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Investing Basics Presentation


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Investing Basics Presentation

  1. 1. Knox Consulting Group LLC Charles Knox, MBA, CCFC® Investment Advisor Investing Basics Representative One Glenlake Parkway Suite 700 Atlanta, GA 30328 Office: 770 439-0357 Fax: 770 321-2542 December 2008
  2. 2. Page 2 of 8 Knox Consulting Group LLC Saving and Investing Wisely the U.S. Department of Labor, the average annual Saving builds a foundation rate of inflation over the past 20 years has been approximately 3%. At 3% annual inflation, something The first step in investing is to secure a strong finan- that costs $100 today would cost $181 in 20 years. cial foundation. Start with these four basic steps: To take advantage of compound interest • Create a quot;rainy dayquot; reserve: Set aside enough cash to get you through an unexpected period Anyone who has a savings account understands the of illness or unemployment--three to six months' basics of compounding: The funds in your savings worth of living expenses is generally recom- account earn interest, and that interest is added to mended. Because you may need to use these your account balance. The next time interest is cal- funds unexpectedly, you'll generally want to put culated, it's based on the increased value of your the cash in a low-risk, liquid investment, such as account. In effect, you earn interest on your interest. a money market account or mutual fund. Many people, however, don't fully appreciate the impact that compounded earnings can have, espe- • Pay off your debts: It may make more sense to cially over a long period of time. pay off high-interest-rate debt (for example, credit card debt) before making investments that may have a lower or more uncertain return. Growth of annual $5,000 investments at 6% • Get insured: There is no better way to put your $500,000 extra cash to work for you than by having ade- $400,000 quate insurance. It's your best protection against financial loss, so review your home, $300,000 auto, health, disability, life, and other policies, $200,000 and increase your coverage, if needed. $100,000 $0 • Max out any tax-deferred retirement plans, such 1 4 7 10 13 16 19 22 25 28 as 401(k)s and IRAs: Putting money in these Y ear accounts defers income taxes, which means This is a hypothetical example and is not intended to you'll have more money to save. Take full ad- reflect the actual performance of any specific investment. vantage if they are available to you. Taxes and investment fees and expenses are not reflected. If they were, the results would have been lower. Why invest? Let's say you invest $5,000 a year for 30 years (see To keep ahead of inflation illustration). After 30 years you will have invested a total of $150,000. Yet, assuming your funds grow at When people say, quot;I'm not an investor,quot; it's often exactly 6% each year, after 30 years you will have because they worry about the potential for loss. It's over $395,000, because of compounding . true that investing involves risk as well as reward. However, there's also another type of loss to be Compounding has a quot;snowballquot; effect. The more aware of: the loss of purchasing power over time. money that is added to the account, the greater its During periods of inflation, each dollar you've saved benefit. Also, the more fre- will buy less and less as time goes on. According to quently interest is com- pounded--for example, The impact of 3% yearly inflation monthly instead of annually-- on the purchasing power of $200,000 the more quickly your savings Inflation reduces build. The sooner you start the purchasing $250,000 saving or investing, the more power of your T o d ay's D o llars time and potential your in- $200,000 dollars over vestments have for growth. In time. $150,000 effect, compounding helps you provide for your financial $100,000 future by doing some of the $50,000 work for you. $0 1 6 11 16 21 26 31 36 Year December 2008
  3. 3. Page 3 of 8 Knox Consulting Group LLC Building on Your Foundation on price volatility. Advisors label as aggressive or Setting investment goals risky an investment whose price has been prone to dramatic ups and downs in the past, or that involves Setting goals is an important part of financial plan- substantial uncertainty and unpredictability. Assets ning. Before you invest your money, you should whose prices historically have experienced a nar- spend some time considering and setting your per- rower range of peaks and valleys are considered sonal goals. For example, do you want to retire more conservative. early? Would you like to start your own business soon? Do you need to pay for a child's college edu- In general, the risk-reward relationship makes sense cation? Would you like to buy or build a new house? to most people. After all, no sensible person would In addition to these, there are several other consid- make a higher-risk investment without the prospect erations that can help you and your financial profes- of a higher reward for taking that risk. That is the sional develop an appropriate plan. tradeoff. As an investor, your goal is to maximize returns without taking on more risk than is necessary Think about your time horizon or comfortable for you. If you find that you can't sleep at night because you're worrying about your One of the first questions you should ask yourself in investments, you've probably assumed too much setting your investment goals is quot;When will I need risk. On the other the money?quot; Will it hand, returns that be in 3 years or 30? The risk/return relationship are too low may Your time horizon for leave you unable each of your finan- to reach your fi- cial goals will have nancial goals. a significant impact on your investment Options & Futures The concept of risk strategy. tolerance refers Common Stock Potential Return not only to your The general rule is: Preferred Stock willingness to as- The longer your sume risk but also time horizon, the Corporate