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Investment Strategies

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									Investment Strategies
   RICHARD E. MCDERMOTT
                      Disclaimer

 The information presented is represents my own opinions.
 I am not an investment advisor and there are many out
  there who know more than I.
 This information is not investment advice.
 The opinions offered may or may not work in your
  particular situation.
 Never invest more money than you can afford to lose and
  seek competent advice before making decisions.
Basic Principles
                         Basic Principles

 No one, regardless of what they say, know the future.
   People use heuristic and statistical models to predict future
    economic events but these models assume.
       The future will be like the past.
       The model captures all significant variables.

     These assumptions are not always true.
                      Basic Principles

 No one, regardless of what they say, know the future.
   I have seen investment news letter predict that the market is
    going up in a January edition, predict it is going down in a May
    edition, and when it goes up make the following statement: “As
    we predicted in January the market went up . . .”
                     Basic Principles

 There are a lot of sharks out there.
   If your investment advisor is so good at predicting the future,
    why doesn’t he or she spend full time investing their own money
    and getting rich?
   Why delete one’s efforts publishing a newsletter?




          Guess
          who he
         wants for
          dinner?
                      Basic Principles

 If an investment seems too good to be true it
 probably is.
    For a good education on investment fraud, watch CNBC’s
     “Greed: Scams, Schemes, and Broken Dreams.”
    One red flag is promises of consistent unusually high returns.
                      Basic Principles

 Never invest in anything you don’t control
   This is a personal decision that might not be applicable to all
    people.
                      Basic Principles

 Never invest unless you can accurately assess the risk
   Remember that to play the game of marbles you can’t lose all
    your marbles.
   You are better off making a reasonable
    return over a long time than
    “making it really big” a couple of times and then losing it all.
                     Basic Principles

 Don’t trust anyone
   Do your homework

   Get the opinion of outside experts

   Be skeptical

   Verify what you have been told

   Establish controls to protect your money
                           Basic Principles

 Diversify
   By investment type
         Stocks, bonds, real estate
     By degree of risk and expected return
     By industry
     Geographically
     And so on
                     Basic Principles

 Start early
   While most of my students don’t have huge sums of money,
    they have time.
   We will discuss the impact of compounding of principle and
    interest in a moment.
   Get a plan and stick with it.
                      Basic Principles

 Never invest in anything you don’t understand.
   Do you homework

   Ask questions

   If you don’t understand the answers ask again

   If you still don’t understand the answers, don’t invest.
                      Basic Principles

 Have an exit strategy
   Private stock placement—when will the stock go public

   Publically traded stocks—when will I take profits, stop losses?
Time Value of Money
            Time Value of Money

 One of the most effective
 tools a student (of any
 major) can learn.
                     A Little Theory . . .

                                  Assume we invest a lump
                                  sum of $100 in time period
 Money                            zero.

                                  The interest rate is 10% per year.




$300

$200

$100



                         Time
         0   1   2   3
                      A Little Theory . . .

                Present value and    We let it grow for three
                future value of a    years.
Money           lump sum.
                                     In one year it is worth
                                     $100 x 1.10 = $110

                                     In two years it is worth
                                     $110 x 1.1 = $121
$130                      $133.10
                                     In three years it is worth
$120                                 $121 x 1.10 = $133.10

$100


                              Time
        0   1     2   3
                          To Illustrate . . .

            Present value and           The first year we make a payment
            future value of an          of $100. That amount grows with
Money       annuity.                    interest until we make a second
                                        payment which in turn grows with
 New                                    interest until we make a third
 Axis
                                        payment.
                          $331
                                        At the end of three years we have
                                        $331 from the annuity.
$300
                                        The future value of 3 payments of
$200                                    $100 at 10% interest per period is $331.
$100                                    Again, we could calculate this from
                                        annuity tables or using a financial
                                        calculator.
                                 Time
        0   1    2    3
       Let’s apply this to buying a home

 One of the largest investments people make is the
  purchase of a home.
 Financing a home the right way can save hundreds of
  thousands of dollars and provide funds for other
  investments as we will soon see.
                              Mortgage

 A mortgage is a form of annuity
   Equal payments

   Equally spaced

 Payment periods can vary considerably—from ten to
 fifty years.
    The typical mortgage today is 30 years.
    One tip: as mortgage rates go up the payoff period should go
     down.
        I will explain why in a moment.
                Mortgage Payment

 A mortgage depends upon the following factors:
   The amount borrowed

   The time of the loan

   The interest rate

 Each of these can be calculated with a business
 calculator using the following buttons.


