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., REVIEW BOOK: Personal Finance. Retrieved Oct 1, 2009 from http://www.flatworldknowledge.com/node/50890 . What is your financial goal? Financial Independence Just starting your own financial life apart from your parent(s)/guardian(s) Financial Stability Managing all of your financial resources effectively, but unprepared to meet financial emergencies Financial Security The ability to manage and absorb financial emergencies IMO, one of the best and easiest ways to attain Financial Security is to create passive income through investments Ways To Earn $1,000,000 Invest $1 a day at 5% for 100 years Invest $1 a day at 10% for 56 years Invest $1 a day at 15% for 40 years Invest $1 a day at 20% for 32 years Invest $10 a day at 20% for 20 years (approximately $300 a month) Invest $850 a month at 20% for 10 years A Primer on Financial Investment Options 1. Federal Government Securities Treasury Securities U.S. Savings Bonds What are the costs/benefits of investing your money in the federal government from a household‟s cost-benefit perspective? Low risk no default risk Highly liquid Earnings are exempt from state and local taxes Relatively low rates of return price of safety 2. Bonds (non-Federal govt) - issued by municipal governments and corporations to raise money needed for a long period of time. Once you purchase them, you earn a fixed, simple interest income for the life of the bond or until you sell it. Costs and benefits default risk varies (2.25% junk bonds to 0.15% all bonds) very liquid inflation risk is high because bonds are purchased at a fixed interest rate Municipal bonds are federal tax-free Effective Yield of a Tax-Free Investment Not paying tax effectively increases your rate of return you get to keep all of your profits, instead of only a portion r 1 taxbracket 100 Example: 28% tax bracket, 5% rate of return .05 1 .28 100 = 6.94% Descriptive Terms for Bond Features ., REVIEW BOOK: Personal Finance. Retrieved Oct 1, 2009 from http://www.flatworldknowledge.com/node/50890 . Bond Ratings A plus sign (“+”) following a rating indicates that it is likely to be upgraded, while a minus sign (“-“) following a rating indicates that it is likely to be downgraded. ., REVIEW BOOK: Personal Finance. Retrieved Oct 1, 2009 from http://www.flatworldknowledge.com/node/50890 . Bond Prices, Bond Yields, and Interest Rates ., REVIEW BOOK: Personal Finance. Retrieved Oct 1, 2009 from http://www.flatworldknowledge.com/node/50890 . Bond Characteristics and Risk ., REVIEW BOOK: Personal Finance. Retrieved Oct 1, 2009 from http://www.flatworldknowledge.com/node/50890 . 3. Certificates of Deposit - long-term deposits with institutions purchased from banks, S&L‟s, credit unions purchased from a stock broker Costs and benefits low default risk (marginally greater with stock broker) some liquidity risk (less with stock broker) sometimes inflation risk (less w/ variable rates) 4. Precious Metals typically viewed as a major alternative to holding currencies. Thus, in inflationary times (when money is losing value) the demand for precious metals rises, bidding up their prices. gold silver platinum Costs and Benefits high market volatility risk very low inflation risk 5. Stock Market investing 2 types of people Investing in the stock market = gambling I know I should invest in the stock market, but I‟m not sure where to start The nature of business Businesses sell stock to raise capital Investing in the stock market is simply investing in companies 5. Stock Market investing Stocks are a claim on the net earnings of a company after the claims of creditors are satisfied. Returns of investment in stocks can take the form of: interest income (dividends) capital gains (appreciation or growth) Costs and benefits higher default risk (can be reduced through diversification) somewhat illiquid (can always sell, but perhaps not at the price you‟d like) Stocks - Costs and benefits continued: little inflation risk high time/money costs associated with managing stock investments unless one diversifies. Shanghai Stock Exchange (SSE) Stock Comparisons ., REVIEW BOOK: Personal Finance. Retrieved Oct 1, 2009 from http://www.flatworldknowledge.com/node/50890 . Playing the Stock Market February 2008/September 29, 2009 COMPANY / INDUSTRY SHARE PRICE COMPANY / INDUSTRY SHARE PRICE Exxon / Oil & Gas (XOM) $81.44/$69.11 Hawaiian Airlines / Airline $4.82/$8.23 (HA) Chevron / Oil & Gas $92.32/$71.15 Idenix Pharmaceuticals / $4.94/$3.10 (CVX) Health Care (IDIX) Fairfax Financial Holding/ $308.15/$379.48 Maxwell Technologies / $7.78/$18.30 Property Insurance (FFH) Hybrid Vehicles (MXWL) Landauer Inc. / $49.84/$54.64 Hasbro / Recreational $24.75/$27.44 Healthcare (LDR) Products (HAS) Colgate-Palmolive / $74.46/$76.59 Disney / Entertainment $31.50/$28.07 Consumer Goods (CL) (DIS) Rangold Resources/ $42.60/$68.35 Wal-Mart / Retail (WMT) $48.83/$49.50 Gold (GOLD) Amgen / Biotechnology $46.31/$60.86 Gilead Sciences Inc / $44.87/$46.18 (AMGN) Biopharmaceuticals (GILD) Halliburton / Engineering $34.09/$27.10 Fred’s / Retail (FRED) $8.63/$12.68 & Construction (HAL) Ross Stores / Retail $27.09/$48.23 Wells Fargo / banking $30.08/$28.60 (ROST) (WFC) Micron / Computer $7.84/$8.23 Harley Davidson (HOG) $37.16/$23.04 Hardware (MU) What is the Yield or Rate of Return on a Financial Investment? Percentage Change: new old 100 old Find the percentage change of each of your 3 stocks, and then find your average rate of return (assuming 1 share of each stock) Compound Annual Growth Rate (Annualized Return) A problem with talking about average investment returns is that there is real ambiguity about what people mean by "average". For example, if you had an investment that went up 100% one year and then came down 50% the next, you certainly wouldn't say that you had an average return of 25% = (100% - 50%)/2, because your principal is back where it started: your real annualized gain is zero. In this example, the 25% is the simple average, or "arithmetic mean". The zero percent that you really got is the "geometric mean", also called the "annualized return", or the "CAGR" for Compound Annual Growth Rate. What is the Yield or Rate of Return on a Financial Investment? Annualized Percentage Change: 1 new old n 1 1 100 old Example: original price=$20/share, current price=$100/share, stock held for 9 years What is the Yield or Rate of Return on a Financial Investment? 1 100 20 9 1 1 100 20 =19.58% Examples of Security Indexes ., REVIEW BOOK: Personal Finance. Retrieved Oct 1, 2009 from http://www.flatworldknowledge.com/node/50890 . Annualized Return of the S&P 500(adjusted for inflation) http://www.moneychimp.com/features/market_cagr.htm 2008 -37.22% 2007 5.46% 2006 15.74% 2005 4.79% 2004 10.82% 2003 28.72% 2002 -22.27% 2001 -11.98% 2000 -9.11% 1999 21.11% 1998 28.73% 1997 33.67% 1996 23.06% NASDAQ Composite Index, 1991-2002 ., REVIEW BOOK: Personal Finance. Retrieved Oct 1, 2009 from http://www.flatworldknowledge.com/node/50890 . Stock Market Average Returns by decade (not adjusted for inflation) 1900s 9.88% 1910s 4.67% 1920s 15.47% 1930s -0.12% 1940s 9.06% 1950s 19.61% 1960s 7.78% 1970s 5.80% 1980s 17.68% 1990s 18.30% Some Numbers… How would $1 invested in 1872 grow, with the interest and dividends reinvested, if held until 2000? A $1 investment in a portfolio comprised entirely of stocks would grow to $6,410. Invested in a portfolio comprised of 75 percent stocks and 25 percent bonds, the $1 would grow to $2,706. A 60 percent stock and 40 percent bond portfolio would grow to $1,484. A portfolio weighted with 75 percent bonds would grow to $289. For the period 1871 to 1996, stocks outperformed bonds 59.5% of the time over a one-year holding period, but when the holding period was 10 years, stocks outperformed bonds 82.1% of the time When the holding period was 30 years, stocks always outperformed bonds. Some Numbers… http://radio.weblogs.com/0103811/2003/05/06.html From 1926-2003 Nominal return of the entire stock market = 12.56% Compounded nominal annual rate of return = 10.7% Compounded real annual rate of return = 7% Of course, this is no guarantee of future performance, but it gives us some room for estimation How to research an investment Talk to your broker Traditional brokerage house Discount brokerage house Research online Most brokerage firms have research pages you can search Can use the finance sections of yahoo.com, moneycentral.msn.com, and etc. Ratios and Their Uses ., REVIEW BOOK: Personal Finance. Retrieved Oct 1, 2009 from http://www.flatworldknowledge.com/node/50890 . Stock Market investing Some terms: Bear market = general time of falling prices Bull market = general time of rising prices Margin = borrowing money from your broker to purchase securities Dollar Cost Averaging (DCA) Committing a set amount of money per month, and always purchasing securities with that money „Averaging‟ means that you purchase more shares when the price is down and fewer shares when the price is high. Caution: DCA may not be all it is purported to be http://moneycentral.msn.com/content/P104966.asp Definition Role Growth Stock Underestimated potential Expect a higher rate of for growth return and no dividends. Value Stock Undervalued by the Expect a higher than market; under-priced average return. Defensive Stock Less volatility than the Expect the value to fall overall market and less less than the market’s sensitive to market during a market decline changes. Stock Market investing, cont. Really good information available at http://beginnersinvest.about.com/ especially under the “Investing 101” and “Investing Lessons” links Bottom line commit to do it, and then just do it! Lessons from Warren Buffet We care because he is one of the wealthiest Americans Why listen to him? He is the single most successful stock market investor in history. If you had put $10,000 in his investment company Berkshire Hathaway (BRK.A) when it was created in 1965 ($19/share), you would have about $53,163,160 today $101,010 Sept. 29, 2009). The S&P stock index for the same amount and length of time you would only have $500,000. Starting young He bought his first share of stock at age 11 and he now regrets that he started too late! He bought a small farm at age 14 with savings from delivering newspapers. His advice to