Investment Fundamentals Chapter 13

1. Investment FundamentalsChapter 13 Personal Finance FIN 235

2. General Objectives • Reasons for Establishing Investment Plans/Programs • Funding investment programs • Understanding the relationships between; risk, return, liquidity, income, and growth • How to manage risk • Considering bonds as part of your portfolio • Government • Corporate • How to evaluate bond investments

3. Funding Investment Programs • Systematic savings plans • Many start with a savings account • Regular weekly or monthly deposits • Regular payroll deductions • Participation in 401(k) plan at work • Many employers make contributions or add based on employee contribution. • Setting aside a small percentage of pay (3 to 5%) • The most important factors: • Start early • Don’t use funds during accumulation period except for emergencies • Early withdrawals subject to penalties and taxes

4. Establishing Investment Plans/Programs • Establishing Investment Goals • Performing a Financial Checkup • Work to Balance Your Budget • Obtain Adequate Insurance Protection • Start an Emergency Fund • Have Access to Other Sources of Cash for Emergency Needs • Getting the Money Needed to Start an Investment Program • Priority of Investment Goals • Employer-Sponsored Retirement Plans • The Value of Long-Term Investment Programs • Financial Independence • Maintaining your lifestyle in retirement

5. Understanding the Relationships • Safety and Risk; run in opposite directions • Components of the Risk Factor • Inflation Risk (maintain purchasing power) • Interest Rate Risk (change in values as rates change) • Business Failure Risk (investment goes sour) • Market Risk (ups and downs of the market) • Investment Income (interest, dividends) • Investment Growth (capital gains) • Investment Liquidity (sell quickly and cheaply)

6. Managing Risk • Portfolio Management and Asset Allocation • Asset Allocation (stocks, bonds, international, cash) • The Time Factor (short or long term) • Your Age (get more risk averse as you get older) • Your Role in the Investment Process • Evaluate Potential Investments • Monitor the Value of Your Investments • Keep Accurate Records • Do some research before you commit to a course of action

7. Bonds as Part of Your Portfolio • Advantages • Known payouts (interest payments, principal at maturity) • Risk a function of credit ratings (AAA – D) • Disadvantages • Interest Rate risk • Default risk • Costly to trade (liquidity may be a problem) • Government Bonds • No defaults • Lower rates • Semi-annual coupons • Municipal bond interest exempt from federal taxation

8. Bonds as Part of Your Portfolio • Corporate Bonds • Better yields • Increased chance of default (especially lower rated bonds) • Quarterly coupons • Secured and unsecured categories as well convertibles • Basic Bond Strategies (if trading) • If rates expected to rise, keep maturities short • If rates expected to fall, go long maturities • Inflation expectations is major factor in forming rates

9. Evaluating Bond Investments • Returns: Stocks vs. Bonds • Since 1926: Bonds average 5.6% per year, Stocks 10.4% • Over a 30 or 40 year investment period, the roughly 5% difference in returns can add up to s significant amount • Example: Invest $200 per month for 30 years • Bond Portfolio = $186,198 • Stock Portfolio = $492,554 • Annuity Example: Payout the above accumulation for 25 years • Bond ($186,198); monthly check = $1,154.56 • Stock ($492,554); monthly check = $4,615.47

10. Concluding Comments • Bonds may be safer than stocks, but the returns are significantly lower. • Government Bonds are safer than Corporate Bonds but the returns are slightly lower. • Timing is important when adding bonds or bond funds to your portfolio. • Expectations about future inflation is a key decision criterion • Global economic conditions are also a factor.

11. Homework • Do The Math: 1, 4, 6 • Be Your Own Personal Financial Planner • 2 – Readiness to invest (w/s 49) • 4 – Your long-term investment strategy (w/s 51)