Introduction to Investing

Introduction to Investing

Take Charge of Your FinancesFamily Economics and Financial

Education

© Family Economics & Financial Education – June 2010 – Investing Unit – Introduction to Investing – Slide 2Funded by a grant from Take Charge America, Inc. to the Norton School of Family and Consumer Sciences at the University of Arizona

1.12.1.G1Saving vs.

InvestingSavings is for short-term goals and emergencies

Investing is for long-term goals, such as college or retirement.

Remember: The purpose

of savings is

to develop financial security.

You should have 3 – 6 months of salary in savings BEFORE

you start investing.


1.12.1.G1

What is Investing?• The purchase of assets with

the goal of increasing future income

• Focuses on wealth accumulation

• Appropriate for long-term goals

What are examples of long-term goals that

can be accomplish

ed by investing?


1.12.1.G1Rate of Return

• Return is money that you earn from your investment.

• The Rate of Return is the total return on an investment expressed as a percentage of the amount of money invested.

Total Retur

n

Amount of

Money Invest

ed

Rate of

Return

Investments

usually earn

higher rates of return than

savings tools.


1.12.1.G1What is Mandy’s

Rate of Return?Mandy saved $2,200 in a

money market deposit account. After one year, she

has a return of $110. What is Mandy’s rate of return?

$110 $2,200

.05 = 5%

Mandy’s rate of return on investment is 5%


1.12.1.G1What is Derek’s

Rate of Return?Derek invested $900. When he withdrew his money from the investment, he had a total of

$1,050. What is Derek’s rate of return?

$150 $900.167

= 16.7

%

Derek’s rate of return on investment is 16.7%


1.12.1.G1

RiskPOTENTIA

L RETURN

RISK

Risk• The uncertainty regarding the outcome

of a situation or eventInvestment Risk• The possibility that an investment will

fail to pay the expected return or fail to pay a return at all


1.12.1.G1Financial Risk

Pyramid

Wealth Accumulati

on- Investments

Financial Security- Savings Tools

SpeculationIncreasing

potential for higher returnsIncreasing risk


1.12.1.G1

InflationInflation

The rise in the general level of prices

Inflation RiskThe danger that money won’t be worth

as much in the future as it is today

Inflation risk should not be a concern with savings since the

goal of savings is to provide current financial security

The rate of return on an investment should be

higher than the rate of inflation.


1.12.1.G1Investment

PhilosophyEach individual has a tolerance level for the

amount of risk they are willing to take on

Investment PhilosophyAn individual’s general

approach to investment risk

The greater the risk a person is willing to

make on an investment, the greater

the potential return will

be.

Generally divided into three categories: conservative, moderate, and aggressive


1.12.1.G1Types of

Investment ToolsStocks Bonds

Mutual Funds

Index Funds

Real Estate

Speculative

Investments


1.12.1.G1

Stocks• Stock–A share of ownership in a

company• Stockholder or shareholder–Owner of the stock

Usually a stockholder owns a very small part

of a company.


1.12.1.G1

Return on StocksThere are two ways people

can make money on stocks:

1. Dividends–Dividends are the share of

profits distributed in cash to stockholders

2. Market Price– The current price that a

buyer is willing to pay for stock


1.12.1.G1

Return on Stocks• If stock is sold for a market

price higher than what was paid, stockholder will receive a return (make money).

• If stock is sold for a market price lower than what was paid, stockholder will lose money


1.12.1.G1

Stock Markets• Stocks are bought and sold

on stock markets by people called brokers.

• The main stock markets in the U.S. are:–New York Stock Exchange

(NYSE)–NASDAQ


1.12.1.G1

Stock Activity• We are going to learn about

stocks using McDonald’s as an example.


1.12.1.G1Bonds

• Bonds are loans.• A company or government will

borrow money from investors by issuing bonds.

• Example: The Crazy Hat Co. wants to build a new distribution center in Louisville, KY which will cost $7,000,000. They can issue 7,000 bonds at $1,000 each.

7,000 x $1,000 = $7,000,000

Bonds are less risky

than stocks but do not have the

potential to earn as

much as a stock.


1.12.1.G1Bonds

• The company or government pays annual interest to the investor until the maturity date is reached– The maturity date is the specified

time in the future when the principal is repaid to the bondholder.

• Bonds issued by a company are called corporate bonds.

• Bonds issued by a government are called:– Treasury bonds (federal

government) –Municipal bonds (local

governments)


1.12.1.G1Example

• The Crazy Hat Co. issues $1,000 bonds that pay 4.5% interest with a maturity date of 11/22/2012 (2 years from today).

• You buy the bond for $1,000.• Each year you will receive a

payment of $1,000 x .045 = $45• On 11/22/2012, you will also get

your $1,000 back.


1.12.1.G1

Stocks vs. Bonds• Stocks are equity.• The stockholder actually owns a

piece of the company.• Equity is the value of the company.• For example, if a company has

10 million shares of stock, and each share is worth $5, then the company’s equity is:

10,000,000 x $5 = $50,000,000


1.12.1.G1Stocks vs. Bonds

• Bonds are debt.• Debt means the bondholder

has lent money to the company that the company will repay with interest.

• Companies must repay debt before they pay anything to stockholders.

• Therefore, bonds are less risky than stocks.


