Class Investing Basics


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A class on basic pricipals of investing. I now do business as Social Thread.

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  • The yearly returns of the stock market, as represented by the S&P 500, are literally all over the place. Some of the biggest, positive, yearly returns followed some of the all-time worst returns. This is where many investors run into trouble. Scared by down markets, they fail to position themselves for the strong markets that often follow. That's the essence of buying high right after the big market gains and selling low right after the market falls. It's one reason why so many investors, according to Dalbar, only earned 162%, instead of 894% between 1984 and 2002.
  • What happens if we take a longer-term view? We discover that the U.S. stock market only had two negative ten-year periods since 1925 and those two periods, ending in 1938 and 1939 encompassed the 1929 stock market crash and subsequent depression. Since then, there has never been a single ten-year period in which the stock market was down, according to Ibbotson Associates.
  • Class Investing Basics

    1. 1. Hansen's Financial Services <ul><ul><li>Investing Basics </li></ul></ul>
    2. 2. Sources of Profit <ul><li>Interest </li></ul><ul><li>Dividends </li></ul><ul><li>Capital Gains </li></ul>
    3. 3. Types of Investments <ul><ul><ul><li>Stocks </li></ul></ul></ul><ul><ul><ul><li>Bonds </li></ul></ul></ul><ul><ul><ul><li>Cash </li></ul></ul></ul><ul><ul><ul><li>Mutual funds — one of these investments, or a combination </li></ul></ul></ul><ul><ul><ul><ul><li>Source: </li></ul></ul></ul></ul><ul><ul><ul><ul><li>The Foundation for Investor Education </li></ul></ul></ul></ul>
    4. 4. Stocks
    5. 5. Stocks <ul><ul><ul><li>Equity investments — purchasing part-ownership in a corporation </li></ul></ul></ul><ul><ul><ul><li>Short-term volatility </li></ul></ul></ul><ul><ul><ul><li>Historically have provided consistently highest returns over 10 years or more </li></ul></ul></ul><ul><ul><ul><ul><li>Source: </li></ul></ul></ul></ul><ul><ul><ul><ul><li>The Foundation for Investor Education </li></ul></ul></ul></ul>
    6. 6. Bonds
    7. 7. Bonds <ul><ul><ul><li>Debt investment — lending money to a corporation, government, or government agency </li></ul></ul></ul><ul><ul><ul><li>Stable income though market price fluctuates </li></ul></ul></ul><ul><ul><ul><li>Potential for stronger returns than stocks in some market conditions </li></ul></ul></ul><ul><ul><ul><ul><li>Source: </li></ul></ul></ul></ul><ul><ul><ul><ul><li>The Foundation for Investor Education </li></ul></ul></ul></ul>
    8. 8. Cash
    9. 9. Cash <ul><li>Cash Equivalents </li></ul><ul><ul><ul><li>Money market accounts, CDs — least risky investment, but most vulnerable to inflation </li></ul></ul></ul><ul><ul><ul><li>Liquid — withdraw cash as needed with little or no loss of value </li></ul></ul></ul><ul><ul><ul><li>Good for short-term goals and emergencies </li></ul></ul></ul><ul><ul><ul><li>Won’t provide growth to meet long-term goals </li></ul></ul></ul><ul><ul><ul><ul><li>Source: </li></ul></ul></ul></ul><ul><ul><ul><ul><li>The Foundation for Investor Education </li></ul></ul></ul></ul>
    10. 10. Others <ul><li>Real Estate </li></ul><ul><li>Commodities </li></ul><ul><li>Natural Resources </li></ul><ul><li>Foreign Currency </li></ul><ul><li>Small Business </li></ul><ul><li>Community </li></ul><ul><li>Charity </li></ul>
    11. 11. Mutual Funds <ul><ul><ul><li>Sell shares to investors </li></ul></ul></ul><ul><ul><ul><li>Pool investors’ money to purchase broad variety of stocks, bonds, cash equivalents, or some combination of those investments </li></ul></ul></ul><ul><ul><ul><li>Low risk or high risk depending on the investments in the fund and its investment objectives </li></ul></ul></ul><ul><ul><ul><li>May help you diversify your portfolio — or spread your investment principal among many different investments </li></ul></ul></ul><ul><ul><ul><ul><li>Source: </li></ul></ul></ul></ul><ul><ul><ul><ul><li>The Foundation for Investor Education </li></ul></ul></ul></ul>
    12. 12. Maximum and Minimum Real Returns Over 1 Year (1802-1997) 1-year returns after inflation: Stocks, bonds, cash Source: Jeremy Siegel, Stocks for the Long Run , McGraw-Hill 1998 <ul><ul><ul><ul><li>Source: </li></ul></ul></ul></ul><ul><ul><ul><ul><li>The Foundation for Investor Education </li></ul></ul></ul></ul>
