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  1. 1. Basics of Investing III Economics 98 / 198 Spring 2008 Copyright 2007 Jason Lee
  2. 2. Schedule <ul><li>Announcements </li></ul><ul><li>Quiz </li></ul><ul><li>Current Events </li></ul><ul><li>Today’s Lecture Content </li></ul><ul><li>Next Week </li></ul>
  3. 3. Announcements <ul><li>Simulation Sign-Ups / Money (last chance) </li></ul><ul><li>Rules of Investment Simulation </li></ul>
  4. 4. QUIZ
  6. 6. Recessions & the Stock Market (S&P 500: 1951 – 1975) 0% 100% 200% 300% 400% Jan-51 Jan-53 Jan-55 Jan-57 Jan-59 Jan-61 Jan-63 Jan-65 Jan-67 Jan-69 Jan-71 Jan-73 Jan-75 Source: Global Financial Data
  7. 7. 0% 300% 700% 1100% 1500% Jan-76 Jan-78 Jan-80 Jan-82 Jan-84 Jan-86 Jan-88 Jan-90 Jan-92 Jan-94 Jan-96 Jan-98 Jan-00 Jan-02 Jan-04 Jan-06 Recessions & the Stock Market (S&P 500: 1976 – 2007) Source: Global Financial Data
  9. 9. Today’s Lecture <ul><li>Basic investing concepts </li></ul><ul><ul><li>Risk-Reward / Financial Goals / Understanding Yourself </li></ul></ul><ul><li>Portfolio Management </li></ul><ul><ul><li>Diversification </li></ul></ul><ul><ul><li>Concentration </li></ul></ul><ul><li>Different investment securities </li></ul><ul><ul><li>Bonds / CDs / Money Market </li></ul></ul><ul><ul><li>Mutual Funds / Exchanged-Traded Funds </li></ul></ul><ul><li>Market Psychology </li></ul>
  10. 10. More Market Basics
  11. 11. Market Hours <ul><li>Trading day begins 930AM EST and ends 4PM EST (630AM – 1PM) </li></ul><ul><li>Orders outside of trading day will not go through </li></ul><ul><li>Pre-market trading </li></ul><ul><li>After-hour trading </li></ul>
  12. 12. Basic Investing Concepts
  13. 13. Determining Your Financial Goals <ul><li>Investing is a long car trip. There needs to be a lot of planning that goes into it. </li></ul><ul><ul><li>How much money do you want to make? By when? </li></ul></ul><ul><ul><li>Will you need to live off your investments in future years? </li></ul></ul><ul><ul><li>What will you be using your money for? </li></ul></ul><ul><li>Having a good understanding of yourself will allow you to align your risk tolerance with various strategies </li></ul>
  14. 14. Determining Your Investment Style <ul><li>What kind of person and investor do you want to be? </li></ul><ul><ul><li>Shooting for singles and doubles, aiming for slow and steady gains? </li></ul></ul><ul><ul><li>Sitting on the sidelines, relying on and cheering someone else? </li></ul></ul><ul><ul><li>Willing to take risks, go for homers, and achieve maximum gains? </li></ul></ul><ul><li>Think about your risk tolerance, time horizons for your investments, and your time commitment </li></ul>
  15. 15. The Risk / Return Tradeoff <ul><li>“principle that potential return rises with an increase in risk” </li></ul><ul><ul><li>Lower risk with lower returns </li></ul></ul><ul><ul><li>Higher risk with high returns </li></ul></ul><ul><li>Important to know your personal risk tolerance when choosing investments </li></ul><ul><ul><li>Balance between risk and reward </li></ul></ul>
  16. 16. What is Your Risk Tolerance? Source: Investopedia. “Determining Risk and The Risk Pyramid.” May 2 2003
  17. 17. Source: Investopedia. “Determining Risk and The Risk Pyramid.” May 2 2003
  18. 18. Portfolio Management
  19. 19. Portfolio <ul><li>“collection of assets—such as stock, bonds, and mutual funds—held by an investor” </li></ul><ul><li>Portfolio Management </li></ul><ul><ul><li>Deciding type of investment mix and allocation for your portfolio </li></ul></ul><ul><ul><li>Risk versus performance </li></ul></ul>
  20. 20. Active versus Passive Management <ul><li>You choose? </li></ul><ul><li>versus </li></ul><ul><li>Someone else chooses for you? </li></ul>
  21. 21. Active versus Passive Management <ul><li>Examples (Active Management) </li></ul><ul><ul><li>Buying / selling different stocks </li></ul></ul><ul><ul><li>Discuss with your broker which stocks to invest </li></ul></ul><ul><ul><li>Choosing between different mutual funds </li></ul></ul><ul><li>Example (Passive Management) </li></ul><ul><ul><li>Choose one mutual fund and forgetting about it for the next 10 years </li></ul></ul><ul><ul><li>Buying an index fund or having your portfolio match the index fund at all times </li></ul></ul>
  22. 22. How many stocks should I own? <ul><li>Diversification </li></ul><ul><li>versus </li></ul><ul><li>Concentration </li></ul>
