Chapter 13:

1. Chapter 13: Investment Fundamentals

2. Learning Objectives • Explain how to get started as an investor. • Discover your own investment philosophy. • Identify the kinds of investments that match your interests. • Describe the major factors that affect the rate of return on investments. • Decide which of the five long-term investment strategies you will utilize. • Create your own investment plan.

3. 1. Starting Your Investment Program • Saving vs. Investing…What’s the difference? • Put Your Money to Work! • Build “real” wealth • Rate of return; Time • Sacrifices are necessary: • Start early, invest regularly • Delay 5: Double Down • We invest in securities[stocks, bonds, mutual funds] • Our invested assets make up our portfolio

4. Are you ready to invest? • Balances on high interest credit cards? • Adequate insurance protection? • An emergency fund that is easily accessible? • A monthly budget? • Contributing to your employer’s retirement plan? • Decide why you want to invest • Achieve financial goals [kids’ education, house down payment] • Supplement income • Reduce tax liability • Retire comfortably • For fun!

5. Getting money to invest • Pay yourself first • Save-- don’t spend– extra funds • Make it automatic • Scrimp for a month • Break a habit, make use of the money It takes money to make money! If you want to be able to invest $1,000 this year, ask yourself these questions… before you buy!

6. Investors hope for a POSITIVE RETURN • Current Income Versus Capital Gain • Current Income is received on a regular basis while you own the investment • dividends from stock; interest from bonds • taxed at your marginal tax rate • Capital gains occur only when you sell the investment • results from you selling it for more than you bought it for • taxed at special lower rates • Capital losses are also possible! • Rate of Return (yield) is an investment’s total yearly return in the form of a percentage

7. What investment returns are possible? • Levels of RETURN ARE related to RISK • Average returns from 1926 – 2006:

8. 2. Your Investment Philosophy • How to handle investment risk • Pure risk vs. Speculative risk • Investment risk: uncertainty about returns • Tradeoff: Between risk and return

9. Ultraconservative “Investors” Are Really Just “Savers” • People that invest very conservatively • They do not get ahead financially over the long term because taxes and inflation offset most of their interest earnings • You can accept more risk when investing for long-term goals • Remember “The Rule of 72”? • 72/4% = 18 years • 72/8% = 9 years

10. What is Your Investment Philosophy? • Your approach to risk tolerance in investments • Risk tolerance: your ability to handle changes in your investments’ value • Levels of Risk Tolerance: • conservative; moderate; aggressive • We must take risks that will enable us to reach our financial goals • Greater risk = greater potential for returns RCRE Investment Risk Tolerance Quiz available online at: www.rce.rutgers.edu/money/riskquiz/

11. Investment Philosophy: • Conservative: Risk averse • Goal = preserve capital • Moderate: Risk indifferent • Goal = long-term profit • Aggressive: Risk seeker • Goal = short-term, quick profit • Investment Approach: • Active Investor – studies the economy, market trends, and investment alternatives • Usually buys individual stocks/seeks quick profits • Passive Investor – does not spend much time monitoring investments. • Usually buys mutual funds/seeks long-term profits

12. 3. Identify the Types of Investments You Want to Make • Your investments should match your interests • You can invest in 2 ways: lending or owning • Debts – “loanership” (lending) investments • the borrower agrees to repay the principal to the investor on a specific date (maturity). • the borrower agrees to pay the investor a specific rate of interest at regular intervals. • Equities – “ownership” investments • Potential for a higher return by sharing in profits Pg. 363 Overview of Investment Alternatives

13. 4. How Risk and Other Factors Affect Return • Randomrisk • All of your eggs are in one basket • What happens if that basket breaks? • Diversification • “Spread the wealth”! • A way of reducing random risk • Averages out the high & low returns, reducing overall risk • Marketrisk (undiversifiable) • Risk results from economic influences that affect entire market

14. Effects of Diversification:Lower Total Return + Less Overall Risk

15. The Tax Consequencesin Investment FundamentalsDid you Know? PG 366 • After-Tax Return • Tax-Deferred Investments • Tax-Exempt Investments

16. 5. Establish Your Long-TermInvestment Strategy Example: 10% return, 7.5% after taxes (25% tax bracket), 3% inflation, real rate of return of 4.5% after taxes and inflation • 4 Strategies • Investing is not “rocket science”… “just do it” • Start as early as possible • Investments should provide a positive Real Rate of Return • Understand the economy as a whole: how are Securities Markets performing? • Bear Market • Bull Market

17. A 10-Year Delay in Investing Can Cost you over $500,000 PG 367 Assumption: $2000 / yr in a tax-deferred account earning 10%

18. Trying to Time the Market is Too Difficult to Accomplish • Long-term investors must be able to withstand some market volatility • What are Market Timers? Constant “shifters” • Hope to capture the upside of rising stock prices while avoiding most of the downside • Very difficult to catch market highs and lows…have to be right twice • Miss the “best trading days” when prices rebound

19. Strategy #1: Buy-and-Hold“The secret to investment success is benign neglect.” • The Emphasis: Hold on to investments in good times and bad • The Action: Buy a diversified mix of stocks or mutual funds, reinvest the dividends, and hold on almost indefinitely • The Expectation: The value of assets will increase over the long run with the growth of the American and world economies • The Challenge: Do not react emotionally to day-to-day changes that occur in the market • The Advice: Buy more shares when prices are lower during normal market downturns

20. Strategy #2: Dollar-Cost Averaging • The Action: Invest equal sums of money at regular intervals regardless of the price of the investment • The Emphasis: Invest regularly, automatically • The Expectation: You will be buying more shares when stock price is down and less when the price is up => reducing average cost per share • Buying shares regularly through a “DRIP”, pg 371

21. Strategy #3: Portfolio Diversification“Diversification is the single most important rule in investing.” • The Action: Create your portfolio by choosing different asset classes • The Emphasis: Spread the wealth! Choose assets based on their dissimilar risk-return characteristics • The Expectation: Different asset classes react differently to economic changes; when one performs poorly, the others will perform well. • The Advice: Never keep more than 10% of your assets in one investment

22. DiversificationAverages Out an Investor’s Returns

23. Diversified Investment Portfolios

24. Strategy #4: Asset Allocation“More than 90% of an investor’s returns are a result of proper allocation.” • The Action: Decide on the proportions of your investment portfolio that will be devoted to various asset categories • The Emphasis: You are in the right place at the right time! your allocation proportions reflect your age, risk tolerance, goals, time horizon • The Expectation: Your portfolio allocation will maximize returns and reduce risk • The Advice: Maintain your desired allocation, rebalancing when necessary

25. Model Portfoliosand Time Horizons

26. RebalancingAssets in Your Portfolio

27. Creating YourOwn Investment Plan • Investment plan: an explanation of your investment philosophy and your logic on investing to reach specific goals • What are the time horizons for your investment goals? • Building up an amount for a down payment on a home? • Creating a college fund for a child? • Putting away money for retirement?