Bonds to your financial more risky (and ability to endure Government Bonds potentially more the consequences lucrative) invest- CDs (Cash equivalents) of loss. That has to ments you may be Treasury Bills (Cash equivalents) do with your stage able to make. Many in life, how soon financial profession- you'll need the als believe that with Risk money, and your a longer time hori- financial goals. zon, you can ride out fluctuations in your investments for the potential of Remember your liquidity needs greater long-term returns. On the other hand, if your time horizon is very short, you may want to concen- Liquidity refers to how quickly you can convert in- trate your investments in less risky vehicles because vestments into cash. Real estate, for example, tends you may not have enough time to recoup losses to be relatively illiquid; it can take a very long time to should they occur. sell. Publicly traded stock, on the other hand, tends to be fairly liquid. Understand your risk tolerance Your need for liquidity will affect the types of invest- Another important question is quot;What is my invest- ments you might choose to meet your goals. For ment risk tolerance?quot; How do you feel about the example, if you have an emergency fund, you're in potential of losing your hard-earned money? Many good health, and your job is secure, you may be investors would forgo the possibility of a large gain if willing to hold some less liquid investments that may they knew there was also the possibility of a large have higher potential for gain. However, if you have loss. Other investors are more willing to take on two children going to college in the next couple of greater risk to try to achieve a higher return. You years, you probably don't want all of their tuition can't completely avoid risk when it comes to invest- money invested in less liquid assets. Also, having ing, but it's possible to manage it. some relatively liquid investments may help protect you from having to sell others when their prices are Almost universally, when financial professionals or down. the media talk about investment risk, their focus is December 2008
  4. 4. Page 4 of 8 Knox Consulting Group LLC Types of Investments: Stocks greater returns. How do stocks work? The universe of stocks offers enormous flexibility to When you buy a company's stock, you're purchasing construct a stock portfolio that is tailored to your a share of ownership in that business. You become needs. There are many different types of stock, and one of the company's stockholders or shareholders. many different ways to diversify your stock holdings. Your percentage of ownership in a company also For example, you can sort through stocks by indus- represents your share of the risks taken and profits try, by company size, by location, and by growth generated by the company. If the company does prospects or income. well, your share of its earnings will be proportionate to how much of the company's stock you own. The Growth stocks flip side, of course, is that your share of any loss will are usually be similarly proportionate to your percentage of characterized ownership. by corporate Potential Return earnings that If you purchase stock, you can make money in one are increasing of two ways. The company's board of directors can at a faster rate Stocks decide to distribute a portion of the company's prof- than their in- its to its shareholders as dividends, which can pro- dustry aver- vide you with income. Also, if the value of the stock Bonds age or the rises, you may be able to sell your stock for more overall market. than you paid for it. Of course, if the value of the Cash Equivalents Income stocks stock has declined, you'll lose money. (for example, Risk utilities or fi- Stocks by Size nancial com- Size Description panies) generally offer higher dividend yields than market averages. Value stocks are typically charac- • Large cap Widely bought and sold terized by selling at a low price relative to a com- ($10+ billion) • Often are well-known pany's sales, names Advantages earnings, or book value. • Midcap Somewhat smaller than • Historically, have ($2 billion to large caps These are only provided higher long-term $10 billion) some of the total return than cash or • Small cap many ways in Less widely traded bonds ($200 million to which stocks • Fewer institutional $2 billion) can be identi- investors • Easy to buy and sell fied, and your • Microcap May trade infrequently financial profes- • Can provide capital ($20 million to • More difficult to research sional can help appreciation as well as $200 million) you decide income from dividends which might be Note: The values used to define companies by size are more appropri- highly variable. Different organizations define these ranges • Ownership rights ate for you than in different ways, and the ranges can vary over time with general stock market values. others. With Tradeoffs stocks, it's es- pecially impor- • Poor company The role of stocks in your portfolio tant to diversify performance can affect your holdings. dividends and share Though past performance is no guarantee of future That way, if one value results, stocks historically have provided higher long company is in -term total returns than cash equivalents or bonds. trouble, it won't • Greater risk to principal However, that potential for greater returns comes have as much with greater risk of volatility and potential for loss. impact on your • May not be appropriate You can lose part or all of the money you invest in a overall return as for short-term investment stock. Because of that volatility, stock investments it would if it may not be appropriate for money you count on to represented • Subject to market be available in the short term. You'll need to think your entire volatility about whether you have the financial and emotional portfolio. ability to ride out those ups and downs as you try for December 2008