  23. 23. <ul><li>“Don’t put all your eggs in one basket” </li></ul>Diversification
  24. 24. Diversification <ul><li>Mixing a wide selection of investments within a portfolio </li></ul><ul><ul><li>By industry, sizes, geographic locations, or other characteristics </li></ul></ul><ul><li>Positive performance of some investments may neutralize the negative performance of others </li></ul>
  25. 25. Diversification…What’s the Catch? <ul><li>Limits your upside potential </li></ul><ul><ul><li>Hot stock makes up only 5% of your portfolio </li></ul></ul><ul><ul><li>50% increase will have small effect </li></ul></ul><ul><li>Many investors tend to over-diversify </li></ul><ul><ul><li>Harder to keep track, slower to react </li></ul></ul><ul><ul><li>Less you know about one area of positions </li></ul></ul><ul><ul><li>Over-diversification usually leads to matching market performance (What’s the point then?) </li></ul></ul><ul><ul><li>Commissions becomes an issue with low capital </li></ul></ul>
  26. 26. Concentration “ putting your eggs in a few baskets that you know well and watching them very carefully”
  27. 27. Concentration <ul><li>Goal: Keep losses small and ride profits for big gains </li></ul><ul><ul><li>Effect: big gains have major effect on your portfolio value </li></ul></ul><ul><li>Note: Avoid temptation of committing too much of portfolio into one position </li></ul><ul><ul><ul><li>Why? Psychology </li></ul></ul></ul>
  28. 28. How Many to C oncentrate on? Account Size # of stocks $3,000 2 $5,000 - $20,000 3 $20,000 - $100,000 4 or 5 $1,000 - $1,000,000 5 or 6 $1,000,000 - $5,000,000 6 or 8
  29. 29. Other Investment Securities Mutual Funds & Exchange-Traded Funds
  30. 30. Various investment securities <ul><li>Money market funds </li></ul><ul><ul><li>Type of risk-free debt investment that has slightly better returns than savings </li></ul></ul><ul><ul><li>Typically mature in less than 1 year </li></ul></ul><ul><ul><li>Very liquid (ie. easy to buy/sell and convert to cash) </li></ul></ul><ul><ul><li>Usually traded through institutions in high volumes </li></ul></ul><ul><li>Certificate of deposits (CDs) </li></ul><ul><ul><li>Certificate to the bearer to receive interest </li></ul></ul><ul><ul><li>Issued by commercial banks for 1 month to years </li></ul></ul><ul><ul><li>Short-term CD’s generally 5.29% percent or up </li></ul></ul><ul><ul><li>Bearer can’t withdraw money until term is up </li></ul></ul>
  31. 31. Various Investment Securities <ul><li>Bonds </li></ul><ul><ul><li>An IOU issued by a borrower to a lender </li></ul></ul><ul><ul><li>Loaning money for pre-determined time </li></ul></ul><ul><ul><li>Borrower pays a coupon payment during time-span as well as lent amount </li></ul></ul><ul><ul><li>Borrowers range from banks, government, to corporations </li></ul></ul><ul><li>Advanced / Alternative Investments </li></ul><ul><ul><li>Options </li></ul></ul><ul><ul><li>Hedge Funds </li></ul></ul><ul><ul><li>Private Equity </li></ul></ul><ul><ul><li>Futures / Derivatives </li></ul></ul>
  32. 32. Mutual Fund Basics <ul><li>Nothing more than a collection of stocks and/or bonds </li></ul><ul><li>You contribute your money to a company that manages a large fund (made up of other people’s money) and invests in a portfolio </li></ul><ul><li>Often, these mutual funds can be hundreds of millions and billions of dollars </li></ul>
  33. 33. Mutual Fund Basics <ul><li>Various types of mutual funds </li></ul><ul><ul><li>Equities, fixed-income, money market </li></ul></ul><ul><ul><li>Mutual funds usually variation of these assets classes </li></ul></ul><ul><li>Also, other special types: global, international, specialty, index funds </li></ul><ul><li>Costs: </li></ul><ul><ul><li>Yearly fees to keep you invested in fund </li></ul></ul><ul><ul><li>Transaction fees paid when buy / sell shares </li></ul></ul><ul><ul><li>Also other various costs: administrative, managing fees, etc. </li></ul></ul>
  34. 34. Buying and Selling Funds <ul><li>Can buy mutual funds by contacting fund companies directly (ie. go to the company’s website) </li></ul><ul><li>Can withdraw your money from fund at the end of market days usually </li></ul><ul><li>If purchase mutual funds through third-parties (brokers, banks, planners), usually faced with extra sales charge (these are called loads) </li></ul>
