invested assets make up our portfolio

4. Decide why you want to invest
Are you ready to invest?
Balances on high interest credit cards?
Adequate insurance protection?
An emergency fund that is easily accessible?
A monthly budget?
Contributing to your employer’s retirement plan?
Decide why you want to invest
Achieve financial goals [kids’ education, house down payment]
Supplement income
Reduce tax liability
Retire comfortably
For fun!

5. It takes money to make money!
Getting money to invest
Pay yourself first
Save-- don’t spend– extra funds
Make it automatic
Scrimp for a month
Break a habit, make use of the money
It takes money to make money!
If you want to be able to invest $1,000 this year, ask yourself these questions… before you buy!

6. Investors hope for a POSITIVE RETURN
Current Income Versus Capital Gain
Current Income is received on a regular basis while you own the investment
dividends from stock; interest from bonds
taxed at your marginal tax rate
Capital gains occur only when you sell the investment
results from you selling it for more than you bought it for
taxed at special lower rates
Capital losses are also possible!
Rate of Return (yield) is an investment’s total yearly return in the form of a percentage

7. What investment returns are possible?
Levels of RETURN ARE related to RISK
Average returns from 1926 – 2006:

8. 2. Your Investment Philosophy
How to handle investment risk
Pure risk vs. Speculative risk
Investment risk: uncertainty about returns
Tradeoff: Between risk and return

9. Ultraconservative “Investors” Are Really Just “Savers”
People that invest very conservatively
They do not get ahead financially over the long term because taxes and inflation offset most of their interest earnings
You can accept more risk when investing for long-term goals
Remember “The Rule of 72”?
72/4% = 18 years
72/8% = 9 years

10. What is Your Investment Philosophy?
Your approach to risk tolerance in investments
Risk tolerance: your ability to handle changes in your investments’ value
Levels of Risk Tolerance:
conservative; moderate; aggressive
We must take risks that will enable us to reach our financial goals
Greater risk = greater potential for returns
RCRE Investment Risk Tolerance Quiz available online at:

11. Investment Philosophy:
Conservative: Risk averse
Goal = preserve capital
Moderate: Risk indifferent
Goal = long-term profit
Aggressive: Risk seeker
Goal = short-term, quick profit
Investment Approach:
Active Investor – studies the economy, market trends, and investment alternatives
Usually buys individual stocks/seeks quick profits
Passive Investor – does not spend much time monitoring investments.
Usually buys mutual funds/seeks long-term profits

12. 3. Identify the Types of Investments You Want to Make
Your investments should match your interests
You can invest in 2 ways: lending or owning
Debts – “loanership” (lending) investments
the borrower agrees to repay the principal to the investor on a specific date (maturity).
the borrower agrees to pay the investor a specific rate of interest at regular intervals.
Equities – “ownership” investments
Potential for a higher return by sharing in profits
Pg. 363 Overview of Investment Alternatives

13. 4. How Risk and Other Factors Affect Return
Random risk
All of your eggs are in one basket
What happens if that basket breaks?
Diversification
“Spread the wealth”!
A way of reducing random risk
Averages out the high & low returns, reducing overall risk
Market risk (undiversifiable)
Risk results from economic influences that affect entire market

14. Effects of Diversification: Lower Total Return + Less Overall Risk

15. The Tax Consequences in Investment Fundamentals Did you Know? PG 366
After-Tax Return
Tax-Deferred Investments
Tax-Exempt Investments

16. 5. Establish Your Long-Term Investment Strategy
Example: 10% return, 7.5% after taxes (25% tax bracket), 3% inflation, real rate of return of 4.5% after taxes and inflation
4 Strategies
Investing is not “rocket science”… “just do it”
Start as early as possible
Investments should provide a positive Real Rate of Return
Understand the economy as a whole: how are Securities Markets performing?
Bear Market
Bull Market

17. A 10-Year Delay in Investing Can Cost you over $500,000 PG 367
Assumption: $2000 / yr in a tax-deferred account earning 10%

18. Trying to Time the Market is Too Difficult to Accomplish
Long-term investors must be able to withstand some market volatility
What are Market Timers? Constant “shifters”
Hope to capture the upside of rising stock prices while avoiding most of the downside
Very difficult to catch market highs and lows…have to be right twice
Miss the “best trading days” when prices rebound

19. Strategy #1: Buy-and-Hold “The secret to investment success is benign neglect.”
The Emphasis: Hold on to investments in good times and bad
The Action: Buy a diversified mix of stocks or mutual funds, reinvest the dividends, and hold on almost indefinitely
The Expectation: The value of assets will increase over the long run with the growth of the American and world economies
The Challenge: Do not react emotionally to day-to-day changes that occur in the market
The Advice: Buy more shares when prices are lower during normal market downturns

20. Strategy #2: Dollar-Cost Averaging
The Action: Invest equal sums of money at regular intervals regardless of the price of the investment
The Emphasis: Invest regularly, automatically
The Expectation: You will be buying more shares when stock price is down and less when the price is up => reducing average cost per share
Buying shares regularly through a “DRIP”, pg 371

21. Strategy #3: Portfolio Diversification “Diversification is the single most important rule in investing.”
The Action: Create your portfolio by choosing different asset classes
The Emphasis: Spread the wealth! Choose assets based on their dissimilar risk-return characteristics
The Expectation: Different asset classes react differently to economic changes; when one performs poorly, the others will perform well.
The Advice: Never keep more than % of your assets in one investment

22. Diversification Averages Out an Investor’s Returns

23. Diversified Investment Portfolios

24. Strategy #4: Asset Allocation “More than 90% of an investor’s returns are a result of proper allocation.”
The Action: Decide on the proportions of your investment portfolio that will be devoted to various asset categories
The Emphasis: You are in the right place at the right time! your allocation proportions reflect your age, risk tolerance, goals, time horizon
The Expectation: Your portfolio allocation will maximize returns and reduce risk
The Advice: Maintain your desired allocation, rebalancing when necessary

25. Model Portfolios and Time Horizons

26. Rebalancing Assets in Your Portfolio

27. Creating Your Own Investment Plan
Investment plan: an explanation of your investment philosophy and your logic on investing to reach specific goals
What are the time horizons for your investment goals?
Building up an amount for a down payment on a home?
Creating a college fund for a child?
Putting away money for retirement?