    13. 13. Reduction of Risk Over Time Copyright © 2004 Ibbotson Associates, Inc. Each bar shows the range of compound annual returns for each asset class over the period 1926–2003. Small Company Stocks—represented by the fifth capitalization quintile of stocks on the NYSE for 1926–1981 and the performance of the Dimensional Fund Advisors, Inc. (DFA) U.S. Micro Cap Portfolio thereafter; Large Company Stocks—Standard & Poor’s 500 ® , which is an unmanaged group of securities and considered to be representative of the stock market in general; Government Bonds—20-year U.S. Government Bond; Treasury Bills—30-day U.S. Treasury Bill. 5-year holding periods 1-year holding periods Small company stocks Large company stocks Government bonds Treasury bills 150% 20-year holding periods 10.4% 12.7% 5.4% 3.7% Compound annual return 1926–2003
    14. 14. Risk & Reward
    15. 15. <ul><li>Risk and Return </li></ul><ul><ul><li>The greater the risk, the greater your potential return </li></ul></ul><ul><ul><li>The longer the time frame, the more opportunity to offset risk </li></ul></ul><ul><ul><li>Past performance is no guarantee of future results </li></ul></ul><ul><ul><ul><ul><li>Source: </li></ul></ul></ul></ul><ul><ul><ul><ul><li>The Foundation for Investor Education </li></ul></ul></ul></ul>
    16. 16. Inflation <ul><ul><ul><li>Persistent increase in the costs of goods and services </li></ul></ul></ul><ul><ul><ul><li>Persistent decrease in buying power of dollar </li></ul></ul></ul><ul><ul><ul><li>Low short-term risk, but high long-term risk </li></ul></ul></ul><ul><ul><ul><ul><li>Source: </li></ul></ul></ul></ul><ul><ul><ul><ul><li>The Foundation for Investor Education </li></ul></ul></ul></ul>
    17. 17. The Impact of Inflation How $1,000 can shrink at just a 4% inflation rate Today $1,000 $676 10 yrs $456 20 yrs $308 30 yrs $208 40 yrs Inflation can reduce the purchasing power of your savings. <ul><ul><ul><ul><li>Source: </li></ul></ul></ul></ul><ul><ul><ul><ul><li>The Foundation for Investor Education </li></ul></ul></ul></ul>
    18. 18. The Emotions of Investing This is easy. No problem, this is only temporary. I’m going to wait and see. I knew I should never have invested so much. Greatest Opportunity Hopeful Thrilled Elated Desolate Alarmed Nervous Hopeful Frightened
    19. 19. Understanding Risk Risk/Return Potential Bonds High Low Stocks Money Market Instruments
    20. 20. Investment Goals In reality, you might have several goals, all with different time frames <ul><ul><ul><ul><li>Source: </li></ul></ul></ul></ul><ul><ul><ul><ul><li>The Foundation for Investor Education </li></ul></ul></ul></ul>Planning for retirement Long term (10+ years) Funding your child’s education Starting your own business Medium term (3 to 10 years) Purchasing a home Purchasing a car Short term (1 to 3 years) POTENTIAL GOAL TIMING
    21. 21. Time Horizon: Returns Vary The S&P 500 is an unmanaged index. It does not reflect payment of expenses and cannot be purchased directly by investors. The above data shows the annual returns of the S&P 500 index over a 74-year time period. Few investors would have held an investment for that period. Index performance is shown for illustrative purposes only and does not depict any particular investment. Past performance is not indicative of future results. S&P 500 Annual Returns 1930 1940 1950 1960 1970 1980 1990 2000
    22. 22. Staying In for 10 Years 1940 1950 1960 1970 1980 1990 2000 The S&P 500 is an unmanaged index representing the broad stock market. It does not reflect payment of expenses and cannot be purchased directly by investors. The above data shows the annual returns of the S&P 500 index at 10-year intervals. Past performance is not indicative of future results. S&P 500 Annualized Returns: Trailing 10 Years
    23. 23. Reduction of Portfolio Risk 0% 2% 4% 6% 8% 10% 12% 14% 1 2 3 4 5 6 7 8 Number of randomly selected assets in portfolio Risk Source: Ibbotson Associates Inc. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. Past performance is no guarantee of future results. 3/31/05. Risk is measured by standard deviation.
    24. 24. Diversify Understanding Risk and Return, the CAPM, and the Fama-French Three-Factor Model. Tuck School of Business at Dartmouth, Case 03-111. 2003.
