What is your financial goal?

., REVIEW BOOK: Personal Finance. Retrieved Oct 1, 2009 from http://www.flatworldknowledge.com/node/50890 .

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 Options1. 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

Example: 28% tax bracket, 5% rate of return

= 6.94%

taxbracket

10028.1

Descriptive Terms for Bond Features

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.

Bond Prices, Bond Yields, and Interest Rates

Bond Characteristics and Risk

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

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)

5. Stock Market investing

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

Playing the Stock MarketFebruary 2008/September 29, 2009

COMPANY / INDUSTRY SHARE PRICE COMPANY / INDUSTRY SHARE PRICE

Exxon / Oil & Gas (XOM) $81.44/$69.11 Hawaiian Airlines / Airline (HA)

$4.82/$8.23

Chevron / Oil & Gas (CVX)

$92.32/$71.15 Idenix Pharmaceuticals / Health Care (IDIX)

$4.94/$3.10

Fairfax Financial Holding/

Property Insurance (FFH)

$308.15/$379.48 Maxwell Technologies / Hybrid Vehicles (MXWL)

$7.78/$18.30

Landauer Inc. / Healthcare (LDR)

$49.84/$54.64 Hasbro / Recreational Products (HAS)

$24.75/$27.44

Colgate-Palmolive / Consumer Goods (CL)

$74.46/$76.59 Disney / Entertainment (DIS)

$31.50/$28.07

Rangold Resources/ Gold (GOLD)

$42.60/$68.35 Wal-Mart / Retail (WMT) $48.83/$49.50

Amgen / Biotechnology (AMGN)

$46.31/$60.86 Gilead Sciences Inc / Biopharmaceuticals (GILD)

$44.87/$46.18

Halliburton / Engineering & Construction (HAL)

$34.09/$27.10 Fred’s / Retail (FRED) $8.63/$12.68

Ross Stores / Retail (ROST)

$27.09/$48.23 Wells Fargo / banking (WFC)

$30.08/$28.60

Micron / Computer Hardware (MU)

$7.84/$8.23 Harley Davidson (HOG) $37.16/$23.04

What is the Yield or Rate of Return on a Financial Investment?

Percentage Change:

Find the percentage change of each of your 3 stocks, and then find your average rate of return (assuming 1 share of each stock)

oldnew

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.

Annualized Percentage Change:

Example: original price=$20/share, current price=$100/share, stock held for 9 years

oldnew

=19.58%

100120

201001

Examples of Security Indexes

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

Stock Market Average Returnsby 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%

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…

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

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 for growth

Expect a higher rate of return and no dividends.

Value Stock Undervalued by the market; under-priced

Expect a higher than average return.

Defensive Stock Less volatility than the overall market and less sensitive to market changes.

Expect the value to fall less than the market’s during a market decline

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 hestarted too late!

He bought a small farm at age 14 with savings from deliveringnewspapers.

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)

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

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

Key TakeawaysCommodities 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 selectionof 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 inusing them to create appropriate portfolios

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.

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.

Key Takeaways

What is your financial goal?

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