Chapter

Investing forthe Future

11

Investment Essentials

Personal InvestingThe use of your savings to earn a financial

return.The overall objective is to earn money with

money.

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Initial Savings / Beginning Investments should be conservative and low risk.

These investments can provide certain tax advantages.Tax deductibleTax deferredNontaxable

Beginning investments are permanent and should be maintained for the long term.

Types of Investments

Systematic investment: a type of permanent investment centering on retirement planning.

Speculative investment: a type of investment that is made in the hope of earning a relatively large profit in a short time.

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Reasons for Investing

Investing is an important part of personal financial management.

An investment program should begin with an emergency fund.

An emergency fund is a certain amount of money that can be obtained quickly in case of immediate need.

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Other Reasons to Invest

To supplement earned incomeTo make a profitTo minimize tax burdens now and in the

futureTo provide income for retirementTo stay ahead of inflation

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Investing Helps Beat Inflation

Inflation is a rise in the general level of prices.

Inflation reduces purchasing power over time. As prices rise, it takes more money to buy

the same goods and services.

Investors seek investments that will grow faster than the inflation rate.

At retirement, people need to have more income than social security or retirement benefits will provide.

The chief difference among investments is how fast growth occurs.

The greatest opportunity for growth is an investment in common stock.

One of the safest investments, such as a certificate of deposit, provides a predictable but limited growth potential.

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Rule of 72

The Rule of 72 is a technique for estimating the number of years required to double your money at a given rate of return. Divide the percentage rate of return into 72 to

estimate how long it will take to double your money. For example, if an investment is yielding an average

of 6 percent, it will take 12 years to double your money (72 ÷ 6).

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Investing Increases Wealth

Financial success grows from the assets that you build up over time.

Investing helps you accumulate wealth faster than if you simply saved your excess cash in a savings account.

When you invest in stocks and bonds, you are participating in helping businesses make and sell new products and services.

You will be rewarded with dividends and interest.

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Investing Is Fun and Challenging

Investors make choices and hope to pick winners.

Once you gain experience, you can have fun choosing investments, buying and selling when the time is right, and using your knowledge to plan for your financial security.

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Risk and Return Risk in an investment means a measure of

uncertainty about the outcome.

Safety in an investment means minimal risk of loss.

One way to minimize risk is through diversification.

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Diversification

Diversification is the spreading of risk among many types of investments.

Diversification reduces overall risk because not all of your choices will perform poorly at the same time.

If one choice does not do well, the others will likely make up some or all of the loss.

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Types of Risk

Short-Term and Long-Term RiskShort-term are less risky than long-term

Inflation and Interest Rate RiskInflation makes your fixed-rate investments

worth less because they are “locked in” at lower rates of interest

Types of RiskPolitical Risk

Government actions that affect business conditions.

Examples: increased taxes; environmental regulations

Market RiskCaused by business declines, sudden

national or world events or interest rate fluctuations

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Investment Strategies

Many individuals never start an investment program because they think they don’t have enough money.

But even small sums of money grow over time.

To achieve financial security, start investing as soon as you can and continue to invest over your lifetime.

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Criteria for Choosing an Investment

Degree of safety (minimal risk of loss)Degree of liquidityHigh return (investment income)Expected growth in value that exceeds

the inflation rateReasonable purchase price and feesTax benefits

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Wise Investment Practices

Define your financial goals.Go slowly.Follow through.Keep good records.Seek good investment advice.Keep investment knowledge current.

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Sources of Financial Information

NewspapersInvestor services and newslettersFinancial magazinesBrokersFinancial advisersAnnual reports Online investor education

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Annual Reports

An annual report is a summary of a corporation’s financial results for the year and its prospects for the future.

The Securities and Exchange Commission (SEC) requires all public corporations to prepare this report each year and send it to their stockholders.

Investors can use the information contained in the report to evaluate the corporation as an investment prospect.

Where to get annual reports Online at the SEC web site Company web sites Libraries

Stocks

Stock represents ownership in a corporation.

A share of stock is a unit of ownership.The owner of stock is called a

stockholder.Receive a stock certificate which is evidence

of ownership

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BondsBonds are debt obligations of corporations

(corporate bonds) or governments (municipal bonds).

Owners are paid a fixed amount of money, called interest, at a fixed interval.

The principal, or amount borrowed, must be repaid at maturity

The maturity date of a bond is the date on which the borrowed money must be repaid.

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U.S. Government Savings BondsWhen you buy a savings bond, you are

lending money to the U. S. government.A discount bond is purchased for less than

the maturity value.A $50 bond is purchased for $25.At maturity, you receive the full value of the

bond.The difference between the purchase price and

maturity value is the amount of interest earned.

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Treasury Securities U.S. Treasury bills (called T-bills) are available in

denominations of $10,000, then in increments of $5,000.

A Treasury bill is for one year or less Mutual funds

A mutual fund is the pooling of money from many investors to buy a large selection of securities.

Real Estate Investment in houses and/or land Good protection against inflation

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Annuities An annuity is a contract that provides the investor

with a series of regular payments, usually after retirement.

You receive income monthly, with payments to continue as long as you live.

You usually purchase an annuity contract from a life insurance company.

Taxes are deferred until a person receives payments

Payments are used to supplement income Opposite of life insurance—you collect while you are

alive.

IRAIndividual Retirement AccountA savings plan where you set aside a certain

amount of money each year for retirement.The advantage is that the money invested in

an IRA is deductible from gross income on your federal income tax return.

You will pay taxes when you start withdrawing funds at age 59 ½ or older.You will then be in a lower tax bracket.

KeoghAn IRA for the self-employed.

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Collectibles

Collectibles include: Coins Art Memorabilia Ceramics

The market for collectibles fluctuates. If you collect an item that goes up in value, you can

reap large rewards by selling. Collectibles gain value when interest is high and

lose value when interest is low.