Investment Fundamentals and Retirement Planning Flashcards

Time Value of Money (Future Value of an Annuity)

• Investing $6000$ each year for 20 years at an 8% return results in $274,572.
• Investing $6000$ each year for 40 years at an 8% return results in $1,554,342$.
• Investing 6000$each year for 20 years at a 4$$178,668.
• Length of time of the investment matters.
• Rate of return of the investment matters.

Financial Checkup

• Before starting an investment program, perform a financial checkup.
• Elements of a financial checkup:
  • Pay bills on time.
  • Balance the budget.
  • Manage credit card debt.
  • Start an emergency fund.
  • Have access to cash for emergencies.
• Emergency funds should be in a “liquid” account to earn interest and be easily accessible.
  • Liquidity: The ease and speed with which an asset can be converted to cash without affecting its value.
    • Liquid investments: stocks, bonds, mutual funds, cash, money in bank accounts.
    • Non-liquid investments: cars/vehicles, real estate, retirement savings accounts.

Saving vs. Investing

• Saving: Gradually putting money away over time.
• Investing: Putting a sum of money into an item with the expectation that it will grow over time.

Obtaining Investment Funds

• Ideas to obtain money for investment:
  • Create a budget and save.
  • Establish a side source of income.
  • Sell unused items.

Risk-Return Tradeoff

• Low risk is associated with low potential returns, while high risk is associated with high potential returns.
• Historically:
  • S&P 500 stocks: ~9% annual return.
  • Bonds: ~5% annual return.
  • Bank accounts: ~1% annual interest.
• Rule of 72 (years to double):
  • Stocks: 72 / 9 = 8 years.
  • Bonds: 72 / 5 = 14.4 years.
  • Bank Account: 72 / 1 = 72 years.
  • Years\,to\,Double = \frac{72}{Interest\,Rate}
• Investors take on risk for the potential of higher returns.

Investing Steps

• Basic steps to begin investing:
  1. Set up an investment account.
  2. Set up automatic payments.
  3. Select investments to be purchased.

Yearly Rate of Return Calculation

• Formula: \frac{change\,in\,investment + annual\,income}{original\,investment's\,value}
• Example: Shelly buys $1,000$of stocks, earns$$50$in dividends, and sells the stock for$$1,070$. Yearly return:$\frac{1070-1000+50}{1000}
• Yearly return as a percent: 12%

Asset Allocation and Diversification

• When building an investment plan, consider:
  • Liquidity.
  • Level of risk.
  • Expected rate of return.
  • Volatility.
• Individuals can invest more heavily in stocks if they are investing for the long-term.
• Older individuals typically have a lower tolerance for risk.
• Many financial planners recommend subtracting your age from 100 to get the % of your assets that can be invested in growth investments.
• Diversification provides safety and reduces overall risk.

Equity Financing

• Companies issue stock to raise money, which is called equity financing.
• Individuals that make an investment to become part owners of a company are called stockholders.
• A company that earns a yearly profit must pay out a dividend: NOT ALWAYS
• When shareholder owns stock in XYZ corporation and decides to sell it, they typically sell it directly back to the XYZ corporation: FALSE
• Asset Allocation: Spreading your assets among several different types of investments.
• Diversification: Putting your assets in different investments.
• Portfolio: All of someone’s investments.

Investment Alternatives

• Investment Alternatives: Derivatives, Digital assets, Precious metals, Collectibles, Commodities, Real estate, Private equity

Stocks

• People buy stocks for income through dividends and potential for capital appreciation (stock price increases).

Bonds

• When someone buys a BOND, they are loaning a corporation or government money.
• The bondholder will earn the stated interest rate until the bond matures.
• The bondholder can keep the bond until its maturity date and then redeem it or they can sell it to another investor before maturity.
• Bonds can be purchased through a broker.

Mutual Funds

• A mutual fund pools money from many investors to purchase various stocks, bonds, and other assets.
• A mutual fund may hold hundreds of different stocks and/or bonds, with the goal of reducing risk by being diversified.
• A major concern for investors who select mutual funds are fees as these fees reduce investment return.
• It is possible for an investor to hold a variety of individual stocks and hold a diversified portfolio.

Real Estate

• Over many years, the nationwide the average annual increase in real estate is 3-5%.
• Investing in real estate should be considered a long-term investment, not a get-rich-quick scheme.

Dividends

• A dividend is a distribution of corporate profits paid out to shareholders.

Investing vs. Gambling:

• Investing and gambling both involve risk.
• Investing in the stock market has a positive expected rate of return.
• Gambling has a positive expected rate of return: FALSE
• The House, when gambling, always has the edge.
• A gambler owns nothing.
• A stockholder owns a share of the company.
• Over time, the odds are in the favor of an investor but not for a gambler.

