Investing for Your Future 1 Basic Concepts and Investment Products


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Investing for Your Future 1 Basic Concepts and Investment Products

  1. 1. Investing For Your Future 1: Basic Concepts and Investment Products Barbara O’Neill, Ph.D., CFP®, AFC, CHC Rutgers Cooperative Extension
  2. 2. Webinar Objectives• Discuss basic investing concepts and terminology• Discuss characteristics of stocks and bonds• Discuss common investment frauds• Discuss investor education and investor protection resources
  3. 3. Investing is an Important Part of the Financial Planning Process
  4. 4. The Difference Between Saving and InvestingSaving Both Investing
  5. 5. The Difference Between Saving and Investing • Saving: – Money held in a short-term cash assets – Money used for emergencies and specific purchases – Low risk, low reward • Investing: – Money used to increase net worth and achieve long- term financial goals – High risk, high POTENTIAL rewardResource:
  6. 6. Investing Videos®) (ING)
  7. 7. Why People Invest• To achieve financial goals, such as purchase of a new car, down payment on a home, or a child’s education• To increase current income (e.g., retirees)• To build wealth over time• For financial security and peace of mind• To have funds available during retirement years
  8. 8. Invest for Long-Term Goals Source: Garman/Forgue, PERSONAL FINANCE, Fifth Edition 9
  9. 9. Taxable vs. Tax-Deferred Investing $250,000 244,700 $200,000 $150,000 160,300 157,900 $100,000 112,200 98,800 27,600 31,300 75,800 $50,000 58,600 48,300 $0 10yrs 15yrs 20yrs 25yrs 30yrs Taxable Returns (at 28%) Garman/Forgue, PERSONAL FINANCE, Fifth Edition, Tax- Sheltered Returns are Greater than Taxable Returns Tax-Deferred Returns (Illustration: 8% Annual Return and $2,000 Annual Contribution)Calculator:
  10. 10. Tax-Exempt and Tax-Deferred Investing Tax-exempt Tax-Deferred– No taxes owed on – Taxes postponed until an money earned on investment is sold or investment earnings are withdrawn– Examples - U.S. savings – Examples - many bonds are exempt from retirement accounts such state tax and municipal as Traditional IRAs and bonds and Roth IRAs 401(k)s and 403(b)s (with qualifications) are exempt from federal tax
  11. 11. Categories of Investments• Ownership (Equity): Own something – Stocks and stock funds – Real estate and REITS (real estate investment trusts) – Collectibles – Commodities• Loanership (Fixed-Income): Lend money – Bonds and bond funds – Certificates of Deposit (CDs)
  12. 12. Investment Pre-requisites• Adequate emergency fund• Adequate insurance• No or low consumer debt balance• Written financial SMART goals• An “investor’s mindset”
  13. 13. Know Your Net Worth• What do you own? ASSETS• What do you owe? LIABILITIES• Net Worth = Assets – Liabilities Example: $250,000 assets - $125,000 debts = $125,000 net worth (Print) (Excel)
  14. 14. Sample Net Worth WorksheetASSETS VALUE Cash, savings account, money market funds, CDs Investments Personal Property, Cars, Motorcycle, Home Furnishings Life Insurance Cash Value Retirement Accounts, IRA, SEP Real estate, Personal Property, Money Owed to YouLIABILITIES VALUE Loans – car, education, personal Mortgage Other Loans Taxes Owed Net Worth = Assets – Liabilities
  15. 15. Where to “Find” Money to Invest• Develop a spending plan • Collect loose change• Reduce spending on • Continue loan repayments “lattes” to yourself• Pay yourself first (PYF) • “Moonlight” for extra income automatically • Sell items you don’t need• Employer matching (“free • Search for unclaimed money”) money• Save bonus/tax refund/windfall moneyResource: (Unit 3, Investing For Your Future)
  16. 16. What $20 a Week in Investment Deposits Adds Up To 5% Return: 10% Return:– 20 Years: $36,100 – 20 Years: $65,500– 30 Years: $72,600 – 30 Years: $188,200– 40 Years: $131,900 – 40 Years: $506,300
  17. 17. The Rule of 72• Calculates the number of years it takes for principal to double – Number of Years = 72 divided by interest rate – Example: 72 ÷ 6% = 12 years• Calculates the interest rate it takes for principal to double – Interest rate = 72 divided by number of years z1rH9rDBUo (calculator)
  18. 18. The Rule of 72Source: Garman/Forgue, PERSONAL FINANCE, Fifth Edition
  19. 19. The Risk-Reward Trade-OffSource: Garman/Forgue, PERSONAL FINANCE, Fifth Edition