  5. 5. Page 5 of 8 Knox Consulting Group LLC Types of Investments: Bonds How do bonds work? Ways to classify bonds When you buy a bond, you're basically buying an By maturity Long-term (10+ years) IOU. Bonds, sometimes called fixed-income securi- Intermediate (1-10 years) ties, are essentially loans to a corporation or govern- mental body. The borrower (the bond issuer) typi- Short-term (less than 1 year) cally promises to pay the lender, or bondholder, regular interest payments until a certain date. At that Corporate By issuer point, the bond is said to have matured. When it Municipal reaches that maturity date, the full amount of the U.S. Treasury loan (the principal or face value) must be repaid. Government-sponsored entities A bond typically pays a stated interest rate called the Foreign corporations and coupon, a term that dates back to the days when a governments bondholder had to clip a coupon attached to the bond and mail it in to receive each interest payment. Investment-grade By quality Most bonds pay interest on a fixed schedule, usually High-yield (quot;junkquot;) quarterly or semiannually, although some pay all interest at maturity along with the principal. By tax Tax-exempt: municipal bonds (generally exempt from federal tax) status There are two fundamental ways that you can profit from owning bonds. The most obvious is the interest Taxable: corporate, U.S. Treasury that bonds pay. However, you can also make money (exempt from most state and local if you sell a bond for more than you paid for it. As tax) with any security, bond prices move up and down in response to investor demand; they also are sensitive to changes in interest rates. If you sell a bond before The bond market often behaves very differently from its maturity date, you may get more than its face stocks. For example, when stock prices are down, value, depending on how its interest rate compares investors often prefer bonds because of their relative to others. However, you could also receive less than stability and interest payments. Also, when interest the face value if you sell before maturity when bond rates are high, bond returns can be attractive prices are down. enough that investors decide not to assume the greater risk of Advantages The role of bonds in your portfolio stocks. Interest from bonds can • Generally, a predictable One of the most important reasons that investors help balance stream of income choose bonds is for their steady and predictable stock fluctua- stream of income through interest payments. Bonds tions and in- • Income typically higher have traditionally been important for retirees for this crease a portfo- than cash investments reason. Also, lio's stability. though they And because a • Relatively lower risk are not risk- bond's face compared to stocks free--for ex- value gets re- ample, a bond paid upon ma- Potential Return • Low correlation with stock issuer could turity, you can market default on a choose a bond payment or that matures Stocks Tradeoffs even fail to when you need repay the prin- the money. Bonds • Risk of default (mostly cipal--bonds with corporate bonds) are consid- Some bonds Cash Equivalents ered some- are exempt • Bond values fluctuate what less risky from federal or with interest rates than stocks. In Risk state and local part, that's income tax. • Generally, lower potential because a corporation must pay interest to bond- This can be returns compared to holders before it pays dividends to its shareholders. appealing to Also, if it declares bankruptcy or dissolves, bond- investors in high stocks holders are first in line to be compensated. tax brackets. December 2008
  6. 6. Page 6 of 8 Knox Consulting Group LLC Types of Investments: Cash tradeoff for their relative safety: Their potential return Cash and cash equivalents is not as high as investments that involve more risk. By focusing solely on playing it safe, you may limit In daily life, your investment income, especially over longer time cash is all periods. around you, as currency, Cash investments can be useful in many ways. First, bank bal- Potential Return they can provide relative stability. While cash ances, nego- equivalents can't assure you of a gain or protect you tiable money from losses, they are generally considered safer orders, and than other asset classes, such as stocks or bonds. Stocks checks. Also, they can provide income on cash that would However, in Bonds otherwise be idle. They can serve as a ready source investing, of cash to pay bills or make purchases. For exam- quot;cashquot; is Cash Equivalents ple, cash equivalents can help preserve money ear- also used to marked for a refer to so- down payment Risk called cash Advantages or a family va- equivalents: cation. Readily • Predictable earnings investments that are considered safe and can be available cash converted to cash quickly. Common cash equiva- also can help • Highly liquid lents include savings accounts, money market de- you cope in a posit accounts, money market funds, certificates of financial emer- • Little risk to principal deposit, guaranteed investment contracts (GICs), gency. Finally, government savings bonds, U.S. Treasury bills, Tradeoffs cash equiva- Eurodollar certificates of deposit, commercial paper, lents can serve and face amount certificates. • Relatively low returns as a temporary parking place The role of cash in your portfolio • May not outpace inflation when you're not sure where to Because of their conservative nature, cash equiva- invest your money. lents involve the least risk. However, there is a Investing Through Mutual Funds and ETFs You can invest in all three major asset actively managed mutual fund, the Advantages classes through mutual funds, which fund manager buys and sells specific • Professional money pool your money with that of other securities, trying to beat a benchmark management investors. Each fund's manager se- index such as the S&P 500. A pas- lects specific securities to buy based sively managed or index fund tries to • Small investment on a stated investment strategy. match the return of a specific index by amounts holding only the securities included in Mutual funds