Investments handout

INVESTMENTS

Objectives:- Understand reasons to save and invest- Understand Risk/Reward Tradeoff- Understand the difference between stocks

& bonds- See examples of low risk, medium risk, and

high risk investments

How are savings & investments related?

• Why is saving important?• What is the difference between saving and

investing?• Investing is a strategy to earn more on your

money than the rate of inflation.• Investments lead to wealth – the

accumulation of assets over time

Emergency Fund

• An emergency fund is money set aside for unplanned expenses.

• An emergency fund of $1,000 is a good first goal.• If you never let your checkbook balance go below

$1,000, that can be a $1,000 emergency fund.• You should work toward having 3 to 6 months

living expenses in an emergency fund.• Liquidity is a measure of how quickly an asset can

be turned into cash.• An emergency fund needs to be liquid.

Investments & Goals

• Short term goals– Emergency fund– Vacation fund

• Medium Term goals– Buying a car– College education– Wedding

• Long term goals– Babies ($475,680 birth to age 17)– House– retirement

Build Financial Security

• The ability to meet current and future needs while living comfortably

• Takes time to build

Retirement & Beyond

• Retirement is the period of time when you are not working but are able to meet expenses through other income sources such as:

• Employer-provided retirement plans• Social Security• Savings & investments

Start Early

Investing $1200/year for 20 years

Estate Planning

• An estate is all that a person owns (assets) minus their debts at the time of their death.

• Who should get this money?• If you don’t make a will before you have your

first baby, do it then.

Health Care Power of Directive

• If you are unable to make medical decisions for yourself, who do you want making them

• Important for anyone over 18 to have

Durable Power of Attorney

• A person who can sign for you, get money out of your account, pay bills for you, etc.

• Often used for elderly people who need assistance

• Sometimes recommended for students away at college

How is risk related to reward?

• The perfect investment:– The principal is completely safe– The rate of return is very high– The investment is liquid– You can invest quickly and easily– The costs of investing are low– The earnings and long term gains are tax-free

• The bad news: There is no perfect investment

How does your principal grow?

• You deposit more money• Interest is added to the principal – compounding

Return on Investment (ROI)

• The amount that the savings or investment grows is called the return.

• The Return on Investment (ROI) is a measurement of return expressed as a percentage.

• Example: – Investment Cost $500– Return: $18– ROI $18/$500 = 3.6%

Another Example

• Purchase an investment for $500.• Sell it a year later for $540• Sales Price – Money Invested x 100• Money Invested• 540-500 = 40 = .08 * 100 = 8%• 500 500

• Now do ROI worksheet

What types of risk do investors face?

• Inflation risk– If you purchase a 4 year investment at 1%, and inflation is 5%

per year, your money has lost value– Current CD Rates

• Industry risk – Ethanol is turning corn into fuel– Corn is more in demand so corn prices go up– Catfish farms feed corn to the fish, but their feed prices

skyrocketed.– Catfish farming industry devastated

• Political risk• Stock risk – individual companies rise and fall

Tax Advantages of Investing• Tax deferral – postponing taxes – IRAs, 401k’s, and 403b’s are retirement funds that are not

taxed until money is withdrawn.– When you are making less money because you are retired,

your tax rate will be lower.– Your interest and dividends accumulate faster if money is

not withdrawn for taxes

Tax Advantages of Investing

• Tax exemption – Series EE and Series I savings bonds are tax free if

they are used for education– Municipal bonds are tax exempt – More valuable for people in higher income

brackets– Rates are lower than corporate bonds because

these are tax exempt

Employer Sponsored Plans

• Some employers encourage you to save by matching part or all of your retirement savings.

• If your employer offers this, make every effort to take advantage of it.

• Employees sometimes must be vested to claim the employer share of this. Vesting often happens after 3 to 5 years of employment.

• If you leave the company before you retire, you can get a cash payout (and pay taxes) or roll it over to an IRA.

Investment Strategies

• Investment tracking – making investment choices by following the prices of stocks and other investments over time.

• Market timing – buying and selling stocks based on what the market is expected to do

• Dollar-cost averaging – investing the same amount of money on a regular basis such as monthly

How can you reduce investment risk?

• Build an investment portfolio that is diversified

• A stock is an ownership interest in a publicly held company

• A bond is a debt instrument issued by a corporation or government

• High and low risk• Some international eventually• Real estate

Consider the market

• A bull market exists when stock prices are steadily increasing

• A bear market exists when stock prices are steadily decreasing

Consider economic conditions

• Economic growth is a period of time when people are working (low unemployment rate), profits are good, wages are rising, and people are optimistic.– If you think a decline is coming, consider selling

• Economic decline is when the economy is slowing down, the market for investments is declining, and prices may be falling– Usually a good time to buy stock (if you have the

money)

Choices

LOW RISK SAVINGS OPTIONS &

INVESTMENTSLower Risks Mean Lower Rewards

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Savings & Checking Accounts

• Banks are FDIC insured. As long as the Federal government is operating, you will not lose your principal.