  20. 20. Risk (Chance of Loss)• There is no such thing as a “perfect” investment (risk-free, tax-free, high return)• All investments have some type of risk• Risk can be caused by: – Inflation – Changes in the economy – Political uncertainty (home and/or abroad) – Business failure – Interest rate changes Investing/ManagingInvestmentRisk/
  21. 21. Investment Risks• Business (Failure) Risk  affects individual company stocks and corporate bonds (when business is not profitable)• Market Risk  the risk of being in the market versus in a risk-free asset (stock prices follow market cycles)• Interest Rate Risk  the value of bonds or preferred stock may increase or decrease with changes in interest rates• Inflation Risk  your investment return may not keep pace with inflation and you lose purchasing power• Currency Risk  changes in investment value related to the value of the U.S. dollar• Political Risk  the risk of political instability in an interconnected global economy
  22. 22. Techniques to Offset Risk• Diversification – Putting your money, “your eggs,” into several “baskets” (e.g., stocks, bonds, cash, real estate) – –• Dollar-Cost Averaging – Investing regular amounts at regular intervals regardless of price – Examples: $50 on the 1st of every month or 6% of your gross income every payday – Lowers average share price cost over time – ulator.jsp
  23. 23. Dollar-Cost Averaging Example January February March April (Market High) (Market Low)Amount $200 $200 $200 $200InvestedShare Price $35 $28 $24 $20Number of 5.7 7.15 8.3 10SharesPurchased Total Number of Shares: 31.15 shares Average Share Cost: $25.68/share ($800 ÷ 31.15)
  24. 24. Asset Allocation• Percentage of portfolio in different asset classes• Important factor in overall investment success• The more stock in portfolio, the more aggressive the asset allocation • One guideline: 110 – age = % of portfolio in stock • Conservative portfolio: less stock in portfolio Conservative Moderate Aggressive C C S C B S B S B
  25. 25. Asset Allocation: A Weighted AverageSource: Garman/Forgue, PERSONAL FINANCE, Fifth Edition
  26. 26. Asset Allocation Models
  27. 27. Asset Allocation Calculators• setallocwizard.html (CNN Money calculator)• et-allocation.aspx ( calculator)• set-allocation-in-retirement-1304478691597/ (Smart Money)
  28. 28. Portfolio Rebalancing• Get back to original asset class weights (percentages) to maintain same risk level• Asset classes grow at different rates• Two ways to do: – Sell assets in over-weighted asset class – Put new money in under-weighted asset class
  29. 29. Best-Performing Assets Change
  30. 30. What is Your Risk Tolerance?Take the Rutgers Cooperative Extension Investment RiskTolerance Quiz:
  31. 31. Basic Investment Principles• Even small amounts invested regularly grow impressively over time – Time + Money = MAGIC!• Volatility “comes with the territory” but not all investments are equally volatile – Volatility = “peaks and valleys” of investment value – Need an “investor’s mindset” to handle• The higher the potential rate of return, the greater the investment risk
  32. 32. Time + Money = “Magic” Source: TIAA-CREFIllustration assumes an 8% average annual return; actual investment results will vary
  33. 33. Investment Volatility• Tendency of investment values to fluctuate – Stock (stock funds) generally more volatile than bonds – Small company stocks generally more volatile than established “blue chip” company stocks• Measured by beta (overall market = 1) – 1.5 = 50% more volatile than average stocks – 0.5 = 50% less volatile than average stocks
  34. 34. Common Stock• Share of ownership in a company• Elect directors• Voting rights on other matters – Proxy – written authorization given by shareholder to someone else to represent him or her and vote his or her shares at a stockholder’s meeting.• Two ways to earn money – value of stock increases (capital gain) – stock pays dividends
  35. 35. Diversify Among Industry Sectors • Capital goods• Building/forestry (e.g., machinery)• Financial services • Energy (e.g., oil)• Consumer growth • Materials (e.g., (e.g., soft drinks) paper)• Consumer staples • Transportation (e.g., food) • Utilities• Consumer cyclicals (e.g., cars) • Health care• Technology • Conglomerates
  36. 36. Historical PerspectiveHistorically, common stocks haveout-performed all other types of investments,over longtime periods BUT…it has not been asmooth ride!