          N       I/Yr     PV      Pmt       FV
                     Financial Calculator


       N             I/Yr                PV              Pmt       FV




Number of Payments   Interest per Year   Present Value   Payment   Future
Value




   The mastery of a financial calculator is an essential skill for any
   investor. Unfortunately, teaching that skill is beyond the scope of
   this presentation. Purchase a financial calculator and read the
   instruction manual or ask for a separate PowerPoint presentation I
   have prepared.
         A mortgage payment has two parts

 Interest which is paid first
 Principle which is paid second
   Remember a mortgage has a fixed number of payments of
    equal fixed amounts paid at equal intervals.
 Let’s illustrate this . . .
   Mark Adams wants to finance a $100,000 mortgage with
    monthly payments for 30 years at 12%* a year (1% a month)
   Using a financial calculator (or Excel) we determine that the
    mortgage payment will be $1,028.61.
       In my life I have seen home mortgage rates as high as 18%.
               Application of the payment

 Mark Adams makes his first payment of $1,028.61
  on January 1, 2012.
 Interest is paid first so let’s calculate that.
     12%/12 = 1% a month x $100,000 = $1,000.
     This is what the allocation looks like.

           Monthly Payment                               $1,028.61
           Less interest to the bank                    -$1,000,00
           Amount applied to the loan                       $28.61

       What! I pay the bank $1,028.61 and only reduce my loan by $28.61!
Let’s look at the amortization schedule for the
                   first year

              Beginning                                                          Principal    Ending       Payment
  Time         Balance      Interest Due    Principal Due Property Tax             Paid       Balance       Made
          1   $100,000.00       $1,000.00          $28.61            0   $0.00       $28.61   $99,971.39    $1,028.61
          2    $99,971.39        $999.71           $28.90            0   $0.00       $28.90   $99,942.49    $1,028.61
          3    $99,942.49        $999.42           $29.19            0   $0.00       $29.19   $99,913.30    $1,028.61
          4    $99,913.30        $999.13           $29.48            0   $0.00       $29.48   $99,883.82    $1,028.61
          5    $99,883.82        $998.84           $29.77            0   $0.00       $29.77   $99,854.05    $1,028.61
          6    $99,854.05        $998.54           $30.07            0   $0.00       $30.07   $99,823.97    $1,028.61
          7    $99,823.97        $998.24           $30.37            0   $0.00       $30.37   $99,793.60    $1,028.61
          8    $99,793.60        $997.94           $30.68            0   $0.00       $30.68   $99,762.93    $1,028.61
          9    $99,762.93        $997.63           $30.98            0   $0.00       $30.98   $99,731.94    $1,028.61
         10    $99,731.94        $997.32           $31.29            0   $0.00       $31.29   $99,700.65    $1,028.61
         11    $99,700.65        $997.01           $31.61            0   $0.00       $31.61   $99,669.04    $1,028.61
         12    $99,669.04        $996.69           $31.92            0   $0.00       $31.92   $99,637.12    $1,028.61
                                                                                    $362.88                $12,343.35




 Note at the end of the year he has paid $12,343.35 in payments but only
 reduced his loan by $362.88!
                                                 What if . . .

 What if the first month, he pays not only his regular payment of $1,028.66 but includes
  the principle payment of $28.90 for the second month?
 In that even he will skip from his first payment to his third. He will never pay that second
  payment of $1,028.61. Not a bad investment—invest $28.90 to save $1,028.68!


