Investment Fundamentals. Introduction Simply saving will not result in financial success. You will...

Investment Fundamentals

Introduction

Simply saving will not result in financial success. You will need to invest in good times and bad. Successful investors take a long-term approach. Slow and steady wins this game.

Your Next Five Years

In the next five years:

1. Sacrifice some of your income and invest in a diversified portfolio for your future needs.

2. Accept more risk when investing for the long term.

Your Next Five Years

3. Invest regularly through your employer’s retirement plan

4. Invest no more than 5 or 10 percent of your portfolio in a single company stock including that of your employer.

5. Rebalance your portfolio at least once a year based on your chosen asset allocation strategy.

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Learning Objective #1

Explain how to get started as an investor.

Starting Your Investment Program

Investing is more than saving. Savings Investing Securities Stocks Portfolio

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Starting Your Investment Program

Are you ready to invest? Live within your income Save regularly Use credit wisely Carry adequate insurance

Starting Your Investment Program

Decide why you want to invest. To achieve goals To gain wealth and security To increase current income To meet retirement needs

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Starting Your Investment Program

Where can you get the money to invest? Live within your means Participate in your employer’s retirement

plan Make savings automatic When loans are paid off put the payments

into your investments

Figure 13.1: “If You Want to Save $1000….”

Starting Your Investment Program

What investment returns are possible? Return is based on Financial Risk

Total Return from current income and capital gains

Current IncomeInterestRentDividends

Starting Your Investment Program

What investment returns are possible?

Capital Gain/Capital Loss

Rate of Return (or Yield)

Figure 13.2: The Long-Term Rates of Return on Investments

Concept Check 13.1

What should you do before you are ready to invest?

Identify three ways that you personally could find some money to invest in the next five years.

What are the two parts of an investor’s total return?

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Learning Objective #2

Discover your own investment philosophy.

Your Investment Philosophy

How to handle investment risk Pure risk

Speculative risk

Investment risk

Figure 13.3: The Risk Pyramid Reveals the Trade-Offs Between Risk and Return

What is your Investment Philosophy?

Are you a conservative Investor? Preservation of capital

Are you a moderate investor? Accept risk as a part of investing

Are you an aggressive investor? Risk seeker

Your Investment Philosophy

Should you take an active or passive investing approach? Active investors Market efficiency Passive investors

Concept Check 13.2

Summarize your investment philosophy and general approach to tolerance for risk.

Indicate whether you view yourself as an active or passive investor, and explain why.

Summarize why so many people are lousy investors and not very successful.

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Learning Objective #3

Identify the kinds of investments that match your interests.

Identify the kinds of investments you want to make.

Do you want to lend or own? Lend = Bonds Fixed maturity Fixed income Own = Equities

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Identify the kinds of investments you want to make.

Making Short-, Intermediate-, and Long-term investments

Choose investments for their components of total return.

Concept Check 13.3

Summarize your personal views on lending or owning investments.

Which type of investment return—current income or capital gains—seems more attractive to you? Why?

Learning Objective #4

Describe the major factors that affect the rate of return on investments.

Random and Market Risk

Random (or unsystematic) risk

Diversification

Market (or Systematic) risk

Other Types of Investment Risks

Business failure risk

Inflation (or purchasing power) risk

Business-cycle risk

Other Types of Investment Risks

Market-volatility risk

Liquidity risk

Reinvestment risk

Investment Returns

Transaction costs reduce returns Commissions

Leverage may increase returns.

Concept Check 13.4

Distinguish between random risk and market risk.

Summarize three other risks that may affect investment returns.

Explain how transactions costs, leverage, and income taxes increase or decrease investment returns.

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Learning Objective #5

Decide which of the five long-term investment strategies you will utilize.

Establish Your Long-Term Investment Strategy

Determine the Real Rate of Return

RRoR = [(1 – MTR) x RoR] - Inflation

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Establish Your Long-Term Investment Strategy

Securities Markets

Bear Markets versus Bull Markets

Figure 13.4: A 10-Year Delay in Investing Can Cost You $500,000

Establish Your Long-Term Investment Strategy

Long-term investors understand market timing.

Establish Your Long-Term Investment Strategy

Strategy 1: Buy and hold anticipates long-term economic growth. Buy-and-Hold (or Buy to Hold)

Establish Your Long-Term Investment Strategy

Strategy 2: Dollar-cost averaging buys at “below-average” costs. Dividend-reinvestment plans

Dollar-cost averaging in a fluctuating market Average Share Price Average Share Cost

Establish Your Long-Term Investment Strategy

Strategy 3: Portfolio diversification reduces portfolio volatility.

Insert Figure 13.5: Diversification Averages Out an Investor’s Return

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Establish Your Long-Term Investment Strategy

Strategy 4: Asset allocation keeps you in the right investment categories at the right time.

Figure 13.6: Model Portfolios and Time Horizons

Figure 13.7: Rebalancing Assets in Your Portfolio

Establish Your Long-Term Investment Strategy

Strategy 5: Modern portfolio theory evolves from asset allocation

Modern Portfolio Theory (or MPT) Monte Carlo Analysis

Concept Check 13.5

Summarize why smart people conclude that it is impossible to beat the average stock market returns, and then note why some marker timers try anyway.

Summarize what the buy-and-hold strategy is all about.

Concept Check 13.5

Explain the concept of dollar-cost-averaging including why one invests at below-average costs.

What is asset allocation and why does it work?

What is the goal of portfolio diversification and how is this accomplished?

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Learning Objective #6

Create your own investment plan.

Creating an Investment Plan

Your investment plan reflects your investment philosophy and your logic for investing to reach specific goals.

Concept Check 13.6

Review tables 13.1 and 13.2 and Figures 13.1 and 13.2, and record in writing an investment plan to fund your retirement, presumably one of your own long-term goals.

The Top 3 Financial Missteps In Investing

People slip up in investment fundamentals when they do the following:

1. Buy and sell more than they should.

2. Diversify less than they should.

3. Hold on to a bad investment long after evidence proves it was a bad decision.

Do It NOW!

Investing is key to financial success. Start today by:

1. Saving even a small amount through a pay-yourself-first philosophy perhaps by using payroll withholding.

Do It NOW!

2. Identifying the percentages you would allocate to stocks, bonds, and cash equivalents using an asset allocation strategy to save for retirement.

3. Visiting www.finance.yahoo.com every weekday for one month to become familiar with how and why the stock market moves from day to day.