Fundamentals of Investing

Dr. John P. Abraham

Professor

UTPA

Investing goals

• Preserve capital

• Increase in value

• Agents:– financial institutions (banks, insurance

companies) and financial markets (forums where suppliers and buyers are brought together).

– Agents can be: government, business or individuals.

Government

• Federal, state and local all require vast sums of money.

• Borrow money to finance projects: war, buildings, schools, housing, bridges, etc.

• They may loan surplus money for short term.

Business & Individuals

• Borrow and loan funds

Security

• Easy to buy and sell• Investments

– Evidence of ownership in a business– Legal right to acquire or sell an ownership interest in a

business– Bonds, stocks, and options

• Direct investment or indirect investment– Direct – buy security– Indirect – own a share in a company that buys

securities.

Property

• Difficult to buy and sell

• Real estate– Land, building

• Tangible personal property– Gold, collectibles

• Usually long term (longer than one year)

Steps in Investing

• Carefully developed plan to achieve specific financial goal.

• Must have living expenses, savings for emergency before investing.

• Goal of investing:– Example in 3 years accumulate down

payment for a house.

• Selecting investments

Portfolio

• Collection of investments assembled to meet goals.

• Diversification– Limit risk and maximize returns

• Managing portfolio– Selling, buying, rebalancing– Short tem CDs, money market, T-bills– Fixed income securities such as bonds and

preferred stocks.

Stocks

• Common stock– Represents ownership in a corporation– May yield dividends– Capital gain

• Preferred stock– Ownership in a corporation with a stated dividend

rate. (preference over common stock).– Convertible securities. Bond or preferred stock that

may be converted to a specified number of shares of common stock.

Options

• Provide investor with an opportunity to sell or buy an underlying security at a specified price within a given period of time.

• Good in a volatile market.

• Call is an option to buy

• Put is an option to sell.

Mutual Funds

• Professionally managed diversified portfolio of securities.

Real Estate

• Commercial

• Residential

IRA, SEP-IRA, ROTH-IRA & 401/403K

• Tax sheltered

• Pay tax up front and let it earn taxfree

• Don’t pay tax up front, let earn, pay taxes when your income is low.

Investment Markets

• IPO – initial public offering– sell directly as in case of Google– Sell through an investment banker (Goldman

Sachs or Solomon brothers)• Buy stocks at a fixed price (discount price) and

take risk of selling it (this is called underwriting).

• Secondary market– After the initial offering, stock may be traded

at secondary markets.

Secondary markets

• Organized Securities and Exchanges– New York Stock Exchange NYSE – American Stock Exchange AMEX– Nasdaq (National association of securities dealers

automated quotation) used to be main OTC.– Options exchanges– Futures Exchanges

• Over the counter market– Sold over telecommunication network. Unlisted

securities.• Foreign Securities Markets (ADR – american

depositary receipts)

Things to Know

• Insider trading• Bull market• Bear market• Market crash• Types of account

– Single or joint, cash or margin

• Types of orders– Market or limit– Stop loss order

In declining market

• Short selling

• Investors sell stocks they don’t have (borrowed selling) – borrowed from broker.

• Must be purchased eventually

Practical Investment guide

• Making a budget

• Savings

• Real Estate– Home– Rentals

• Stocks

• Bonds

Making a budget(live within your means)

• Budget is a plan• Must be realistic• Must be mutually agreed upon (if married)• Must adhere to it as much as possible

– Goal is to remain under budget in spending– And over budget in income

• My advice: borrowing money is bad.– Using credit card is even worse – if you do not

pay off entire amount each month.

Savings

• The best time to save is when you get your first real job. Do not raise your standard of living immediately; instead save.

• Minimum savings:– Enough to live for 3 to 6 months if you lost

your job.– Enough to pay for a down payment on a

house and a car.

Savings in buying

• Don’t buy anything unless you have daily or periodic use for it.

• Don’t be an impulsive buyer. Buy items on your buy list.

• Find different devices that will do the same job, you may be able to save as much as 80% or more.

• As much as possible, buy things that are on sale without sacrificing quality (moldy bread at deep discount is useless!)

Real estate

• First investment should be a place to live.

• Renting vs. buying (show calculation)

• Only time borrowing is allowed (my opinion)– You are paying with cheaper money while

your home is appreciating.– Government is subsidizing your interest.

Real Estate Investments

• Positives– Appreciation– Tenants pay your loans

• Negatives– May have negative cash flow– May be vacant– Not liquid

Land vs. income producing

• Land in the right location will bring profits many fold.

• Must pay (in my opinion) cash – no loans.

• Income producing – you can borrow.

• You need to do most of the repair & maintenance work.

Stocks

Bonds