• Very liquid – quick and easy to get money out• Low returns– checking– savings

Money Market Accounts & Funds

• Offered by banks and brokerage firms• Very liquid• Offer higher rates of interest in exchange for larger

than normal deposits. Minimum balance might be $1000 or $5000.

• A money market fund is a type of mutual fund that invests in low risk securities such as U.S. Treasury bills. Not FDIC insured, but generally considered safe.

• Number of withdrawals per month is usually limited.

Certificates of Deposit

• Money set aside for a specific period of time at a fixed interest rate

• Higher interest rates than savings accounts or money markets, but less liquid

• FDIC insured – principal is very safe• If you redeem a CD early you pay an early

withdrawal penalty• A jumbo CD is for a large amount, usually

$100,000 or more, and pays higher interest

Life Insurance Savings Plans

• “Permanent” life insurance has a savings feature that gains in cash value.

• Low rates of return.• Illiquid • Not FDIC insured – if the insurance company

goes under, this disappears

Bonds

• A bond is a loan that a buyer makes to a bond issuer

• The face value is the amount the bondholder will be repaid on the maturity date.

• A discount bond is one that is sold for less than its face value. (interest rate is low)

• A premium bond is one that would be sold for more than face value. (interest rate is high)

Corporate Bonds

• Corporations issue these to raise money• Corporate bonds pay a coupon rate, which is the fixed

rate of interest that is paid semiannually for the life of a bond.

• At maturity, the bond can be redeemed for face value.• Offered for sale in multiples of $1,000 to $5,000.• Wide variety of terms– Short term: 1-2 years – Medium term: 3-10 years– Long term: >10 years

Corporate Bond Terms

• A callable bond has a clause that allows the issuer to repay the bond early. – If interest rates go down, the corporation will call

the bond and issue bonds at a lower rate.– Usually pays a higher interest rate because of the

additional risk.• A convertible bond can be exchanged for

shares of common stock at the option of the bondholder.

Corporate Bond Terms

• A zero coupon bond is a discount corporate bond that does not provide the typical semiannual interest payments.– Sold at a deep discount and grows in value over

time– Good for long term investments like a child’s

education or retirement

Bond Risks

• Some bonds have low risk, some have high risk• Standard & Poor’s and other organizations rate

bonds• Investment-grade bonds have high ratings (AAA,

AA, A, and BBB)• Speculative-grade bonds have low ratings (BB and

lower). Also called junk bonds• Which type of bond pays higher interest?• Corporate bonds are riskier than government

bonds and pay more.

Government Bonds and Securities

• Issued by the U.S. Treasury or by U.S. government agencies

• Low risk when held to maturity• Most are state and local tax free, so they are

a tax shelter – an investment that allows you to legally avoid or reduce income taxes.

Government Bonds and Securities - Examples

• Series EE Savings bonds– Interest added monthly and paid when redeemed– Interest is tax-free if used to pay for education– Can hold up to 30 years

• I Savings Bonds– Similar to Series EE but a combination of a fixed rate and a

variable rate adjusted annually based on inflation

• Treasury Bills “T-bills”– Sold in terms of 4 to 52 weeks– Sold at a discount from the face value. You might pay $980

for a bond and redeem it 4 weeks later for $1000.

Government Bonds and Securities - Examples

• Treasury Notes “T-notes”– Sold in terms of 2 to 10 years

• Treasury Bonds– 30 year terms– Interest rates usually higher because of the longer

terms

• Treasury Inflation-Protected Securities (TIPS)– Guaranteed to keep pace with the rate of inflation as

measured by the Consumer Price Index (CPI)– Terms of 5 to 30 years

State and Local Securities

• Municipal Bonds– Issued by states, counties, cities, and towns– Used to pay for roads, public buildings, etc.– Low risk – governments seldom go bankrupt– Most are exempt from Federal, state, and local

taxes– Good investments for people in high tax brackets

Annuities

• An annuity is a contract purchased from an insurance company that guarantees a series of regular monthly payments for a set time.– Often used to provide retirement income– Only as safe as the company you invest with– Sometimes tax deferred – pay taxes when you

collect the payments

MEDIUM RISK INVESTMENTS

Higher Risks Mean Higher Rewards

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Mutual Funds• A mutual fund is a professionally managed group of

investments bought using a pool of money from many investors.

• Contain stocks, bonds, and other investments, so they are diversified, which lowers risk

• Mutual funds are an example of indirect investing – you buy shares of the fund instead of individual stocks and bonds.