    25. 25. Asset Class Winners and Losers Annual asset class returns from highest to lowest This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. Past performance is no guarantee of future results. March 1, 2005. 2005 Ibbotson Associates, Inc. Large Stocks 28.7% 10.9% 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 LT Gov’t Bonds -7.8% 30 Day T-Bills 5.6% LT Gov’t Bonds -0.9% Internat’l Stocks 2.1% Small Stocks -7.3% LT Gov’t Bonds -9.0% International Stocks -14.0% -21.2% Large Stocks -22.1% 30 Day T-Bills 1.0% 1.2% Large Stocks 1.3% Internat’l Stocks 11.6% 30 Day T-Bills 5.2% 5.3% 4.9% 4.7% Large Stocks -9.1% -11.9% Internat’l Stocks -15.7% LT Government Bonds 1.5% 8.5% Small Stocks 3.1% LT Gov’t Bonds 31.7% Internat’l Stocks 6.4% LT Government Bonds 15.9% 13.1% Large Stocks 21.0% Small Stocks -3.6% LT Gov’t Bonds 3.7% Small Stocks -13.3% 30 Day T-Bills 3.9% Small Stocks 34.5% 17.6% 22.8% International Stocks 20.3% 27.3% 30 Day T-Bills 5.9% 3.8% 1.7% Internat’l Stocks 39.2% Small Stocks 18.4% Small Stocks 29.8% LT Gov’t Bonds 21.5% Small Stocks 22.8% LT Gov’t Bonds 17.8% Small Stocks 60.7% Internat’l Stocks 20.7% Internat’l Stocks 8.1% Large Stocks 37.4% 23.1% 33.4% 28.6%
    26. 26. Returns Source: Ibottson. Past performance is not a guarantee of future results
    27. 27. What to expect?
    28. 28. Asset Allocation Overview Fixed income portfolio 1970–2004 Return 8.5% Risk 5.7% Lower risk portfolio Return 8.5% Risk 7.7% Higher return portfolio Return 9.4% Risk 7.7% Risk is measured by standard deviation. Return is the compound annual return. Risk and return are based on annual data over the period 1970–2004. Portfolios presented are based on modern portfolio theory. Source: Ibbotson Associates Inc. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an Index. Past performance is no guarantee of future results. 3/31/05. Stocks—Standard & Poor’s 500®, which is an unmanaged group of securities and considered to be representative of the stock market in general; Long-Term Government Bonds—20-year U.S. Government Bond; Intermediate-Term Government Bonds—5-year U.S. Government Bond; Cash—30-day U.S. Treasury Bill. Bonds 85% Cash 15% Bonds 50% Stocks 30% Cash 20% Bonds 37% Stocks 21% Cash 42%
    29. 29. How Important Is Asset Allocation? Asset allocation determines 93.6% of the variance in portfolio returns Asset allocation Security selection, market timing, and other factors Source: Ibbotson, Roger G. and Paul D. Kaplan, “Does Asset Allocation Policy Explain 40 Percent, 90 Percent, or 100 Percent of Performance?,” Financial Analysts Journal , January/February 2000.
    30. 30. Asset Allocation Conservative
    31. 31. Asset Allocation Moderate
    32. 32. Asset Allocation Aggressive
    33. 33. How much will my savings grow? Investing $100 monthly Investing $500 monthly Investing $1,000 monthly $24,000 $59,295 $120,000 $240,000 $296,474 $592,247 Investment Earnings Total Invested This is a hypothetical illustration and not representative of any specific investment. Assumes 8% annual return over 20-year period. Your situation will vary.
    34. 34. The Power of Time* Investor A invested $100/month for 10 years. Investor B started 10 years later and invested $100/month for 30 years. Investor A Investor B Account value at age 65 Total contributions $185,320 $150,030 $12,000 $36,0000 * These are hypothetical investments used for illustrative purposes only and are not an indication or guarantee of the actual return on any investment. Example assumes contributions plus 8% annual return on investments, compounded monthly.