                   Beginning                                                          Principal    Ending       Payment
       Time         Balance      Interest Due    Principal Due Property Tax             Paid       Balance       Made
               1   $100,000.00       $1,000.00          $28.61            0   $0.00       $28.61   $99,971.39    $1,028.61
               2    $99,971.39        $999.71           $28.90            0   $0.00       $28.90   $99,942.49    $1,028.61
               3    $99,942.49        $999.42           $29.19            0   $0.00       $29.19   $99,913.30    $1,028.61
               4    $99,913.30        $999.13           $29.48            0   $0.00       $29.48   $99,883.82    $1,028.61
               5    $99,883.82        $998.84           $29.77            0   $0.00       $29.77   $99,854.05    $1,028.61
               6    $99,854.05        $998.54           $30.07            0   $0.00       $30.07   $99,823.97    $1,028.61
               7    $99,823.97        $998.24           $30.37            0   $0.00       $30.37   $99,793.60    $1,028.61
               8    $99,793.60        $997.94           $30.68            0   $0.00       $30.68   $99,762.93    $1,028.61
               9    $99,762.93        $997.63           $30.98            0   $0.00       $30.98   $99,731.94    $1,028.61
              10    $99,731.94        $997.32           $31.29            0   $0.00       $31.29   $99,700.65    $1,028.61
              11    $99,700.65        $997.01           $31.61            0   $0.00       $31.61   $99,669.04    $1,028.61
              12    $99,669.04        $996.69           $31.92            0   $0.00       $31.92   $99,637.12    $1,028.61
                                                                                         $362.88                $12,343.35
                                                 What if . . ?


 What if, instead of buying that new SUV, he encloses (in addition to his monthly check of
  $1,028.61) and additional $334.27. He will then skip from his 1st payment to his 13th
  payment and will never make those 11 payments of $1,026.61 (a total savings of
  $12,343.32).
 He will still need to make a payment next month, but it will be the 13th payment.


                   Beginning                                                          Principal    Ending       Payment
       Time         Balance      Interest Due    Principal Due Property Tax             Paid       Balance       Made
               1   $100,000.00       $1,000.00          $28.61            0   $0.00       $28.61   $99,971.39    $1,028.61
               2    $99,971.39        $999.71           $28.90            0   $0.00       $28.90   $99,942.49    $1,028.61
               3    $99,942.49        $999.42           $29.19            0   $0.00       $29.19   $99,913.30    $1,028.61
               4    $99,913.30        $999.13           $29.48            0   $0.00       $29.48   $99,883.82    $1,028.61
               5    $99,883.82        $998.84           $29.77            0   $0.00       $29.77   $99,854.05    $1,028.61
               6    $99,854.05        $998.54           $30.07            0   $0.00       $30.07   $99,823.97    $1,028.61
               7    $99,823.97        $998.24           $30.37            0   $0.00       $30.37   $99,793.60    $1,028.61
               8    $99,793.60        $997.94           $30.68            0   $0.00       $30.68   $99,762.93    $1,028.61
               9    $99,762.93        $997.63           $30.98            0   $0.00       $30.98   $99,731.94    $1,028.61
              10    $99,731.94        $997.32           $31.29            0   $0.00       $31.29   $99,700.65    $1,028.61
              11    $99,700.65        $997.01           $31.61            0   $0.00       $31.61   $99,669.04    $1,028.61
              12    $99,669.04        $996.69           $31.92            0   $0.00       $31.92   $99,637.12    $1,028.61
                                                                                         $362.88                $12,343.35
Look how little difference in monthly payments a
       change length of mortgage makes




            Number of Years            Monthly Payment                 Total Paid
                      15                     $1200.17                $219,090.60
                      20                      1101.09                 264,261.60
                      30                     1028.61                  370,299.60
                      40                     1008.50                  484,08000
                      50                     1002.56                  601,536.00
                     100                      1001.01                1,200,012.00

The purpose of this exercise is not to tell you what to do, but to show you how you can determine the
                                 impact of different decision options.
          Let’s Have Some fun

     Assume there are twin brothers, Fred and Frank




They have the same income and the same taste in houses.
                    Dream Home



 They have purchased the    Dream House
  plans for the same home,
  a large brick colonial
  costing $250,000.
 To simplify calculations
  assume no down
  payment, interest rate
  8%, and no inflation.
                 Fred’s Decision

 Fred has to have things NOW!!!
 He borrows the money and incurs an $1,831.34
 monthly payment for thirty years.
                  Frank’s Decision

 Frank is a little more patient.
 He has the same money to make a house payment
  withy.
 He takes the financial calculator and determines how
  much house he can buy with the 10 year mortgage
  for $1,834.41 per month.
 He buys a modest home
  for $151,195
             Jump Ahead Ten Years

Frank                      Fred


 Frank’s home is paid      Fred has made the
  for.                       same payments.
 He has $151,195 equity    He still owes $219,312.
  in his home,              He has $30,688 equity
                             in his home.
             What Does Frank Do?

