investing for your future 1 basic concepts and investment products
TRANSCRIPT
Investing For Your Future 1:
Basic Concepts and
Investment Products
Barbara O’Neill, Ph.D., CFP®, AFC, CHC
Rutgers Cooperative Extension
Webinar Objectives
• Discuss basic investing concepts and
terminology
• Discuss characteristics of stocks and bonds
• Discuss common investment frauds
• Discuss investor education and investor
protection resources
Investing is an Important Part of
the Financial Planning Process
The Difference Between
Saving and Investing
Both
Saving
Investing
The Difference Between Saving
and Investing • Saving:
– Money held in a short-term cash assets
– Money used for emergencies and specific purchases
– Low risk, low reward
• Investing:
– Money used to increase net worth and achieve long- term financial goals
– High risk, high POTENTIAL reward
Resource: http://www.finweb.com/financial-planning/saving-vs-investing.html
Investing Videos
http://www.youtube.com/watch?v=UaPfs1WY9QM
(commoncraft®)
http://www.youtube.com/watch?v=2DBdWeTxXeU&feat
ure=related (ING)
Why People Invest
• To achieve financial goals, such as purchase of a
new car, down payment on a home, or a child’s
education
• To increase current income (e.g., retirees)
• To build wealth over time
• For financial security and peace of mind
• To have funds available during retirement years
Invest for Long-Term Goals
http://njaes.rutgers.edu/money/pdfs/goalsettingworksheet.pdf
Source: Garman/Forgue, PERSONAL FINANCE, Fifth Edition
9
Taxable vs. Tax-Deferred Investing
27
,60
0
31
,30
0
48
,30
0
58
,60
0
75
,80
0
98
,80
0
11
2,2
00
15
7,9
00
16
0,3
00
24
4,7
00
$0
$50,000
$100,000
$150,000
$200,000
$250,000
10yrs 15yrs 20yrs 25yrs 30yrs
Taxable Returns (at 28%)
Tax-Deferred Returns
Garman/Forgue, PERSONAL FINANCE, Fifth Edition, Tax-
Sheltered Returns are Greater than Taxable Returns
(Illustration: 8% Annual Return and $2,000 Annual Contribution)
Calculator: http://www.calcxml.com/do/inv07
Tax-Exempt and
Tax-Deferred Investing
Tax-exempt
– No taxes owed on
money earned on
investment
– Examples - U.S. savings
bonds are exempt from
state tax and municipal
bonds and Roth IRAs
(with qualifications) are
exempt from federal tax
Tax-Deferred
– Taxes postponed until an
investment is sold or
earnings are withdrawn
– Examples - many
retirement accounts such
as Traditional IRAs and
401(k)s and 403(b)s
Categories of Investments
• Ownership (Equity): Own something
– Stocks and stock funds
– Real estate and REITS (real estate investment trusts)
– Collectibles
– Commodities
• Loanership (Fixed-Income): Lend money
– Bonds and bond funds
– Certificates of Deposit (CDs)
Investment Pre-requisites
• Adequate emergency fund
• Adequate insurance
• No or low consumer debt balance
• Written financial SMART goals
• An “investor’s mindset”
• What do you own? ASSETS
• What do you owe? LIABILITIES
• Net Worth = Assets – Liabilities
Example: $250,000 assets - $125,000 debts
= $125,000 net worth
http://njaes.rutgers.edu/money/pdfs/networthcalcworksheet.pdf (Print)
http://njaes.rutgers.edu/money/default.asp#resources (Excel)
Know Your Net Worth
Sample Net Worth Worksheet
ASSETS VALUE
Cash, savings account, money market funds, CDs
Investments
Personal Property, Cars, Motorcycle, Home Furnishings
Life Insurance Cash Value
Retirement Accounts, IRA, SEP
Real estate, Personal Property, Money Owed to You
LIABILITIES VALUE
Loans – car, education, personal
Mortgage
Other Loans
Taxes Owed
Net Worth = Assets – Liabilities
Where to “Find” Money to Invest
• Develop a spending plan
• Reduce spending on
“lattes”
• Pay yourself first (PYF)
automatically
• Employer matching (“free
money”)
• Save bonus/tax
refund/windfall money
• Collect loose change
• Continue loan repayments
to yourself
• “Moonlight” for extra income
• Sell items you don’t need
• Search for unclaimed
money
Resource: www.investing.rutgers.edu (Unit 3, Investing For Your Future)
What $20 a Week in Investment
Deposits Adds Up To
5% Return:
– 20 Years: $36,100
– 30 Years: $72,600
– 40 Years: $131,900
10% Return:
– 20 Years: $65,500
– 30 Years: $188,200
– 40 Years: $506,300
The Rule of 72
• Calculates the number of years it takes for principal to double – Number of Years = 72 divided by interest rate
– Example: 72 ÷ 6% = 12 years
• Calculates the interest rate it takes for principal to double – Interest rate = 72 divided by number of years