  35. 35. Advantages Disadvantages <ul><li>Professional Management </li></ul><ul><li>Diversification </li></ul><ul><li>Economies of Scale </li></ul><ul><li>Liquidity </li></ul><ul><li>Simplicity </li></ul><ul><li>Professional Management (huh?!) </li></ul><ul><li>Costs </li></ul><ul><li>Dilution </li></ul><ul><li>Taxes </li></ul><ul><li>Reaction Time </li></ul>
  36. 36. Choosing Mutual Funds <ul><li>Always compare fund performance to stock market averages (S&P500, NASDAQ) </li></ul><ul><ul><li>Pay attention to the years in which market averages were down (anyone can make money in the bull market) </li></ul></ul><ul><ul><li>Look for solid track records </li></ul></ul><ul><li>Make sure objectives of mutual fund are in line with your goals and risk / rewards desires </li></ul><ul><ul><li>Aggressive growth? Slow, steady returns? </li></ul></ul>
  37. 37. Exchange-Traded Funds <ul><li>Like mutual fund, but trades like stock </li></ul><ul><ul><li>Represents a basket of stocks that reflect an index / industry such as the S&P500 or alternative energy </li></ul></ul><ul><ul><li>Diversification like an index fund, but the flexibility of a stock </li></ul></ul><ul><li>Value of ETF updated daily as supply and demand fluctuates </li></ul>
  38. 38. Exchange-Traded Funds <ul><li>Number of ETF for various industries and markets </li></ul><ul><ul><li>International, oil, retail, emerging markets, etc. </li></ul></ul><ul><li>Buying and selling ETF as simple as buying / selling a stock </li></ul><ul><ul><li>Symbols assigned to each ETF (QQQQ for Nasdaq 100 average) </li></ul></ul><ul><ul><li>Go to broker & enter buy order for QQQQ </li></ul></ul><ul><li>Can buy / sell at any point of the day </li></ul>
  39. 39. Advantages over Mutual Funds <ul><li>Lower costs </li></ul><ul><li>Greater tax efficiency </li></ul><ul><li>Easier asset allocation </li></ul><ul><li>No fraud (ETF’s are transparent) </li></ul><ul><li>Flexibility </li></ul><ul><li>Shorting opportunity </li></ul>
  40. 40. Sample ETF Symbols ETF Ticker Fund Name Fund Description IVV iShares S&P 500 Index Fund Large cap US stocks IJH iShares S&P Mid Cap 400 Index Fund Mid cap US stocks IWM iShares Russell 2000 Index Fund Small cap US stocks EFA iShares MSCI EAFE Index Fund Large cap foreign developed market stocks EEM iShares MSCI Emerging Markets Index Fund Large cap emerging market stocks RWR streetTRACKS Wilshire REIT Index Fund Real estate investment trust index fund LQD iShares GS $ Investop Corporate Bond Fund US corporate bonds SHY iShares Lehman 1 to 3 Year Treasury Bond Fund US short-term Governement bonds IEF iShares Lehman 7 to 10 Year Treasury Bond Fund US long-term Governement bonds TIP iShares Lehman TIPs Bond Fund US Governement inflation-protected bonds
  41. 41. Additional Resources for ETF’s <ul><li>Radical Guide to ETF Investing </li></ul><ul><li> </li></ul><ul><li>ETF Central (Charts) </li></ul><ul><li>http://www.etf-fund-investing/technical_analysis_charts / </li></ul><ul><li>ETF Investor </li></ul><ul><li>http:// / </li></ul><ul><li>ETF Trends </li></ul><ul><li>http:// / </li></ul>
  43. 43. Trading Psychology <ul><li>Emotions severely impair your judgment in deciding whether to buy or sells tocks </li></ul><ul><ul><ul><ul><li>HOPE </li></ul></ul></ul></ul><ul><ul><ul><ul><li>FEAR </li></ul></ul></ul></ul><ul><ul><ul><ul><li>GREED </li></ul></ul></ul></ul><ul><ul><ul><ul><li>PRIDE </li></ul></ul></ul></ul>
  44. 45. Psychology & The Stock Market <ul><li>Emotions can wreak havoc on your results and decisions </li></ul><ul><li>Need to take emotion out of investing </li></ul><ul><li>Do this by developing a system with rules to follow with discipline </li></ul>
  45. 46. Trading Psychology <ul><li>“ Your biggest enemy, when trading, is within yourself. Success will only come when you learn to control your emotions” </li></ul><ul><li>- Edwin Lefevre </li></ul>
  46. 47. Next Week <ul><li>Financial Statements Primer </li></ul><ul><ul><li>Income Sheet </li></ul></ul><ul><ul><li>Balance Sheet </li></ul></ul><ul><ul><li>Cash Flow Statement </li></ul></ul><ul><li>Financial Ratios </li></ul><ul><ul><li>P/E, ROE, Margins, etc. </li></ul></ul><ul><li>Earning Reports, Analyst Estimates </li></ul>
  47. 48. Reading <ul><li>Assigned Reading: </li></ul><ul><ul><li>SEC. Beginner’s Guide to Financial Statements </li></ul></ul><ul><ul><li>Look at Google’s financial statements (income statement, balance sheet, cash flow statement) </li></ul></ul><ul><li>Extra Reading: </li></ul><ul><ul><li>Ratio Analysis (Investopedia) </li></ul></ul><ul><ul><li> </li></ul></ul>