1.12.1.g1 introduction to investing financial literacy
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1.12.1.G1
Introduction to Investing
Financial Literacy
Saving and InvestingWe need to have enough money to
meet our needs and provide emergency funds
Once an appropriate amount of liquid assets are reached
Recommend refocusing goals from saving to investing
Remember: The
purpose of savings is to
develop financial security
What is Investing?• Purchase of assets with the goal of
increasing future income• Focuses on wealth accumulation• Appropriate for long-term goals
What are examples of long-term
goals that can be
accomplished by investing?
RiskPOTENTIAL
RETURNRISK
Risk- uncertainty regarding the outcome of a situation or event
Investment Risk- possibility that an investment will fail to pay the expected
return or fail to pay a return at all
All investment tools carry some level of risk
What is the risk level of savings
tools?
InflationInflation
Rise in the general level of prices
Inflation RiskThe danger that money won’t be worth as
much in the future as it is today
Inflation risk is usually not a concern with savings since the goal of savings is to provide current financial security
Strive to have the rate of return on
investment be higher than the rate of inflation
Types of Investment Tools
Stocks Bonds
Mutual Funds
Index Funds Real Estate
Speculative Investments
StocksStock Stockholder or shareholder
Usually a stockholder owns a very
small part of a company
A share of ownership in a company
Owner of the stock
Dividends Market Price
Return on Stocks
If stock is sold for a market price
higher than what was paid
Share of profits distributed in cash
to stockholders
Dividends may or may not be paid;
it depends on company profit
and policy
Current price that a buyer is willing to pay for stock
If stock is sold for a market price
lower than what was paid
Stockholder will receive a return
Stockholder will lose money
Definition
What is received?
Bonds
Form of lending to a company or the government
(city, state, or federal)
Annual interest is paid to investor
Once the maturity date is reached, the principal is
repaid to the bondholder
Bonds are less risky than stocks but
usually do not have the
potential to earn as high of
a return
Definition
Return
Advantage Disadvantage
Mutual FundsMutual fund- when a company combines the funds of many different investors and then invests that money in a diversified portfolio of stocks and bonds– Mutual funds
charge a fee for the administration of the fund, even if they lose money
Make sure to research the fees charged by a mutual
fund
Reduces investment
riskFees may be
highSaves
investors time
Index Fund
Index: Index Fund:
A mutual fund that invests in ALL the stocks and bonds that make up an index
A group of similar stocks and bonds such as the S & P 500, Dow Jones Industrial Average, and Nasdaq
Index Fund
What is the difference between a
mutual fund and an index
fund?
Advantage Disadvantage
High diversification
Usually charge lower fees than
mutual funds
Still charge fees
Real Estate
• Any residential or commercial property or land as well as the rights accompanying that land
• A family home is usually not considered an investment asset
• Can be risky and more time consuming but has potential for large returns
Examples of real estate
investments include rental
units and commercial
property
Speculative Investments
High risk investmentsHave the potential for significant fluctuations in return over a short
period of time
Futures Options Commercial Paper
Collectibles
Financial Risk Pyramid
Speculative Investment
ToolsIncreasing potential for
higher returns
Increasing risk
Savings ToolsChecking
AccountSavings Account
Money Market Deposit Account
Certificate of Deposit
Savings Bonds
Investment Tools
Bonds
Stocks
Mutual Funds
Real Estate
Options Collectibles
Futures
Commercial Paper
Index Funds
The risk level for specific investment tools may vary
Investment PhilosophyEveryone has a tolerance level for the
amount of risk they are willing to take on
Investment Philosophy- an individual’s general approach to investment riskThe greater
the risk a person is
willing to make on an
investment, the greater the
potential return will be
Generally divided into three categories: conservative, moderate, aggressive
Portfolio Diversification
Portfolio Diversification- reduces risk by spreading investment money among a
wide array of investment tools
Creates a collection of investments that will provide an acceptable return
with an acceptable exposure to risk
Assists with investment risk reduction
Referred to as “Building a Portfolio”
DISCOUNT BROKER (EXAMPLE: SCOTRADE)
Buying and Selling Investments
Brokerage firm acts as a buying and selling agent for an investor (except for real estate and
certain speculative investments)
FULL SERVICE GENERAL BROKERAGE FIRM (EXAMPLE: CHARLES SCHWAB)
Complete investment
transactions
Offer investment advice and one-on-one attention
from a broker
Only complete investment transactions
Offer no advice to investors but
charge 40-60% less
TaxationProfits earned on investments are unearned
income (not from working at a job)
Taxes are often owed on unearned income
Taxes are due on most investment returns in the year the unearned income is received, such as
interest earned on a savings account
Tax-Sheltered Investments
Government tries to encourage certain types of investments by making them tax-
sheltered, or protected from taxes
Tax-sheltered
investments are usually
not tax-free!
Tax-sheltered investments-
eliminate, reduce, defer, or adjust the current year
tax liability
• Retirement• Child/dependent care• Education expenses• Health care expenses
When are taxes for tax-sheltered investments usually paid?
Money is invested after taxes are paid
Example: Roth IRA
Money grows untaxed with help from compounding interest
Money is withdrawn at retirement but NOT EVER TAXED
Money is invested but not taxed at the time of investment
Examples: 401(k) and IRA
Money grows untaxed with help from compounding interest
Money is withdrawn at retirement and taxes are paid
There are often limits to the amount that can be invested
OR
What is the benefit of a tax-
sheltered investment if
taxes still have to be paid?
Difference in Ending Balance With Tax
Sheltering$100,000 investment for 36 years at 6%
Tax Sheltered:
Will double in value every 12 years (72/6 = 12)
Year 1: 100,000Year 12: 200,000Year 24: 400,000Year 36: 800,000
Not Tax Sheltered with 2% paid in taxes every year:
Will double in value every 18 years (72/4 = 18)
Year 1: 100,000Year 18: 200,000Year 36: 400,000
You end up with DOUBLE the ending amount of money!!
Types of Tax-Sheltered Investments
• 401(k):–employer sponsored, employer may
match employee contribution–Money invested is before taxes are
calculated, so you save on taxes NOW– Investment can grow tax free until
retirement–When funds are withdrawn, taxes are
paid
Types of Tax-Sheltered Investments
• IRA (Individual Retirement Account)–Anyone can have an IRA–Not connected to your job–Money invested is before tax– Investment can grow tax-free
until retirement–Taxes are paid when money is
withdrawn at retirement
Types of Tax-Sheltered Investments
• Roth IRA–Anyone can have a Roth IRA–Money invested is after taxes are paid– Investment can grow tax-free until
retirement–NO TAXES are paid on original
investment or increase in principal EVER (this is a big advantage to taxpayer)
Advantages of Employer-Sponsored Investments: 401(k)
Reduces tax liability
Makes investing
automatic
Possibility for employer to match
investment
It is recommended that a person utilize these investment
tools as much as possible if
they are offered
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