  37. 37. Historical Perspective: The 2000s Year S&P 500 Return 2001 -11.90% 2002 -22.1% 2003 28.7% 2004 10.9% 2005 4.9% 2006 15.9% 2007 5.5% 2008 -37.0%wtoinvest/a/marketreturns.htm 2009 26.5% 2010 15.1%4/investing-unit-4:-common-stocks
  38. 38. Analyzing Stock Performance Earnings per share (EPS) – Formula: Corporation’s after-tax income divided by number of outstanding shares of common stock – Example: $5,000,000/10,000,000 = $0.50 – EPS increase = generally a healthy sign
  39. 39. Analyzing Stock Performance Price-Earnings Ratio (P/E Multiple) – Price per share of stock ÷ firm’s earnings per share (EPS) • Example: $10 price/0.50 EPS = a PE ratio of 20 – How much investors are paying for company’s earning power – Based on historical data; cannot make predictions – P/E of 15  long-term average P/E – Need to compare P/E of stock to firms in same industry
  40. 40. Time-Tested Stock Strategies• Buy what you know or get to know (research)• Buy and hold quality stocks• Diversify among industry sectors• Dollar-cost average• Reinvest dividends and capital gains• Don’t invest > 10% of total portfolio in your own employer’s stock
  41. 41. Bonds• Debts (IOUs) of government and corporations• Investors “loan” money and receive interest• Major bond investment risks: – Credit risk – Interest rate risk – Inflation risk – Call risk
  42. 42. Bond Investor Decisions• Decide on risk level – Investment grade bonds: top 4 grades (BBB, A, AA, AAA) – Junk bonds (high-yield bonds): lower rated and higher risk• Decide on maturity – Match to financial goals• Determine the after-tax return – Taxable versus tax-exemptFederal Marginal Tax Brackets:
  43. 43. Bond Ratings Measure Default Risk
  44. 44. U.S. Treasury Securities• Considered safest fixed-income investment• Sold at periodic auctions; secondary market• Earnings exempt from state and local tax (principle of “reciprocal immunity”)• $100 minimum with $100 increments – Bills: Maturities up to 12 months; buy at discount – Notes: 2-, 3-, 5-, 7-, and 10-year maturities – Bonds: 30-year maturities (“long bonds”)
  45. 45. Corporate Bonds• Corporation’s pledge to repay principal and periodic interest• Considered safer than company stocks• Face Value – Dollar amount bondholder receives at bond’s maturity date – Usually $1,000• Coupon rate – Stated interest rate – Interest payments made every six months – Example: $1,000 x 5.8% = $58 (in two $29 payments)• Maturity Date = Date that face value is repaid; generally 1 to 30 years
  46. 46. Investment CharacteristicsSource: Focus on Personal Finance, Third Edition, McGraw-Hill
  47. 47. Investment Returns• Rent – payment received in return for use of your real estate, such as a building• Interest – “rent” for the use of your money• Dividend – portion of a company’s earnings that the firm pays out to its shareholders• Capital Gain – occurs only when investment is sold; results from increase in value of initial investment.
  48. 48. Total ReturnMeasure of profit before taxes and fees• Formula: Gain or loss in value + investment earnings• Examples: – $1 per share dividend + $5 increase in share value = $6 per share TR before expenses – $1 per share dividend + $5 loss in share value = <$4> share TR before expenses –
  49. 49. Protect Your Money• Learn how to spot investment fraud – “Cold calls” with “limited time offers” – E-mail spam promising high “guaranteed” returns• Ask questions before investing• Get written information on companies/investments• Ask yourself: Why is a complete stranger giving me a “hot tip”?
  50. 50. “Pump and Dump” Scams• Promoter urges you to “buy 30 now or lose out” 25• Price rises sharply 20 15• Fraudsters sell at peak 10• Price drops when the hype 5 stops 0 Day 1 Day 2 Day 3 Day 4 Day 5• Investors lose money Stock Price
  51. 51. Pyramid SchemesLevels Number of Participants 1 6 2 36 3 216 4 1,296 5 7,776 6 46,656 7 279,936 8 1,679,616 9 10,077,696 10 60,466,176 11 362,797,056 - more than U.S. Population 12 2,176,782,336 13 13,060,694,016 - more than double World Population
  52. 52. Affinity Frauds• Target members of a group - Race - Profession - Religion - Age• Recruit group leader to spread the word• Keys to scheme = trustHow to avoid: Ask questions! (about product, sponsor, salesperson, etc.)
  53. 53. Is It Too Good to Be True?• High yield often means high risk• Watch out for buzz-words: “guaranteed,” “limited offer,” “safe as a CD,” or “risk-free”• Beware of exotic, unusual productsWarning: If it sounds too good to be true, it probably is! Get the facts in writing OR hang up/delete
  54. 54. In Summary• Investments are designed to achieve long-term goals• Two investment categories are ownership and loanership• Net Worth = Assets – Debts• Use the “Rule of 72” to estimate how money doubles• A relationship exists between investment risk and reward• All investments have some type(s) of risk• Volatility is part of investing and should be expected• If an investment sounds too good to be true, it probably is
  55. 55. Action Steps• Write down financial goals with a date and cost• Watch one or more investment videos or Web sites• Calculate your net worth• Take the Rutgers Investment Risk Tolerance Quiz• Start a dollar-cost averaging investment habit• Determine your current asset allocation
  56. 56. Investor Education Resources• eXtension Ask an Expert and FAQs –• Better Investing –• American Association of Individual Investors –• Personal finance monthly publications – Kiplinger’s Personal Finance, Money• (federal government agencies) –
  57. 57. Investor Protection Resources• U.S. Securities and Exchange Commission• State securities regulators:• Central Registration Depository (CRD):• FINRA BrokerCheck®:• Securities Investor Protection Corporation (SIPC)
  58. 58. Investing For Your Future Home Study Course (Cooperative Extension)• Free of charge and downloadable• Updated annually• 11 units; do at your own pace• Designed for beginning investors• Monthly investment messages•
  59. 59. FINRA Investor Education Foundation Content Modules• Free of charge and downloadable• 11 content modules• Designed for beginning investors• Used for library investor education programs•
  60. 60. Questions? Comments Experiences?Part 2 Webinar:Investing For Your Future 2:Mutual funds and Tax-Deferred InvestmentsPlease complete the webinar evaluation form