    35. 35. You Have the Tools — Get Started! * Example is hypothetical and does not represent the performance of any particular investment vehicle. Assumes an 8% rate of return and contributions in the beginning of each month. An early start can be a strong ally Investor A invested $100/month from age 25 - 35. Total investment $12,000 $150,030* $185,320* Investor B invested $100/month from age 35 - 65. Total investment $36,000
    36. 36. When to invest? <ul><li>Always Pay yourself first! </li></ul><ul><ul><ul><li>$50,000 income before taxes means about $35,000 after taxes </li></ul></ul></ul><ul><ul><ul><ul><li>10% savings = $290/mo </li></ul></ul></ul></ul><ul><ul><ul><ul><li>5% savings = $145/mo </li></ul></ul></ul></ul><ul><ul><ul><ul><li>3% savings = $88/mo </li></ul></ul></ul></ul><ul><ul><ul><ul><li>1% savings = $30/mo </li></ul></ul></ul></ul><ul><li>Do it automatically from paycheck or checking account! </li></ul>
    37. 37. Tax-Deferred and Tax-Free Investing
    38. 38. Tax What? <ul><li>Tax Free, Tax Deferred, and Pretax: What’s the Difference? </li></ul><ul><li>Tax free: Earnings or income on which no tax is owed </li></ul><ul><li>Tax deferred: No tax is due on earnings until they are withdrawn at some point in the future </li></ul><ul><li>Pretax: Income contributed before taxes are deducted </li></ul><ul><ul><ul><ul><li>Source: </li></ul></ul></ul></ul><ul><ul><ul><ul><li>The Foundation for Investor Education </li></ul></ul></ul></ul>
    39. 39. <ul><li>Tax-Free Investments </li></ul><ul><ul><ul><li>Municipal bonds </li></ul></ul></ul><ul><ul><ul><li>Roth IRAs </li></ul></ul></ul><ul><ul><ul><li>Coverdell education savings accounts </li></ul></ul></ul><ul><ul><ul><li>529 plans — at least until 2011 </li></ul></ul></ul><ul><li>No tax is owed on your investment earnings </li></ul><ul><li>You’d have to earn 4.17% on a taxable corporate bond to match the tax-free income on a 3% municipal bond* </li></ul><ul><li>*Based on a marginal federal tax rate of 28% </li></ul><ul><ul><ul><ul><li>Source: </li></ul></ul></ul></ul><ul><ul><ul><ul><li>The Foundation for Investor Education </li></ul></ul></ul></ul>
    40. 40. <ul><li>Tax-Deferred Investments </li></ul><ul><ul><ul><li>Traditional IRAs </li></ul></ul></ul><ul><ul><ul><li>Employer-sponsored retirement plans — 401(k)s, 403(b)s, 457s </li></ul></ul></ul><ul><ul><ul><li>Annuities </li></ul></ul></ul><ul><li>Don’t pay tax on earnings as they accumulate, but tax is owed when money is withdrawn </li></ul><ul><li>Strong potential for compounding </li></ul><ul><ul><ul><ul><li>Source: </li></ul></ul></ul></ul><ul><ul><ul><ul><li>The Foundation for Investor Education </li></ul></ul></ul></ul>
    41. 41. Taxable vs. Tax-Deferred Earnings *This example is a hypothetical illustration and is not based on the return of any specific investment <ul><ul><ul><ul><li>Source: </li></ul></ul></ul></ul><ul><ul><ul><ul><li>The Foundation for Investor Education </li></ul></ul></ul></ul>$414,100 $336,600 After 20 years* $210,500 $189,000 After 10 years* $107,000 $105,950 Reinvested amount -$1,050 $7,000 $100,000 TAXABLE ACCOUNT -$0 Tax on realized gains or dividends (15% long-term capital gains tax) $7,000 Annual 7% return $100,000 Stock investment TAX-DEFERRED ACCOUNT
    42. 42. Saving on Saving <ul><li>*(FED/ST/SS) </li></ul><ul><li>By saving before taxes you have $30 more in your pocket than by saving after taxes. </li></ul><ul><li>Therefore, if you save $100 a pay, you will only miss approximately $70 from your net pay. </li></ul><ul><li>If you saved $50 a pay, you would miss approximately $35 from your net pay. </li></ul>$630 = $0 - $630 = $270 - $900 $100 $1000 B) Save Before $600 = $100 - $700 = $300 - $1000 $0 $1000 A) Save After = - Net Pay = Less Taxes* - Gross Pay $ In Your Pocket Save After Taxes Taxable Amount Save Before Taxes
    43. 43. <ul><li>Pretax Contributions </li></ul><ul><ul><ul><li>Deductible IRAs </li></ul></ul></ul><ul><ul><ul><li>401(k)s, 403(b)s, 457s </li></ul></ul></ul><ul><li>You contribute pretax dollars, often through an employer-sponsored plan, which lowers your taxable income </li></ul>*Single filer, using standard deduction <ul><ul><ul><ul><li>Source: </li></ul></ul></ul></ul><ul><ul><ul><ul><li>The Foundation for Investor Education </li></ul></ul></ul></ul>$11,100 $13,600 Estimated federal income tax* $75,000 $0 $75,000 SCENARIO A $65,000 Taxable salary $10,000 401(k) contribution $75,000 Annual income SCENARIO B
    44. 44. Types of Retirement Plans Penalty if taken out before 59½? How do I contribute? When is it taxed? IRA 401k or 403b ROTH IRAs When Withdrawn When Withdrawn Before it goes in From checking from paycheck From checking Yes Yes No for principal Yes for growth
    45. 45. Hansen's Financial Services <ul><ul><li>Investing Basics </li></ul></ul>