Chapter 13
Investing
Fundamentals
Chapter 13
Learning Objectives
 Describe why you should establish an investment
program
 Assess how safety, risk, income, growth and
liquidity affect your investment decisions
 Explain how asset allocation and different
investments alternatives affect your investment
plan
 Recognize the importance of your role in a
personal investment program
 Use various sources of financial information that
can reduce risks and increase investment returns
2
Preparing for an Investment Program
Objective 1: Describe why you should establish an
investment program
 ESTABLISHING INVESTMENT GOALS
-- accumulating retirement funds
-- enhancing current income
-- saving for major expenditures
-- sheltering income from taxes
3
Preparing for an Investment Program
Objective 1: Describe why you should establish an
investment program
ESTABLISHING INVESTMENT GOALS
 Financial goals should be specific and measurable. To
develop your goals ask yourself. . .
 What will you use the money for?
 How much will you need for your goals?
 How will you obtain the money?
 How long will it take you to obtain the money?
 How much risk are you willing to assume in an
investment program?
4
Preparing for an Investment Program
(continued)
 What possible economic or personal conditions
could alter your investment goals?
 Given your economic circumstances, are your
investment goals reasonable?
 Are you willing to make the sacrifices necessary to
meet your investment goals?
 What will the consequences be if you don’t reach
your investment goals?
5
Preparing for an Investment Program
(continued)
PERFORMING A FINANCIAL CHECKUP
 Work to balance your budget
 Do your regularly spend more than you make
 Pay off high interest credit card debt first
 Start an emergency fund you can access quickly
 Three to nine months of living expenses
 Have access to other sources of cash for emergencies
 Line of credit is a short-term loan approved before the
money is needed
 Cash advance on your credit card
6
Preparing for an Investment Program
(continued)
GETTING THE MONEY NEEDED TO START AN
INVESTMENT PROGRAM
 How badly do you want to achieve your investment goals
 Are you willing to sacrifice some purchases to provide
financing for your investments
 What do you value
 Participate in elective savings programs
 Payroll deduction or electronic transfer
 Make extra effort to save one or two months each year
 Take advantage of gifts, inheritances, and windfalls
7
Preparing for an Investment Program
(continued)
The value of long term investment program
 After graduation, you plan to invest $200 per month in
the stock market. If you earn 6% per year on your stocks,
how much will you have accumulated after 10 years?
 Use time value of money calculation:
pmt = 200, I = 6/12 = 0.5, n = 10*12 = 120 FV = ?
FV = $32,775
8
Preparing for an Investment Program
(continued)
The value of long term investment program
 After graduation, you plan to invest $400 per month in
the stock market. If you earn 6% per year on your stocks,
how much will you have accumulated after 15 years?
 Use time value of money calculation:
pmt = 400, I = 6/12 = 0.5, n = 15*12 = 180 FV = ?
FV = $116,327
9
Preparing for an Investment Program
(continued)
The value of long term investment program
 After graduation, you plan to invest $400 per month in
the stock market. If you earn 12% per year on your
stocks, how much will you have accumulated after 15
years?
 Use time value of money calculation:
pmt = 400, I = 12/12 = 1, n = 15*12 = 180 FV = ?
FV = $199,832
10
Preparing for an Investment Program
(continued)
The value of long term investment program
 After graduation, you plan to invest $400 per month in
the stock market. If you earn 12% per year on your
stocks, how much will you have accumulated when you
retire in 30 years?
 Use time value of money calculation:
pmt = 400, I = 12/12 = 1, n = 30*12 = 360
FV = ?
FV = $1,397,985
11
Preparing for an Investment Program
(continued)
Comparison:
$200, 6%, 10 years  32,775
$400, 6%, 15 years  116,327
$400, 12%, 15 years  199,832
$400, 12%, 30 years  1,397,985
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Factors Affecting the
Choice of Investments
Objective 2: Assess how safety, risk, income, growth,
and liquidity affect your investment decisions
 Safety and risk
 Safety in any investment means minimal risk of loss
 Risk means a measure of uncertainty about the
outcome
13
Factors Affecting the
Choice of Investments
Company A
Company B
0.5
0.2
0.45
0.18
0.4
0.16
0.35
0.14
0.3
0.12
0.25
0.1
0.2
0.08
0.15
0.06
0.1
0.04
0.05
0.02
0
0
4
8
12
-10
-5
0
5
10
15
20
25
30
14
Factors Affecting the Choice of Investments
 To get a general idea of a stock’s price variability, we could
look at the stock’s price range over the past year.
52 weeks
Yld
Vol
Net
Hi Lo Sym Div % PE 100s Hi Lo Close Chg
134 80 IBM .52 .5 21 143402 98 95 9549 -3
115 40 MSFT
…
29 558918 55
52
5194 -475
15
Factors Affecting the Choice of Investments
 Investments range from very safe to very risky
Annual Rates of Return 1926-2002
Standard Deviation
SmallStock
LargeStock
Long-term
Corp-bond
Long-term
Gov-bond
U.S. Tre-bill
33.2%
Real Average Return
13.8%
20.5
9.1
8.7
3.1
9.4
2.7
3.2
0.7
16
Factors Affecting the
Choice of Investments
 The potential return on any investment should be
directly related to the risk the investor assumes
 Speculative investments are high risk
 The Risk-Return Trade-Off
17
Factors Affecting the
Choice of Investments (continued)
18
Factors Affecting the
Choice of Investments (continued)
Calculate return on an investment
 Rate of return: income you receive on an investment over a
specific period of time divided by the original amount
invested
 Buy 1000 shares of Microsoft at $25, sell it at $30 a year later,
and you receive $1 dividend per share. What is the rate of
return for this investment?