young people: Stay away from credit cards and invest in yourself Money doesn't create man, but it is the man who created money. Live your life as simple as you are. Don't do what others say. Just listen to them, but do what makes you feel good. Don't go on brand names. Wear those things in which you feel comfortable. Don't waste your money on unnecessary things. Spend on those who really are in need. After all, it's your life. Why give others the chance to rule your life? 6. Mutual Funds - pool of resources created by investing organization. Resources are invested in a wide array of financial instruments including: precious metals stocks bonds real estate government securities Mutual funds are distinguished by what they invest in. Costs and Benefits Broad diversification Less time spent in financial management (benefit from professional manager) Tax implications (capital gains) Fees A basic mutual fund that has no or low fees is a …. No-Load Index Fund Dow Jones Industrial Average Comprised of 30 stocks More expensive stocks influence the avg S&P 500 Index, so the value itself is meaningless; must compare to other years Base = 1941-1943 = 10 If the index = 1000, the average stock price has increased 100 times What are some of Heather‟s objections to mutual funds? 80% of mutual funds underperform the stock market in general because of FEES Too many stocks dilute returns Warren Buffett says not to have more than 12 The average actively managed fund returns 2% less per year than the market in general Over 50 years, $10,000 grows to $1,173,908 at 10% $469,016 at 8% Mutual funds are structured in three ways: Closed-end funds Open-end funds (most funds) Exchange-traded funds (ETF) ., REVIEW BOOK: Personal Finance. Retrieved Oct 1, 2009 from http://www.flatworldknowledge.com/node/50890 . Value of Mutual Funds Net Asset Value (NAV) NAV = (Market value of fund securities – fund liabilities ÷ number of shares outstanding. NAV is usually calculated once per day at the close of trading except for EFTs. A Mutual Fund Example ., REVIEW BOOK: Personal Finance. Retrieved Oct 1, 2009 from http://www.flatworldknowledge.com/node/50890 . So, what drives households‟ investment choices? Very little active investment on the part of households -- why? High time costs Risk averse nature Time horizons View financial investment as “residual” category of household expenditures Do people really own FC investments? 52% of Americans own stocks or stock-based mutual funds Financial assets represent 42% of people‟s assets Stocks/stock funds = 34% of assets Retirement accounts = another 28% of assets 2001 SCF – cited in Azicorbe & Kennickell (2003) Major Asset Bubbles Since 1636 ., REVIEW BOOK: Personal Finance. Retrieved Oct 1, 2009 from http://www.flatworldknowledge.com/node/50890 . Key Takeaways Commodities are •natural or cultivated resources. •traded to hedge revenue or production needs or to speculate on resources’ prices. •traded on commodities exchanges through brokers. Derivatives are instruments based on the future, and therefore uncertain, price of another security, such as a share of stock, a government bond, a currency, or a commodity. Mutual funds are portfolios of investments designed to achieve maximum diversification with minimal cost through economies of scale. An index fund is a mutual fund designed to replicate the performance of an asset class or selection of investments listed on an index. An exchange-traded fund is a mutual fund whose shares are traded on an exchange. Institutional and individual investors differ in the use of different investment instruments and in using them to create appropriate portfolios ., REVIEW BOOK: Personal Finance. Retrieved Oct 1, 2009 from http://www.flatworldknowledge.com/node/50890 . Key Takeaways Bonds are • a way to raise capital through borrowing, used by corporations and governments. • an investment for the bondholder that creates return through regular fixed or floating interest payments on the debt and the repayment of principal at maturity. • Traded on bond exchanges through brokers. Key Takeaways Stocks are • a way to raise capital through selling ownership or equity. • an investment for shareholders that creates return through the distribution of corporate profits as dividends or through gains (losses) in corporate value. • traded on stock exchanges through member brokers. Key Takeaways Commodities are Natural or cultivated resources. Traded to hedge revenue or production needs or to speculate on resources’ prices. Traded on commodities exchanges through brokers. Key Takeaways Derivatives are Instruments based on the future, and therefore uncertain, price of another security, such as a share of stock, a government bond, a currrency, or a commodity. Key Takeaways Mutual funds are Portfolios of investments designed to achieve maximum diversification with minimal cost through economies of scale. An index fund is a mutual fund designed to replicate the performance of an asset class or selection of investments listed on an index. An exchange-traded fund is a mutual fund whose shares are traded on an exchange.
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