Speculative Investment

• A speculative investment is high-risk, made hoping for a large profit in a short time.
• Examples: Options, Commodities, Derivatives, Bitcoin & other cryptocurrencies, precious metals & gemstones, antiques, collectables.

Sources of Investment Information

• Sources include: News programs, business periodicals, newspapers, corporate reports, investor services, newsletters.

Prospectus

• A prospectus is a written document required by the SEC that provides details about a new offering of securities.

Equity Financing

• Money received from the sale of shares of ownership in a business
• Stockholders can earn profit from is a distribution of cash quarterly/yearly or by an increase in stock price.
• Since the end of WWII, stocks have returned almost 10 % a year.

Stock Results

• Past stock results guarantee future earnings: FALSE
• Stocks are risky, and therefore there are no guarantees.
• Stockholders vote on the company’s board of directors and major corporate policies.
• Long-term investments (held more than 1 year) are typically taxed at a lower rate than short-term investments.
• Public companies must report earnings quarterly.
• Wall Street watches revenue and earnings data carefully and stock prices change based on this data
• A more speculative stock will have a Beta greater than 1.
• The Beta for the S&P 500 is 1.
• The price of a stock reflects the current value of company and what investors believe the expected growth of that company will be.
• Based on the Rule of 72, how long would it take for a stock investment earning the above return to double in value? 7.2 years
• Short-term investments (held less than 1 year) are taxed as ordinary income rates.

Stock Split

• Stock Split: Company divides its existing shares into multiple new shares
• Does a stock split guarantee that the stock’s price will increase? No, not always

Corporate Earnings Impact

• Corporate earnings impact stock prices because they significantly impact the companies overall value.
• Earnings per Share (EPS) – measure of a company's profitability
• Price to Earnings (P-E Ratio) net income/number of outstanding shares
• Beta measures systematic risk of investment

Initial Public Offering (IPO)

• An Initial Public Offering (IPO) is when a private company first sells shares of stock to the public.

Secondary Market

• The majority of stock trading is done in the secondary market.
• Secondary markets include the New York Stock Exchange (the Big Board), NASDAQ and AMEX.
• You can purchase Common and preferred stocks of public companies (e.g., Apple, Tesla, Microsoft), ETF's, Corporate bonds, mutual funds, government securities on the Secondary market

Ticker Symbol

• A ticker symbol is a unique series of letters assigned to a publicly traded company's stock
• Kroger's: KR

Brokerage Firms

• Full service Brokers include Examples include: Merrill Lynch, Edward Jones, Morgan Stanley
  • Advantages: investment expertise, advice, and services in exchange for commissions and fees.
  • Disadvantages: higher fees, which generally run from 1% to 2% of assets managed per year
• Discount Broker Examples include: Vanguard, TD Ameritrade, Fidelity
  • Advantages: sometimes offer free educational and research tools to help you with your investment decisions.
  • Disadvantages: you decide for yourself what your overall investment strategy should be
• Make sure you address the fees charged by both types of Brokers.

Investment Strategies

• Buy and Hold Technique: Purchasing stock and hold onto it for many years, this helps it increase in value
• Dollar Cost Averaging: Purchasing an equal dollar amount of the same stock at equal intervals, helps to avoid buying high and selling low
• Day Trading: buying a stock and then selling a stock in a short period of time, it can be close to gambling because you can always predict the market
  • considered similar to gambling because you can always predict the market

Market Cycles

• Typically, when the stock market takes a dive, an investor should stay in the market especially if they are in the market long-term.
• The market is cyclical and stock prices will go up and down.
• An investor’s risk tolerance level should be utilized when selecting the right investments for that individual.
• It is wise to think long term, instead of panic selling when the stock prices drop.
• The buy and hold strategy is recommended even during market declines.
• Historically bonds earn a lower average rate of return compared to stocks due to lower risk.

Buying on the Margin

• When someone borrows money from their broker to purchase stock it is called buying on the margin. This means if the share price decreases, they will have to provide additional cash as collateral.

Bonds

• A bond is essentially a loan an investor makes to a borrower, like a company or government, in exchange for a promise to repay the principal amount
• Assuming an average yearly return of 4% on bonds, how long would it take for the investment to double in value (use Rule of 72)? 18
• What is the Call feature? feature allowing a corporation to call in, or buy outstanding bonds from current bondholders before the maturity date
• What is Face Value? dollar amount the bondholder will receive at the bonds maturity

Bonds Characteristics

• Bonds earn a set interest rate and it is paid according to a predetermined schedule
• A Bear Market (when the overall stock market declines) reminds investors the virtues of bonds safety and stability.
• Bonds can especially be appropriate for those who cannot tolerate the short-term volatility of the stock market (i.e., someone who needs the money in a few years).
• Bonds can be purchased through a broker (for a fee) or directly from the government.
• The price of bond will be constant until its maturity date: FALSE