 Capital gain: 1000 * (30-25) = $5,000
 Dividend: $1*1000 = $5,000
 Total income: 5000 + 5000 = $10,000
 Rate of return : 10,000 / (25* 1000) = 40%
19
Factors Affecting the
Choice of Investments (continued)
COMPONENTS OF THE RISK FACTOR
 Inflation risk - during periods of high inflation your
investment return may not keep pace with the inflation
rate
 Interest rate risk - you may invest in a bond at a 6%,
rates later go up to 8%; your bond price falls
 Business failure risk - bad management or products
affect stocks and corporate bonds and mutual funds that
invest in stock
 Market risk - prices fluctuate because of behaviors of
investors
 Global investment risk - changes in currency affect the
return on your investment
20
Factors Affecting the
Choice of Investments (continued)
INVESTMENT INCOME
 Safest investments – predictable income
 Savings accounts and certificates of deposit
 U.S. savings bonds
 United States treasury bills
 Higher potential income investments include…
 Municipal bonds
 Corporate bonds
 Preferred stocks and income common stocks
 Income mutual funds
 Real estate rental property
21
Factors Affecting the
Choice of Investments (continued)
INVESTMENT GROWTH
 Growth means investment will increase in value
 Common stock
 Growth companies pay little or no dividends, but
reinvest in the company
 Mutual funds, government and corporate bonds, and
real estate offer growth potential
 Gemstones and collectibles - more speculative
 INVESTMENT LIQUIDITY
 Ability to buy or sell an investment quickly without
substantially affecting the investment’s value; e.g. Real
estate is not a very liquid investment
22
Asset Allocation and Investment Alternatives
 Asset Allocation
 The process of placing your assets among several types of
investments which lessens your investment risk
 Types of assets
-- stocks of large corporations
-- stocks of medium-sized corporations
-- stocks of small companies
-- foreign stocks
-- bonds
-- cash
23
Asset Allocation and Investment Alternatives
(contined)
24
Asset Allocation and Investment Alternatives
(contined)
25
Asset Allocation and Investment Alternatives
(contined)
 Time Factor
 The longer that you are invested the better
your returns
 Your Age
 The type and style of your investments
should change with your age
26
27
Asset Allocation and Investment
Alternatives
Investment alternatives
Stock or equity financing
 Equity capital is provided by stockholders who buy
shares of a company’s stock.
 Stockholders are owners and share in the success of
the company.
 A corporation is not required to repay the money
obtained from the sale of stock.
 The corporation is under no legal obligation to pay
dividends to stockholders: they may instead retain all
or part of earnings.
28
Asset Allocation and Investment
Alternatives (continued)
CORPORATE AND GOVERNMENT BONDS
 A bond is a loan to a corporation, the federal
government, or a municipality
 Bondholders receive periodic interest payments,
and the principal is repaid at maturity (1-30 years)
 Bondholders can keep the bond until maturity or
sell it to another investor before maturity
29
Asset Allocation and Investment Alternatives
(continued)
 Mutual funds
 Investors’ money is pooled and invested by a
professional fund manager
 You buy shares in the fund
 Provides diversification to reduce risk
 Funds range from conservative to extremely speculative
 Match your needs with a fund’s objective
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Asset Allocation and Investment
Alternatives (continued)
REAL ESTATE
 The goal of a real estate investment is to buy a property and
sell it at a profit. Nationally, 3% appreciation in price a year is
average.
 Location, location, location is important.
 Before you buy real estate...
 Is the property priced competitively?
 What type, if any, of financing is available?
 How much are the taxes?
 What is the condition of the buildings and houses in the
immediate area?
 Why are the present owners selling?
 Could the property decrease in value?
31
Asset Allocation and Investment
Alternatives (continued)
OTHER SPECULATIVE INVESTMENTS
 Speculative investments
 A speculative investment is a high-risk investment
made in the hope of earning a relatively large profit in a
short time Typical speculative investments include:






Antiques and collectibles
Call and put options
Derivatives
Commodities
Coins and stamps
Precious metals and gemstones
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A Personal Plan for Investing
 Establish realistic goals
 Determine the amount of money needed to meet
your goals
 Specify the amount of money available to fund your
investments
 List different investments you want to evaluate
 Evaluate risk and potential return for each
 Reduce possible investments to a reasonable
number
 Choose at least two different investments
 Continue to evaluate your investment program
33
Factors that Reduce Investment Risk
Objective 4: Recognize the importance of your
role in a personal investment program
YOUR ROLE IN THE INVESTMENT PROCESS
 Evaluate potential investments
 Seek the assistance of a financial planner (see
Appendix at the back of the text)
 Monitor the value of your investments
 Keep accurate and current records
 Consider the tax consequences of selling your
investments
34
Sources of Investment Information
Objective 5: Use the various sources of financial
information that can reduce risks and increase the
investment returns
 The Internet
 A wealth of investment information is available
 View sites such as www.fool.com and




www.money.cnn.com
Newspapers and news programs
Business periodicals such as Smart Money and government
publications
Corporate Reports
Investor services and newsletters, such as ValueLine or
Morningstar and financial calculators
35