offer two key benefits. that index. • Diversification Because most mutual funds own doz- ens or hundreds of securities, you Exchange traded funds (ETFs) are a • Liquidity achieve greater diversification than different type of passively managed Tradeoffs buying a few individual securities on fund. Like index funds, they invest in a your own. Also, the fund manager's group of securities represented in a • Fluctuating share expertise is part of what you pay for in specific index. Because of this passive values buying mutual fund shares. style, ETF expenses typically are lower than those of actively managed mutual • Some money kept A mutual fund may invest in one of the funds. Unlike mutual funds, ETFs are In cash for fund three asset classes, or combine them. traded throughout the day as stocks liquidity needs For example, a balanced fund typi- are, and can be bought on margin. cally includes stocks and bonds. A • Potential tax lifecycle or target fund adjusts its mix inefficiency of investments over time, investing more conservatively as the fund's • Mutual fund fees target date gets closer. With an and expenses December 2008
  7. 7. Page 7 of 8 Knox Consulting Group LLC Asset Allocation The combination of investments you choose can be stocks, bonds, and cash or cash equivalents. How- as important as your specific investments. The mix ever, there are others that also can be used to com- of various asset classes, such as stocks, bonds, and plement the major asset classes once you've got cash equivalents, account for most of the ups and those basics covered. They include real estate and alternative investments such as hedge funds, private downs of a portfolio's returns. equity, metals, or collectibles. Because their returns Deciding how don't necessarily correlate closely with returns from much of each you major asset classes, they can provide additional should include is diversification and balance in a portfolio. one of your most important tasks as Even within an asset class, consider how your as- an investor. That sets are allocated. For example, if you're investing in balance between stocks, you could allocate a certain amount to large- potential for cap stocks and a different percentage to stocks of growth, income, smaller companies. Or you might allocate based on and stability is geography, putting some money in U.S. stocks and called your asset some in foreign companies. Bond investments might allocation. It be allocated by various maturities, with some money doesn't guarantee a profit or insure against a loss, in bonds that mature quickly and some in longer- but it does help you manage the level and type of term bonds. Or you might favor tax-free bonds over risks you face. taxable ones, depending on your tax status and the type of account in which the bonds are held. Balancing risk and return Monitoring your portfolio Ideally, you should strive for an overall combination of investments that minimizes the risk you take in Even if you've chosen an asset allocation, market trying to achieve a targeted rate of return. This often forces may quickly begin to tweak it. For example, if means balancing more conservative investments stock prices go up, you may eventually find yourself against others that are designed to provide a higher with a greater percentage of stocks in your portfolio return but that also involve more risk. For example, than you want. If they go down, you might worry that let's say you want to get a 7.5% return on your you won't be able to reach your financial goals. The money. Your financial professional tells you that in same is true for bonds and other investments. the past, stock market returns have averaged about Do you have a 10% annually, and bonds roughly 5%. One way to strategy for try to achieve your 7.5% return would be by choos- dealing with ing a 50-50 mix of stocks and bonds. It might not those changes? work out that way, of course. This is only a hypo- Of course you'll thetical illustration, not a real portfolio, and there's probably want to no guarantee that either stocks or bonds will perform take a look at as they have in the past. But asset allocation gives your individual you a place to start. investments, but Many publications feature model investment portfo- you'll also want to lios that recommend generic asset allocations based think about your on an investor's age. These can help jump-start your asset allocation. Just like your initial investing thinking about how to divide up your investments. strategy, your game plan for fine-tuning your portfo- However, because they're based on averages and lio periodically should reflect your investing person- hypothetical situations, they shouldn't be seen as ality. definitive. Your asset allocation is--or should be--as Even if you're happy with your asset allocation, re- unique as you are. Even if two people are the same member that your circumstances will change over age and have similar incomes, they may have very time. Those changes may affect how well your in- different needs and goals. You should make sure vestments match your goals. At a minimum, you your asset allocation is tailored to your individual should periodically review the reasons for your initial circumstances. choices to make sure they're still valid. Also, some investments, such as mutual funds, may actually Many ways to diversify change over time; make sure they're still a good fit. When financial professionals refer to asset alloca- tion, they're usually talking about overall classes: December 2008
  8. 8. Page 8 of 8 Knox Consulting Group Securities and Investment Advisory Services offered LLC through International Financial Solutions Inc. Member FINRA•SPIC. Charles Knox, MBA, CCFC® Insurance Services offered through L.R. Johnson & Associates Inc. Investment Advisor Representative KCG LLC and LRJ & Associates Inc. are independent entities of One Glenlake Parkway International Financial Solutions Inc. Suite 700 Atlanta, GA 30328 Office: 770 439-0357 Fax: 770 321-2542 Prepared by Forefield Inc, Copyright 2008