 Frank takes his $1515,195 equity and makes a down
  payment on the $250,000 home.
 The remaining mortgage after the down payment is
  $98,805.
 He continues making the $1,834.41 mortgage
  payment each year.
          We are now 187 months out

Frank                        Fred


 It takes 67 months (5       Fred still owes $187,966.
                               He has 173 payments still
  years 7 months) for          to make.
  Frank to retire this new    Since Frank no longer
  mortgage.                    has a mortgage,
                               payment, he invests the
 He now owns the big          amount he would have
  home outright.               paid each month in the
                               stock market.
                                 The historical return on the
                                  stock market has been 10% a
                                  year.
       Thirty Years After Initial Purchase

Fred                       Frank


 Fred finally finishes     Frank has the same
  paying off the 30 year     home but in addition
  mortgage.                  he has $710,850 in
 He has the $250,000        savings.
  home.                     His total net worth is
                             $980,851.
                            Both have made the
                             same payments.
Another Illustration on the Time Value of Money

 Young couples often believe they don’t have a lot of
  money to invest for retirement.
 What they do have, however, is time.
 The earlier they start, the better.
                  Rob and Rich

 Fred and Frank have two cousins that resemble
  them—Rob and Rich.
 Both are concerned about retirement.
                     Rob and Rich

 At age 25, Rob makes 5 yearly deposits of $2,000 in
    a mutual fund earning 12% (remember the current
    rates are at a historical low).
   He never makes another deposit.
   Rich during these years saves nothing. He spends his
    money on wine, women and song . . . and the rest of
    it he plain wastes.
   At the end of the 5th year Rich wakes up,
   He starts depositing $2,000 a year.
                       Rob and Rich

 It takes Rich almost 25 years to catch up with his
  brother.
 When they both retire at age 65,
    Rob who has made 6 deposits of $2,000 has $856,957.79 in
     his savings account.
    Rob who has made 34 deposits of $2,000 each has
     $861, 329.69 in his account.
 How important is time when you are compounding
 interest?
Investing in Real Estate
                      Flipping Houses

 Money can be made but you must be careful.
 The popular series “Flip this House” lost more
  money for people than it made them.
 To make money you must.
    Buy at the right price (distressed).
    Buy at the right location.
    Only do those things that add significantly to the value of the
     home.
    Keep your costs low (doing you own work helps).
                        Rentals

 Strategy of accumulating rentals works best if you
    are going to live in one place.
   They provide a continuous flow of income that can
    pay off the mortgage.
   Depending upon the tax code, there may be certain
    tax advantages.
   They often appreciate in value over the years.
   They involve the hassle of being a land lord.
   If the stock market crashes, you still have your
    property.
                               Land

 Some believe that strategic investments in raw land
  provide higher long-run returns.
 Identify where the city will grow and buy outside the
  perimeter.
    Study future plans for transportation arteries into the city.
 Land provides no interim cash flow to pay down the
  mortgage.
 There are no landlord hassles.
                        Stocks

 Historically they have outperformed bonds by 3%
 Since 1930 the average return on stocks has been
  19%
 Our nation has never faced a similar situation as far
  as national debt is concerned.
 Forecasting the future using the past may be risky.
 Most analysts believe that the market is too
  optimistic, it is not reacting to bad news like the
  Japan earthquakes and the Libian War.
                        Why?

 One reason may be that interest rates are so low,
  that investment houses are being pushed in the
  market to try and find some kind of return.
 No country that has printed money to buy down
  national debt has avoided excessive inflation.
 Many feel that when the current recession ends, that
  we may be hit by historically high hyper-inflation.
 The question is, how will this affect the stock
  market?
             Two Investment Models

Fundamental Analysis        Technical Analysis

 Depends on the             Highly statistically
  fundamentals of the         driven.
  company.
                             Uses price patterns,
 Uses earnings and
                              flags, trend lines,
  ratios like debt/equity
  ratios.                     moving averages, and
                              momentum theory.
 Warren Buffet is a
  fundamental analysis
  man.
                  Fundamental Analysis

 Typically taught in finance courses and in some
  chapters in accounting textbooks.
 Looks at the pricing of capital assets, future earnings
  flows, return on equity, and so on.
 Different analysts use different tools.
    Some feel low price earnings ratios are a possible signal to buy.
    Others feel they are a strong signal to sell.
    Read “24 Essential Lessons for Investment Success” by
     William J. O’Neil.
      Publisher of Investors Business Daily—an excellent newspaper.
      Prof. McDermott has adopted much of his philosophy.
                    Technical Analysis

