Investing Basics

Investing Basics
By: Michael Alfaro & Wellington Rodriguez

Our Objective Today is to… Identify your investment needs See what’s out there Recognize the risks Understand the fees Reap the rewards Diversify your asset pool

Thinking Like an Investor Dale CarnegieTake a chance! All life is a chance. The man who goes the furthest is generally the one who is willing to do and dare. Russian Proverb: He who doesn’t risk never gets to drink champagne. Oscar Wilde: When I was young I thought that money was the most important thing in life; now that I am old I know that it is.

I don’t like risk… Well that’s too bad! Risk is a fact of life No risk= a big risk Limit your returns

An Introduction to Risk This is Boring

So what is this Risky Business? There are multiple definitions for risk Standard deviation Opportunity Cost Bad outcome Charlie Sheen What we really care about is downside risk!

Financial Products: Treasuries T-Bills, T-Notes, T-Bonds, and TIPS Bills are 4 weeks to 52 weeks in maturity Notes are for 2-10 years Bonds are for 30 years TIPS range from 5 years to 30 years in maturity

Financial Products: Treasuries Treasury Bill Characteristics Bills are zero coupon bonds Considered to be risk-free Historically have returned 3.7% from 1926-2005 Highly liquid, practically cash Treasury Bill Conventions Quoted in terms of discount yield Minimum Investment $100 Exempt from state and local taxes, but not federal

Financial Products: Treasuries Treasury Bond/Notes Characteristics Pay interest semi-annually When it matures the owner is paid the face value Trade of increments of $100 Can be held to maturity or sold prior to maturity Historical return for bonds 5.5% and 5.3% for notes from 1926-2005 How can I buy some Treasuries? From a broker From your bank From Treasurydirect.gov

Ok, so what’s the catch? Low risk means low return Price risk Inflation risk Interest rate risk

Bonds are known as fixed-income investments They traditionally pay a fixed coupon payment They come in different flavors such as high-yield, corporate, and municipal. Most bonds pay interest semiannually Have historically returned 5.9% from 1926-2005 for corporates Financial Products: Bonds

Advantages of Bonds over Stocks to Investors Safety Reliable income Potential for capital gains Diversification Tax advantages

Risks of Bonds Bond risk Bonds are generally less risky than stocks, but they do suffer from several types of risk. NOTHING is risk free: Credit risk Reinvestment risk Purchasing power risk Call risk Liquidity risk Foreign exchange risk

Bonds prices and interest rates An interest rate is the price a borrower pays for using someone else's money. When market interest rates rise, the prices of existing bonds in the market fall and vice versa. Investors are willing to pay more for a bond that has higher coupon payments. This leads to bonds selling at a premium (over par, > $1,000) or discount (under par, < $1,000)

Financial Products: Stocks Common Shares Preferred Shares Represents ownership rights Returns achieved through dividends and capital gains Have historically returned 10.4% from 1926-2005 Hybrid equity/bond instrument No voting rights Dividends can be suspended

Financial Products: Common Stocks Benefits Risks High Reward Very liquid Reduce your tax liability Different flavors High Volatility Systematic risk Unsystematic risk Last during liquidation

Financial Products: Stocks Income Portion Dividend paying stocks Master Limited Partnerships (MLP) Real Estate Investment Trusts (REITs) Growth Portion Make money through capital appreciation Known as growth companies Man Chasing Yield

Financial Products: Stocks Taxation and Fees Short-term capital gains: Regular tax-bracket Long-term capital gains: 15% Broker Commissions: Flat fee trading: ThinkorSwim $9.95 per trade Per share commission:ThinkorSwim$0.015 per share OTC Pinks: ThinkorSwim $9.99

Financial Products: Mutual Funds & ETFs Mutual Funds An Investment pool used to buy financial instruments There are two types: Open-ended Closed-ended They have a Net Asset Value Can be actively or passively managed ETFs Investment Fund that tracks an index Trade on Exchanges just like closed-ended Mutual Funds Can be leveraged Can track virtually anything

Mutual Fund Process

Financial Products: ETFs Advantages Great tax advantages No minimum investment Very liquid Great way to diversify at a low expense Alter risk-reward style Disadvantages Price risk Dividend Distribution Commissions

Financial Products: Mutual Funds Advantages Prices are consistent No commissions for trades Dividend reinvestment Diversification Disadvantages Required minimum investments Front-end, back-end, management, and 12b-1 fees May not match your investment style

Asset Allocation

Diversification

Investor’s Characteristics Objectives Risk tolerance Time horizon Capital amount Liquidity needs

Objectives Each investor has different goals: Retirement Buy a new house Vacations College of his/her kids It is important to: Prioritize Compromise

Risk What would you prefer? Earn a 2% return with inflation at 6% Lose 1% with inflation at 2%

Risk Tolerance RISK= Volatility Tolerance

Time Horizon Two major risks Inflation Volatility

Types of Investors Conservative Average Aggressive

Deciding Investment Portfolio Asset Classes Long-term percentage of each class Ranges that can be modified (Exploit Opportunities) Market Timing Securities within the classes Passive (Indexes) Active (Notion of superior skills)

Types Of Portfolios

Investing Basics