Investing 101
Part 1 : Creating a Diversified Portfolio
Part 2 : Investing in the Stock Market,
Indexing vs Active Management
By: Bruce McNutt
The Goal of the Personal Investor
 Your
goal is to manage a well
diversified portfolio through dollar cost
averaging that meets your risk
assessment needs through proper
asset allocation in each of the asset
classes.
Investing vs. Saving

Saving:
Holding onto the money you already have

Investing
Using your money to make more money
Investing

Successful Investing requires time and a
well thought out plan.

Successful investing requires a good
understanding of the financial markets and
investing strategy, unless you want to pay
someone else to do it for you.
How Investments Grow

Investments grow for two reasons, through a
process called compounding, and because you
add money to them.

“The most powerful force in the Universe is
Compounded Interest” Albert Einstein

Compounding means that not only does your
original investment grow, but the interest you
earn grows as well
This calculator is at www.moneychimp.com
A Word About Dollar Cost Averaging
When an investor puts a little bit in his
investment on a regular basis (i.e. every
paycheck) he is said to be Dollar Cost
Averaging.
 The idea is to but more shares when the
market is down and fewer shares when
the market is up

Why it’s so important to start early
https://flagship.vanguard.com/VGApp/hnw/planningeducation/retirement/PEdRetInvHow
MuchToSaveContent.jsp
The 3 Most Common Investments
 Cash
 Stocks
 Bonds
Other Common Investments
 Real
Estate
 Precious Metals
Cash

Cash refers to money you have in a bank
account, money market, or C.D. type of
investment.

These accounts are virtually guaranteed to pay
you the interest they promise.

They are considered very low risk, and usually
low reward
Bonds

When you purchase a bond, you are really
loaning money to either a government or
company and they are promising to pay
you back with interest

There are MANY types of bonds.
The Stock Market

When you buy a stock, you are buying a piece of
a company (a share) that someone else is
selling
OR

During an IPO (Initial Public Offering) you are
still buying shares, but now you are giving
money to the actual company.
Risk vs. Reward

Risk : Anything that can cause your
investment to go down in value

Reward : Your investment goes up in value
Risk vs. Reward

There is no such thing as reward without
risk in investing.

As a general rule, the higher the potential
reward, the greater the risk
Loan $20,000 to a friend to go drill for oil
 Put $20,000 in a C.D.

Relative
Potential
Relative
RiskReward
Potential
Risk
Reward
Lowest
Cash
Investment
Type
Bonds
Stocks
Mid
Highest
X
X
X
Potential Reward when Investing in
Cash

You will earn the percent the investment
guarantees.

These percentages usually run in the 1%5% Range
Types of Risks when Investing in
Cash

Inflation Risk : The rate of inflation may
outpace your rate of return

The Risk of the Unexpected:
Potential Reward when Investing in
Bonds

The long term rate of return on Bonds is in
the 6-7% range.
Types of Risks when Investing in
Bonds

Call Risk : The issuer of the bond decides to pay off in
full their obligation on their bonds

Credit Risk : The issuer of the bond fails to pay their
interest or principal (default)(The federal government has
never defaulted on a bond obligation)

Interest Rate Risk : changing interest rates cause bond
prices to change
Potential Reward when Investing in
Stocks

The historical long term rate of return on
Stocks is around 10%
Types of Risks when Investing in
Stocks

Market Risk : The Stock Market can (and will) go down
over certain time intervals

Investment Style Risk : The specific types of stocks you
invest in can (and will) go down

Manager Risk : the person you have picking your stocks
picks bad ones

Expense Risk : The fees you pay cut into your gains
The Million Dollar Question
How do you know how much
of my money to put in each
type of investment?
Asset Allocation

Your ASSET ALLOCATION is the answer
to your million dollar question.

