Personal Finance

FIN 235

* Investment FundamentalsChapter 13

*General Objectives

A. Reasons for Establishing Investment Plans/Programs

B. Funding investment programs

C. Understanding the relationships between; risk, return, liquidity, income, and growth

D. How to manage risk

E. Considering bonds as part of your portfolio1. Government

2. Corporate

F. How to evaluate bond investments

*Funding Investment Programs

A. Systematic savings plans1. Many start with a savings account

2. Regular weekly or monthly deposits

3. Regular payroll deductions

B. Participation in 401(k) plan at work1. Many employers make contributions or add based on employee

contribution.

2. Setting aside a small percentage of pay (3 to 5%)

C. The most important factors:1. Start early

2. Don’t use funds during accumulation period except for emergencies

3. Early withdrawals subject to penalties and taxes

*Establishing Investment Plans/Programs

A. Establishing Investment Goals

B. Performing a Financial Checkup1. Work to Balance Your Budget

2. Obtain Adequate Insurance Protection

3. Start an Emergency Fund

4. Have Access to Other Sources of Cash for Emergency Needs

C. Getting the Money Needed to Start an Investment Program1. Priority of Investment Goals

2. Employer-Sponsored Retirement Plans

D. The Value of Long-Term Investment Programs1. Financial Independence

2. Maintaining your lifestyle in retirement

*Understanding the Relationships

A. Safety and Risk; run in opposite directions

B. Components of the Risk Factor1. Inflation Risk (maintain purchasing power)

2. Interest Rate Risk (change in values as rates change)

3. Business Failure Risk (investment goes sour)

4. Market Risk (ups and downs of the market)

C. Investment Income (interest, dividends)

D. Investment Growth (capital gains)

E. Investment Liquidity (sell quickly and cheaply)

*Managing Risk

A. Portfolio Management and Asset Allocation1. Asset Allocation (stocks, bonds, international, cash)

2. The Time Factor (short or long term)

3. Your Age (get more risk averse as you get older)

B. Your Role in the Investment Process1. Evaluate Potential Investments

2. Monitor the Value of Your Investments

3. Keep Accurate Records

4. Do some research before you commit to a course of action

*Bonds as Part of Your Portfolio

A. Advantages1. Known payouts (interest payments, principal at maturity)

2. Risk a function of credit ratings (AAA – D)

B. Disadvantages1. Interest Rate risk

2. Default risk

3. Costly to trade (liquidity may be a problem)

C. Government Bonds1. No defaults

2. Lower rates

3. Semi-annual coupons

4. Municipal bond interest exempt from federal taxation

*Bonds as Part of Your Portfolio

D. Corporate Bonds1. Better yields

2. Increased chance of default (especially lower rated bonds)

3. Quarterly coupons

4. Secured and unsecured categories as well convertibles

E. Basic Bond Strategies (if trading)

1. If rates expected to rise, keep maturities short

2. If rates expected to fall, go long maturities

3. Inflation expectations is major factor in forming rates

*Evaluating Bond Investments

A. Returns: Stocks vs. Bonds1. Since 1926: Bonds average 5.6% per year, Stocks

10.4%

2. Over a 30 or 40 year investment period, the roughly 5% difference in returns can add up to s significant amount

3. Example: Invest $200 per month for 30 yearsa. Bond Portfolio = $186,198

b. Stock Portfolio = $492,554

4. Annuity Example: Payout the above accumulation for 25 years

a. Bond ($186,198); monthly check = $1,154.56

b. Stock ($492,554); monthly check = $4,615.47

*Concluding Comments

A. Bonds may be safer than stocks, but the returns are significantly lower.

B. Government Bonds are safer than Corporate Bonds but the returns are slightly lower.

C. Timing is important when adding bonds or bond funds to your portfolio.

1. Expectations about future inflation is a key decision criterion

2. Global economic conditions are also a factor.

Homework

A. Do The Math: 1, 4, 6

B. Be Your Own Personal Financial Planner1. 2 – Readiness to invest (w/s 49)

2. 4 – Your long-term investment strategy (w/s 51)