Mutual Funds

• It is important to know the objective of a particular mutual fund before purchasing because the objectives can vary.
• A Mutual Fund pools investors money together and purchases a variety of securities, which can change
• What types of underlying assets can a Mutual Fund hold? Stocks, bonds, money market instruments, sometimes derivatives.
• Does a Mutual Fund typically provide some level of diversification to an investor? Yes, because it will put your money into various different sources
• Does past performance of Mutual Fund guarantee future returns? No
• Actively Managed Mutual Fund: Mutual funds that is actively managed by a professional fund manager
• Index Fund: An investment fund that aims to replicate the performance of a specific market index
• Exchange-traded Fund (ETF): A basket of investments made up of assets such as stocks or bonds, which allow you to invest in many securities all at once

Underlying Assets

• What types of underlying assets can an ETF, an Actively Managed Mutual Fund and an Index Fund hold? stocks, bonds, commodities, currencies, and derivatives

Expense Ratios

• What are the average Expense Ratios associated with an ETF, an Actively Managed Mutual Fund and an Index Fund? Less than .3%

Life-Cycle Fund

• What is a Life-Cycle Fund (also called a Targeted Date Fund)? Is a Life-Cycle Fund considered diversified and why? How does the asset mix of a Life-Cycle Fund change over time?
• type of mutual fund that automatically adjusts its asset allocation over time to become more conservative as the target retirement date approaches
• Yes, it is a type of mutual funds
• Any of the different types of mutual funds (including a Life Cycle fund) can be offered and held within an individual’s own Retirement account (401(k) and 403(b) accounts).

Investment Expenses

• Management Fee Fee is a % of the asset value. Managed funds may charge 1.5% per year.
• Front-end Load fee Investors pay a commission (sales charge) every time they purchase shares. Average load charge is 3 to 5%
• Back-end Load fee Investors pay a commission (sales charge) every time they sell shares. Average load charge is 3 to 5%
• Expense Ratio Consists of the different management fees, 12b-1 fees (if any), and additional operating costs for a specific mutual fund (does not include Front or Back End Fees)
• Does the expense ratio that investors are charged matter much? Yes, because even if its small at one time, over time the cost will add up

Mutual Fund Returns

• If a mutual fund earns a return of 8.5% and has an expense ratio of 1.5% per year, the investor really earns 7% return on their investments.
• What is the Future Value of an investment of $4000$annually (an annuity) at 7$$59,896
• If a mutual fund earns a return of 8.5% and has an expense ratio of .5% per year, the investor really earns 8 % return on their investments.

Investment Decisions

• Index funds seek to earn the Market Average Returns.
• Actively managed funds tend to have lower fees than Index Funds and ETFs: FALSE
• History shows that it is extremely difficult for an Actively Managed Mutual Fund to beat the Indexes over time.
• Actively managed mutual funds attempt to beat the market but are rarely successful.
• Higher fees that actively managed funds charge significantly reduce long-term returns.
• For most investors, Index Funds and EFTs are a better choice than Actively Managed Funds.
• You can solely depend on Social Security and your Pension to cover your expenses while in retired: FALSE.
• What is the Future Value of an investment of $4000 annually (an annuity) at 8% return for 40 years? $$$86,900
• Note: All investors should know how their Investor Advisor/Broker/Account Manager WILL BE PAID. Every investor needs to know which fees they will pay directly or indirectly. Ask lots of questions until the information is clear!

Retirement Savings

• According to the Retirement Planning video in eLearn, when should you start saving for retirement and why? Why does everyone need to save for retirement?
  • When people retire, they will live 16-30 years after retirement, pension will not be enough, during retirement prices will increase, sooner you start more time you have to compounds
• Social Security typically replaces 40 % of the average worker’s preretirement earnings.
• Social Security benefits increase by 8 % for each month past the age of 65 that an individual delays collecting Social Security benefits but only up to the age of 70.

Defined Benefit Plan

• What is an employer sponsored Defined Benefit Plan?
• Employer pays a prior employee a set amount of money per month (a pension) when the individual retires.
• What factors contribute to how much an individual receives on a monthly basis with a Defined Benefit plan?
  • Length of employment and salary history

Retirement Savings Accounts

Defined Contribution Plan

• What is an employer sponsored Defined-Contribution Plan?
  • Employer sponsored plan with an individual account for each plan participant
• What are some examples of defined-contribution plans?
  • 401(k) plan – for most employees
  • 403(b) plan – for education and some non-profit employees
  • 457 or TSP – for government employees