 What does market momentum tell us?
   If you were standing at a railroad crossing and a train rolled by
    you at 70 miles per hour, what is the probability you could
    guess accurately if the train were going to stop in the next 100
    yards or so?
   If you threw a ball into the air, and knew its weight, and
    present momentum, and a little physics, how accurately could
    you predict when it would change directions (from up to
    down)?
                     Technical Analysis

 Some analysts place significant weight on sentiment
indicators.
    These are gauges of market psychology.
    Often they will tell you to do just opposite of what you should
     be doing.
      Some investors tout contrarianism.
      “Be fearful when others are greedy and greedy only when others
       are fearful.” Warren Buffet
    Some Important Sentiment Indicators

 Investors Intelligence Advisory Sentiment Index
 Index of Investor Optimism (can be used as
  contrarian signal)
 American Association of Individual Investors
  Survey
 Chicago Board of Options Exchange Options
  Volatility Index
 And so on.
 Very Brief Exposure to Technical Analysis Tools

 Stochastics
   Popular with futures traders

   Standard formula uses short time spans

   The theory is that prices tend to close near the upper end of a
    trading range during an uptrend. As the trend matures, the
    tendency for prices to clo9se away from the higher end of the
    trading range becomes pronounced.
   In a downward moving market the opposite hold true.
               Stochastic Indicator

 The stochastic indicator attempts, therefore, to
 measure points in a rising trend at which the closing
 prices tend to cluster around the lows for the period
 in question and vice versa.
Fundamental Analysis Ratios
Technical Analysis

             RYAIX
             3/12/2011
                         %k = (current close-lowest
                         low)/(highest high – lowest
                         low)*100

                         %D = 3-day SMA of K
    Moving Average Convergency-Divergence
                   (MACD)

 Simple but effective momentum indicator.
 MACD turns two trend-following indicators , moving
  averages, into a momentum oscillator by subtracting
  the longer moving average from the shorter moving
  average.
 MACD fluctuates above and below the zero line as
  moving averages converge, cross and diverge.
 Traders look for signal line crossovers, centerline
  crossovers, and divergences to generate signals.
MACD indicates undersold or oversold
                 Candlestick Charts

       Intended to show which way stock is going to move.




There are dozens of configurations that can be used to predict future
                        market movement.
Candlestick Signals
                  Other Sources

 http://stockcharts.com
 Technical Analysis Explained by Martin J. Pring
 Hundreds of other resources on the web
                              Options

 An option is a contract to buy or sell a specific
  financial product officially known as the option's
  underlying instrument or underlying interest.
 For equity options, the underlying instrument is a
  stock, exchange-traded fund (ETF), or similar
  product.




 Quoted fromo OIC—The Options Industry Council. www.optionseducation.org
                              Options

 The contract itself is very precise. It establishes a
 specific price, called the strike price, at which the
 contract may be exercised, or acted on. And it has an
 expiration date. When an option expires, it no longer
 has value and no longer exists.




 Quoted fromo OIC—The Options Industry Council. www.optionseducation.org
                       Options

 Options come in two varieties, calls and puts, and
  you can buy or sell either type.
 You make those choices - whether to buy or sell and
  whether to choose a call or a put - based on what you
  want to achieve as an options investor.
                        Options

 A call allows you to buy a stock at a future date at a
  specific price.
 A put allows you to put a stock to another person at a
  future date at a specific price.
                    Covered Call

 Options Strategies: Covered Call
 The covered call is a strategy in which an investor
 writes a call option contract while at the same time
 owning an equivalent number of shares of the
 underlying stock.
 Market Opinion?
   Neutral to Bullish on the Underlying Stock

 When to Use?
   Though the covered call can be utilized in any market
    condition, it is most often employed when the investor, while
    bullish on the underlying stock, feels that its market value will
    experience little range over the lifetime of the call contract. The
    investor desires to either generate additional income (over
    dividends) from shares of the underlying stock, and/or provide
    a limited amount of protection against a decline in underlying
    stock value.
                      Covered Calls




$82.00/$5067 = .02 for 38 days or 19% a year return
Tyco International
                      The End

 This is where we will end today, if we continue
 tomorrow we can discuss other options strategies.

								
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