Investing Fundamentals - Notes

Establishing Investment Goals

• Investment goals should be written, specific, and measurable.
• Considerations for setting goals:
  • Amount of money needed.
  • Time to obtain the money.
  • Risk tolerance.
  • Potential economic or personal changes.
  • Willingness to make sacrifices.
  • Consequences of not reaching goals.
  • Reasonableness of goals.

Performing a Financial Checkup

• Balance your budget by avoiding overspending.
• Manage credit card debt and avoid cash advances.
• Start an emergency fund with 3-6 months of living expenses.
• Have access to other sources of cash like a line of credit.

Economic Factors

• Economics affects personal finances.
• Government actions and the business cycle influence investment values.

Managing Money

• Establish a larger than usual emergency fund.
• Know what you owe.
• Reduce spending.
• Notify creditors if unable to make payments.
• Monitor investments and retirement accounts.

Time Value of Money

• Small sums invested over time can grow significantly.
• Rate of return matters.
• Seek tax-postponing investments like IRA or 401(k) accounts.

Factors Affecting Investment Choices

• Safety: Minimal risk of loss.
• Risk: Uncertainty about the outcome.
• Speculative investment: High-risk, hoping for large profit in short time.

Risk-Return Trade-Off

• Higher risk investments should offer higher potential returns.
• Rate \, of \, Return = \frac{(Increase \, or \, decrease \, in \, value + Annual \, income)}{Original \, investment}
• Example:
  • Invest \$6,400 in Proctor & Gamble stock.
  • Receive \$40 in dividends.
  • Stock value increases to \$6,950 at year-end.
  • Rate \, of \, return = \frac{(\$550 + \$40)}{\$6,400} = 9.2\%

Components of Risk

• Inflation Risk: Investment returns may not keep pace with inflation.
• Interest Rate Risk: Fixed-rate investment value decreases when interest rates rise.
• Business Failure Risk: Affects stocks, corporate bonds, and related mutual funds.
• Market Risk: Price fluctuations due to systematic/unsystematic risk and investor behavior.
• Global Investment Risk: Important for diversification.

Investment Income

• Safest investments: Savings accounts, CDs, U.S. government securities.
• Higher potential income: Municipal bonds, corporate bonds, preferred stocks, select common stocks, mutual funds, real estate.

Investment Growth and Liquidity

• Growth: Investment will increase in value (e.g., common stock, growth mutual funds, real estate).
• Liquidity: Ability to sell an investment quickly without affecting its value (e.g., real estate is not very liquid).

Asset Allocation and Diversification

• Asset allocation: Spreading assets to lessen risk.
• Time factor: Longer investment horizon allows for potentially higher returns.
• Age: Investment types should change with age.

Investment Pyramid Levels

• Level 1: Financial Security (Cash, CDs, U.S. government bonds).
• Level 2: Safety and Income (U.S. securities, corporate and municipal bonds, income stocks).
• Level 3: Growth (Growth stocks, growth-oriented mutual funds, rental property).
• Level 4: Speculation (Speculative stocks, options, commodities).

Stock or Equity Financing

• Equity capital: Money from owners (stockholders).
• Stockholders: Owners who share in company success.
• Corporation: Not required to repay money from stock sales.
• Dividend: Distribution of money/stock to stockholders.
• Two stock types: Common and preferred.

Corporate and Government Bonds

• Corporate bond: Loan to a corporation.
• Government bond: Pledge to repay a sum with interest.
• Bondholders: Receive interest and principal at maturity.

Mutual Funds

• Pool money from many investors.
• Diversification to reduce risk.
• Funds range from conservative to speculative.
• Match fund objective to needs.
• Expense ratio: Management fees and operating costs.

Real Estate

• Potential for value increase, but no guarantees.
• Consider location, financing, taxes, repairs, and area conditions.

Other Investment Alternatives

• Speculative investments: High-risk, hoping for large profit.
• Examples: Options, commodities, derivatives, precious metals, collectibles.

Personal Plan for Investing

1. Establish investment goals.
2. Determine the amount of money needed.
3. Specify available funds.
4. List potential investments.
5. Evaluate risk and return.
6. Reduce the number of investments.
7. Choose at least two investments.
8. Continue to evaluate the program.

Factors to Evaluate for Investments

• Safety, risk, income, growth, liquidity.

Factors that Reduce Investment Risk

• Evaluate potential investments and monitor values.
• Keep accurate records.
• Choose financial planner wisely.
• Be aware of commissions.

Sources of Investment Information

• Internet (Yahoo!, Bing, Google).
• Newspapers and news programs.
• Business periodicals and government publications (The Wall Street Journal, Time, Newsweek, Kiplinger’s Personal Finance).
• Corporate reports.
• Investor services and newsletters (Value Line, Standard & Poor’s, Morningstar Investment Reports).