401(k) Plans

• Employers frequently match a portion of an employee’s contribution to a 401(k) plan.
• The employee has no say in the underlying investments in their 401(k) account: FALSE
• The employee typically can select various asset classes (managed mutual funds, index funds, targeted date retirement funds, bonds funds etc) where the money in their 401(k) is invested.
• Individuals who have a Defined Contribution Plan should be aware of the fees they are incurring.
• If an individual changes jobs and withdrawals the money they have in their 401(k) plan, they frequently must pay taxes on the withdrawal and pay significant penalties: TRUE. Therefore, a better option is to leave to funds in the old employer’s plan or to roll it over into the new employer’s plan or to an IRA
• Individuals regardless of income can make yearly contributions to an IRA account.
• The IRS limits how much can be deposited yearly in any type of IRA, adjusting the amount periodically.
• What factors contribute to how much an individual has in their 401(k) account when they retire?
  • How much they contribute, how long their investments have been compounding

IRA Account

• List some of the features of an IRA account. tax advantages, investment flexibility, and potential for long-term growth, Many IRAs do not charge commissions or transfer fees.
• Yearly contributions to which type of IRA are typically tax deductible? Traditional IRA's
• Withdraws from which type of IRA are typically taxable? Traditional IRA

The 4% Rule

• The first year, individuals can withdraw 4% of their total investment balance. In following year, they can withdraw the same 4% plus the inflation rate

Retirement Saving Tips

• Summarize the four steps that Clark Howard advises in his article on Retirement Saving.
  • Live on less money than you make, if possible avoid all debt
  • be a saver before you become an investor, you can potentially loose money you invest so have a solid amount of savings in case you were to need to fall back on them
  • make investing for retirement your priority, put any extra budget money into retirement
  • enroll in your companies retirement plan, take advantage of any plans available

Asset Allocation

• Asset Allocation refers to the mix of stocks, bonds and cash an investor holds.
• Someone can typically invest more heavily in stocks if they are younger.
• Someone can typically invest more heavily in stocks when they are investing for the long-term.
• Someone can invest more heavily in stocks if they have a low tolerance for risk: FALSE
• An investor holding one stock and one bond might have a diversified portfolio: FALSE
• Typically, is recommended that individuals save at 10-15% of their income for retirement.
• If an individual initially cannot save 10% of their income, they should save a smaller percent of their pay and then each year increase the percentage saved by a small amount.
• Having automatically deposits to a retirement account each pay period, increases the chance of success.
• Asset Allocation will change over an investor’s lifetime.
• As someone gets closer to retirement, it is typically recommended that the investor decrease the amount of stock held.

Financial Advisor vs. Fiduciary

• What standard does a Financial Advisor operate under?
  • advisers need to place trades under a "best execution" standard
• A financial advisor is typically paid a % of the portfolio balance (a management or advisor fee). Some financial advisors earn commissions on the investments they recommend. This may influence which investments they recommend to their clients. In addition, if an investor works with a financial advisor and purchases a mutual fund, the investor typically pays both an Advisor Fee and the Expense Ratio associated with the fund.
• What standard does a Fiduciary operate under?
  • a fiduciary standard that is regulated by the Securities and Exchange Commission (SEC) or state securities regulators
• A fiduciary typically is paid by the hour.

Asset Allocation & Investment Goals

• An individual’s purchase of bonds will be impacted by their desired asset allocation and diversification.
• List some key tips regarding Investing for Retirement
  • start savings early, to give your money more time to compound
  • contribute regularly, or as regularly as possible, if possible set up regular payments
  • To make a Will legally binding, an individual should have two witnesses (who are not listed as beneficiaries) and it is advisable to get it notarized by a notary public.
  • Max out your employers retirement plans
  • diversify your accounts as much as possible
  • be aware of possible fees/be aware of inflation

Estate Planning

• Why is Estate Planning important?
  • So that the items you own will go to the people and places that you want them to go after you die
• What is a Last Will and who needs one?
  • legal document that outlines how your property and assets should be distributed after your death.What are the responsibilities of the Executor?
• Anyone with assets should have a will, as well as anyone with children
• Why is it important to designate a Guardian for minor children?
  • So that they are being taken care of according to who you want them to be with, that they'll be safe
• What is a Living Will and why is it important to have one?
  • Provides for your wishes if you become physically or mentally disabled, it's important because it will help delegate your assets if your no longer able to do it
• What is a Durable Power of Attorney?
  • also known as health care proxy, If you are unable to make decisions regarding your health care, this authorizes someone to do it for you
• What are the responsibilities of someone designated as the Health Care Power of Attorney?
  • Overall, making medical care decisions, choosing health care providers, following the rules and instructions of the principal
• It is helpful to have an organized file that includes all important financial documents and information for your loved ones.
• Why is it important to have a Health Care Power of Attorney designated?
  • Just in case your no longer able to care for yourself in the future
• What is a Trust?
• legal arrangement through which a trustee holds your assets for your benefit or that of your beneficiaries
• What is the benefit of having a Trust?
  • Trust remains private after death, unlike a will, reduces estate taxes, protects your assets