Investment in Financial Capital

1. Investment in Financial Capital

2. 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. Objectives

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?

5. What are your financial goals? • Financial Independence • Just starting your own financial life apart from your parent(s)/guardian(s) • Financial Stability • Managing all of your financial resources effectively, but unprepared to meet financial emergencies • Financial Security • The ability to manage and absorb financial emergencies • IMO, one of the best and easiest ways to attain Financial Security is to create passive income through investments

6. Steps to Create a Personal Investing Plan Step 1 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._______________

7. 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.

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

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

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

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

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

13. 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

14. 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

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

16. Personal Investment Philosophy • Handling risk • Ultraconservative strategies • Conservative • Moderate • Aggressive

17. Personal Investment Philosophy • Handling risk • Ultraconservative strategies • Conservative • Moderate • Aggressive

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

19. 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

20. 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

21. 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

22. 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

23. 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.

24. Risk Tolerance Quiz • Take the quiz listed in notes…. http://njaes.rutgers.edu/money/riskquiz/

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

26. CommoditiesJunk bondsOptions High Quality Rentalproperty Stocks Mutual funds Government Corporatebonds Utility stocks Securities MoneyMarket Savings Accounts CDs Cash Investment Pyramid High risk Lowrisk

27. Investment Growth and Liquidity • Growth • 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

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

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

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

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

32. Risk Tolerance ., REVIEWBOOK: Personal Finance. Retrieved Oct 1, 2009 from http://www.flatworldknowledge.com/node/50890 .

33. Calculating Percentage Rate of Return

34. 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

35. Real Rate of Return Example • 1. You are in the 28 percent tax bracket. • 1.0 - .28 = .72 • If the yield on your investment is 6.25% then: .0625 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

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

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

38. An Example of Asset Allocation ., REVIEWBOOK: Personal Finance. Retrieved Oct 1, 2009 from http://www.flatworldknowledge.com/node/50890 .

39. Levels of Diversification ., REVIEWBOOK: Personal Finance. Retrieved Oct 1, 2009 from http://www.flatworldknowledge.com/node/50890 .

40. 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 isrepaid at maturity (1-30 years) • You can keep the bond until maturity or sell it to another investor

41. 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

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

43. 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

44. Investment Philosophies

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

46. 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

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

48. Income and Consumption Over the Life Cycle

49. 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.

50. 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.