1.12.1.G1Portfolio

DiversificationPortfolio Diversification-

reduces risk by spreading investment money among different investment tools

Creates a collection of investments that will increase return while

reducing riskThe main goal of

diversification is to reduce risk.

Referred to as “Building a Portfolio.”


1.12.1.G1

Mutual Funds• Mutual fund- invests money in a

diversified portfolio of stocks and bonds

Always research the fees

charged by a mutual

fund.

Reduces investment risk

by helping people diversify their portfolio

Fees can be high

Saves investors time


1.12.1.G1How Do Mutual

Funds Work?• Individuals buy shares• The money is used to

purchase stocks, bonds, and other investments.

• Profits returned to shareholders monthly, quarterly, or semi-annually in the form of dividends.


1.12.1.G1

How Do Mutual Funds Work?


1.12.1.G1

What is the Advantage of Investing in a Mutual Fund?

• Allows small investors to get professional account

management and diversification normally only available to large

investors.

• This allows investors with a little bit of money to be able to invest in a variety of stocks, bonds, & other

investments.


1.12.1.G1There are lots of different

types of mutual funds!

http://forexcare.net/wp-content/uploads/2009/10/mutual-types.png


1.12.1.G1Market Indexes

• A market index is the value of a group of stocks or other investments.

• Market indexes are intended to represent an entire stock market and thus track the market's changes over time.



1.12.1.G1Market Indexes

• Dow Jones Industrial Average (DJIA or “The Dow”)–30 large companies traded

on NYSE or NASDAQ• Standard & Poors 500 Index

(S&P 500)–An index of 500 large

companies selected by a committee

• Others–Russell 2000, Wilshire 5000



1.12.1.G1

Index Fund• A mutual fund that was designed

to reduce fees by investing in the stocks and bonds that make up an index.

• Offers high diversification with low fees.



1.12.1.G1

Real Estate• Includes any residential or

commercial property or land as well as the rights accompanying that land

• A family home is not considered an investment asset

• Can be risky and more time consuming but has potential for large returns

Examples of real estate

investments include

rental units and

commercial property.



1.12.1.G1Speculative

Investments• Have the potential for

significant fluctuations in return over a short period of time–Examples- future, options,

commercial paper, collectibles

• Recommended for people with an aggressive investment philosophy and a high level of financial security



1.12.1.G1

DISCOUNT

BROKER

Buying and Selling Investments

Investors must utilize a brokerage firm that acts as a buying and selling agent

for the investor (except for when buying real estate and certain speculative

investments).FULL

SERVICE GENERAL

BROKERAGE FIRM

Complete investment

transactions

Offer investment advice and one-on-one attention

from a broker

Only complete

investment transactions

Offer no advice to investors

but charge 40-60% less



1.12.1.G1

TaxationProfits earned on investments are considered to be income

Income taxes MUST be paid on this money

Includes all forms of returns: interest, dividends, and price

appreciationTaxes are due on most

investment returns in the year the income is received


1.12.1.G1Employee-Sponsored

Investment Accounts• Allow employees to reduce

their tax liability and make investing automatic

• Money is automatically taken out of an employee’s paycheck

• Employers often contribute a portion of money to the investment with no additional cost from the employee

It is recommend

ed that a person

utilize these investment

tools as much as

possible if they are offered.



1.12.1.G1

Rule of 72Rule of 72

Allows a person to easily calculate when the future

value of an investment will double the principal amount

72Intere

st Rate

Number of years

needed to double the principal

investment



1.12.1.G1

Albert EinsteinCredited for

discovering the mathematical equation for

compounding interest, thus the

“Rule of 72.” At 10% interest rate, money

doubles every 7.2 years,

T=P(I+I/N)YN

“It is the greatest mathematical

discovery of all time.”

http://www.th.physik.uni-frankfurt.de/~jr/gif/phys/einstein4.jpg


1.12.1.G1What Can the “Rule

of 72” Determine?How many years

it will take an investment to

double at a given interest

rate using compounding

interest

How long it will take debt to double if

no payments are made

The interest rate an

investment must earn to double within a specific time

period

How many times money (or debt) will double in a

specific time period


1.12.1.G1

“Rule of 72” FYI• The rule is only an

approximation• The interest rate must remain

constant• The equation does not allow

for additional payments to be made to the original amount

• Interest earned is reinvested• Tax deductions are not

included within the equation


1.12.1.G1Doug’s Certificate

of Deposit

• Invested $2,500• Interest Rate is 6.5%

Doug invested $2,500 into a Certificate of Deposit earning a 6.5%

interest rate. How long will it take Doug’s investment to double?

726.5% = .065

11 years to double


1.12.1.G1Jessica’s Credit

Card Debt

• $2,200 balance on credit card• 18% interest rate

Jessica has a $2,200 balance on her credit card with an 18% interest rate. If Jessica chooses to not make any payments and does not receive late charges, how long will it take for her

balance to double?

7218

% = .18

4 years to

double


1.12.1.G1

Jacob’s Car

• $5,000 to invest• Wants investment to double in 4

years

Jacob currently has $5,000 to invest in a car after graduation in 4 years. What interest rate is required for

him to double his investment?

724

years

18% interest

rate

ANY QUESTIONS?

Documents

Introduction to Investing