• Different funds have different strategies• Investors can do asset allocation – choosing a combination

of funds within a single mutual fund company. For example:

Mutual Fund Type Description

Balanced funds Diversified portfolio that includes low, medium, and high risk stocks, with a balance between growth and income

Bond funds Invest in a variety of bonds

Global funds Invest in international companiesGrowth funds Invest in companies that are expected to grow over the

long run. Often high-risk in the short run

Income funds Invest in bonds and stocks that produce steady and reliable dividends and interest payments

Index funds Invest in entire market (lots of stocks or lots of bonds) Vanguard Stock Index Fund

Money market funds Invest in short-term securities that go up or down with current interest rates and the economy

New venture funds Invest in new and emerging businesses and industries. High risk, high return choices

Precious metal funds Invest in companies that are associated with precious metals such as gold, silver, and platinum

Stock funds Invest primarily in stocks. Can be categorized into types of stocks – blue chips, technology, medical, etc.

Personal Residence

• Possibly the best investment you will ever make

• Usually takes several years to make a profit• Good tax shelter. The first $250,000 of profit

is tax exempt when you sell your house (or $500,000 for a married couple)

• Anything over that is subject to capital gains tax

Individual Retirement Accounts

• An IRA (Individual Retirement Account) allows individuals to deposit money into an account during their working years for withdrawal when they are retired.

• Managed by the investor• Maximum contribution in 2016 is $5,500

Types of IRAs

• Traditional– Tax deferred – You can deduct the amount you deposit if your adjusted

gross income is below $117,000 (or $184,000 if married filing jointly)

– you must begin withdrawals by age 70 ½ • Roth– Contributions are taxed but earnings are not

• Spousal– Set up by a working spouse for a spouse who has no income– Can be traditional or Roth

SEP Accounts

• SEP (Simplified employee pension) plan is a tax-deferred retirement plan for small business owners and their employees.

• Similar to an IRA• The amount of money that can be set aside is

higher than for an IRA• The employer sets up a SEP IRA for each

employee and contributes to it• Each employee chooses how to invest their own

money

Keogh Accounts

• A Keogh account is a tax-deferred retirement plan for self-employed professionals

• Similar to a SEP but more complex to establish

• Up to $195,000 per year can be contributed• Often used by higher-income business

professionals such as doctors and lawyers

Retirement Plans Through Employers

• A defined-contribution plan is an employer-sponsored retirement plan in which employees can receive a periodic or lump-sum payment for retirement.

• Employees are not promised a specific amount – it will depend on how much they put in and how their investments did.

• Employees invest part of their salaries.

Types of Defined-Contribution Plans

• 401(k)– Used by employees of for-profit companies– Sometimes employers match part or all of

employee contributions. (If they do, definitely participate!)

• 403(b)– Used by employees of government and nonprofit

organizations– Never matched by employers

Defined Benefit Plans

• A defined-benefit plan is an employer-sponsored retirement plan in which retired workers receive a set monthly or lump sum payment based on their wages earned and number of years of service.

• Also known as a pension• Disappearing because if the economy goes bad

or the company is doing poorly, it is very difficult for them to make the payments (General Motors, for example)

Portability

• Most retirement accounts are portable – you can take the account with you when you leave a job.

• A rollover is the process of moving a retirement account balance to another qualified account without incurring a tax penalty.

Peer to Peer Lending

• In $25 increments loan money to individuals over the Internet

• You get to see their credit scores and you earn more interest for loaning to people with lower credit scores

• Lendingclub.com is one website that does this

HIGH RISK INVESTMENTS

Higher Risks Mean Higher Rewards

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Direct Investing

• Direct investing is buying stocks and other investments directly from companies

• When you buy stock in a corporation, you become a stockholder. Stockholders own the company.

• Stockholders hope to make money by:– Dividends, usually paid 4 times a year– Growth - Selling stock for more than they purchased

it for

Stock Terms

• Stocks are considered risky because an individual company can fail.

• Stocks are considered long-term investments.• Stocks are purchased through stockbrokers.• Stock brokers have accounts at stock

exchanges such as the New York Stock Exchange (NYSE) and the over-the-counter market (NASDAQ)

Stock Terms

• Many companies have 2 kinds of stock:• Common stock pays variable dividends and

gives owners voting rights.• Preferred stock guarantees a fixed dividend

but does not provide voting rights. Generally more expensive than common stock.

Futures Contracts & Commodities

• A futures contract is an agreement to buy or sell a specific commodity at a set price on a set date in the future.

• A commodity is an item that has the same value across the market with little or no difference in quality among producers.– Soybeans, silver, cattle, coffee, pork bellies

• Futures contracts are used to hedge, or reduce the likelihood of losing money in the future.

Investment Clubs

• An investment club is a group of people who pool their money together to buy and sell investments.

Business Ownership

• Starting a business– Sometimes the goal is an initial public offering (IPO)

• Buying a business– A franchise is one way of doing this

• Investing in a business venture– Venture capitalists use their own money to help new

businesses get started, and often offer advice too. In return, they own part of the company

– A business owner who invests but lets others make the decisions is a silent partner.

Other High-Risk Choices

• Real Estate– Land– Real Estate Investment Trusts (REIT) – a

corporation that pools the money of many individuals to invest in real estate.

– Rental property• Collectibles• Precious metals and gems