Diversification by liwenting

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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




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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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