Asset Allocation means what percent of
your money is invested in each type of
investment.
Ultra Conservative : 100% Cash
0% Bonds
0% Stocks
Ultra Aggressive :
0% Cash
0% Bonds
100% Stocks
What is your personal Asset
Allocation

Your asset allocation is based on your risk
tolerance, and there is no one size fits all
formula

Your risk tolerance is a function of…
 Your
age
 Your personal risk tolerance
 Your financial position
Marge:
24 years old.
 No family yet
 Has $100 per month to invest

Bill
45 years old
 Has 14 years until retirement
 Has $100 per month to invest and already
has $70,000 in his 403(b)(7)

Jane
62 years old
 Retiring next year
 Already has $200,000 in her 403(b)(7)
 Will rely on this money for retirement
income

The General Rule
You should have a number of months
worth of emergency money in cash.
 The younger you are, the greater
percentage of your money that should be
in stocks.
 The closer you get to needing your money
for daily living, the more that should be in
bonds and cash

A Balanced Portfolio

A balanced portfolio is one that is
adequately spread out within asset
classes according to your asset allocation
plan.
Asset Allocation Over Time

Most advisors recommend that as you
age, you want to adjust you asset
allocation to have less in stocks and more
in bonds over time.

That way, as you get closer to needing the
money, bad years in the market won’t
substantially deplete your nest egg
What you want in your Asset Allocation

You want Diversification

Diversification : your assets are spread out
within your asset allocation plan
Bad Plan on a 100,000 Portfolio
Stocks 40%
Bonds 40%
Cash 20%
Stocks: Microsoft $25,000 Wal-Mart $15,000
Bonds: Ford Motor Company Corporate
Bonds $40,000
Cash: A 6 month C.D. $20,000
A Better Plan for a $100,000 Portfolio
Stocks 40%
Stocks:
Bonds 40%
Cash 20%
Large Companies $25,000
Medium Companies $10,000
Small Companies $5,000
Bonds:
Government Bonds $15,000
Corporate Bonds $5,000
Cash: A 6 month C.D. $5,000
A 9 month C.D. $5,000
A 12 month C.D. $5,000 A 15 month C.D. $5,000
What to Avoid

You want to avoid having too high a
percentage of your money in any one
place at any one time.

Enron
What a Professional Financial Advisor Does
1.
2.
3.
Assess your risk tolerance
Set up a diversified portfolio
Manage your portfolio over time
Finding your own Asset Allocation

Go to almost any financial companies website
and search asset allocation.

Try Vanguard, Fidelity, T.Rowe Price and then
compare what each company says.

Google asset allocation, don’t do the ones you
have to pay for.
Summary of Part 1
Part 2:Investing in the Stock Market
A Short Course in the History of the
Stock Market
Mutual Funds

Purchasing shares of a mutual fund
means you are buying shares of many
companies at one time

Example of a Vanguard Fund

Why buy Mutual Funds as opposed to
buying individual stocks?
Diversify, Diversify, Diversify

The point of buying many companies is to
reduce risk, which of course reduces
potential gain, but it keeps risk at a
manageable level
The two main types of mutual funds

Index : An index is used to decide what stocks to
hold in your fund : S&P 500, Wilshire 5000,
Russell 2000, Dow Jones

Active : A fund manager, or a team of managers,
decides what stocks to hold in your fund

American Fund Managers
Fees and Expenses
Expense Ratio
 All Mutual Funds charge an expense ratio
 Some mutual funds charge 12b-1
(advertising) fees
 Some funds are load funds that have a
sales charge when you either buy or sell
fund shares

Lets Compare Two Funds

The Vanguard Small Cap Index Fund

The Trend-Star Small Cap Fund
The Prospectus
Fund Strategies
Active
Index Fund
Fund

The strategy of an index fund is to mimic a
particular index.

Vanguard 500 Fund
Who Manages the
Active
Index Fund
Fund
Fund

Nobody
Judging Performance
Costs and Fees
Active
Index Fund
Fund
Do Expenses Really Matter?
Assume you are going to invest
$25,000 in both the Vanguard
Small Cap Index Fund and the
TrendStar Small Cap Fund for the
next 25 years and the average
rate of return will be 8%.
David Serchuk and James M. Clash
June 5th, 2006 Forbes Magazine

There's a bracing logic to letting your money ride
on an S&P 500 index fund. The most celebrated
of them, the Vanguard 500 Index, has beaten
60% of all actively managed domestic stock
funds over the past ten years. Buying an index
fund means giving up on picking a smart money
manager. But this saves you money
management fees and also spares you the
worry that your manager will do much worse
than the averages.
My Recommendations for Learning
About Investing

Subscribe to Money Magazine (and read it).

Read Teach and Retire Rich by Dan Otter
available at the www.403bwise.com website

Read the business section every day, especially
the personal finance section

Find a friend to take the journey with you