http://www.investopedia.com/ask/answers/04/040104.asp#axzz1rH9rDBUo
http://www.moneychimp.com/features/rule72.htm (calculator)
The Rule of 72 Source: Garman/Forgue, PERSONAL FINANCE, Fifth Edition
The Risk-Reward Trade-Off
Source: Garman/Forgue, PERSONAL FINANCE, Fifth Edition
Risk (Chance of Loss)
• There is no such thing as a “perfect” investment (risk-free, tax-free, high return)
• All investments have some type of risk
• Risk can be caused by:
– Inflation
– Changes in the economy
– Political uncertainty (home and/or abroad)
– Business failure
– Interest rate changes
http://www.finra.org/Investors/SmartInvesting/AdvancedInvesting/ManagingInvestmentRisk/
Investment Risks
• Business (Failure) Risk affects individual company stocks and corporate bonds (when business is not profitable)
• Market Risk the risk of being in the market versus in a risk-free asset (stock prices follow market cycles)
• Interest Rate Risk the value of bonds or preferred stock may increase or decrease with changes in interest rates
• Inflation Risk your investment return may not keep pace with inflation and you lose purchasing power
• Currency Risk changes in investment value related to the value of the U.S. dollar
• Political Risk the risk of political instability in an interconnected global economy
Techniques to Offset Risk
• Diversification – Putting your money, “your eggs,” into several “baskets” (e.g.,
stocks, bonds, cash, real estate)
– http://www.sec.gov/investor/pubs/assetallocation.htm
– http://www.investopedia.com/articles/02/111502.asp#axzz1rH9rDBUo
• Dollar-Cost Averaging
– Investing regular amounts at regular intervals regardless of price
– Examples: $50 on the 1st of every month or 6% of your gross income every payday
– Lowers average share price cost over time
– https://www.americancentury.com/calculator/dollar_cost_averaging_calculator.jsp
Dollar-Cost Averaging
Example January
(Market High)
February March April
(Market Low)
Amount
Invested
$200 $200 $200 $200
Share Price $35 $28 $24 $20
Number of
Shares
Purchased
5.7 7.15 8.3 10
Total Number of Shares: 31.15 shares
Average Share Cost: $25.68/share ($800 ÷ 31.15)
Asset Allocation
• Percentage of portfolio in different asset classes
• Important factor in overall investment success
• The more stock in portfolio, the more aggressive the asset
allocation
• One guideline: 110 – age = % of portfolio in stock
• Conservative portfolio: less stock in portfolio
Conservative Moderate Aggressive
C
B
SC
B
S
C
B
S
Asset Allocation: A Weighted
Average
Source: Garman/Forgue, PERSONAL FINANCE, Fifth Edition
Asset Allocation Models
Asset Allocation Calculators
• http://cgi.money.cnn.com/tools/assetallocwizard/as
setallocwizard.html (CNN Money calculator)
• http://www.bankrate.com/calculators/retirement/ass
et-allocation.aspx (Bankrate.com calculator)
• http://www.smartmoney.com/calculator/investing/as
set-allocation-in-retirement-1304478691597/
(Smart Money)
Portfolio Rebalancing
• Get back to original asset class weights
(percentages) to maintain same risk level
• Asset classes grow at different rates
• Two ways to do:
– Sell assets in over-weighted asset class
– Put new money in under-weighted asset class
http://www.investopedia.com/articles/pf/05/051105.asp#axzz1rH9rDBUo
Best-Performing Assets Change
What is Your Risk Tolerance?
Take the Rutgers Cooperative Extension Investment Risk
Tolerance Quiz: http://njaes.rutgers.edu/money/riskquiz/
Basic Investment Principles
• Even small amounts invested regularly grow impressively over time
– Time + Money = MAGIC!
• Volatility “comes with the territory” but not all investments are equally volatile
– Volatility = “peaks and valleys” of investment value
– Need an “investor’s mindset” to handle
• The higher the potential rate of return, the greater the investment risk
Time + Money = “Magic”
Illustration assumes an 8% average annual return; actual investment results will vary
Source: TIAA-CREF
Investment Volatility
• Tendency of investment values to fluctuate
– Stock (stock funds) generally more volatile than
bonds
– Small company stocks generally more volatile
than established “blue chip” company stocks
• Measured by beta (overall market = 1)
– 1.5 = 50% more volatile than average stocks
– 0.5 = 50% less volatile than average stocks
Common Stock
• Share of ownership in a company
• Elect directors
• Voting rights on other matters
– Proxy – written authorization given by shareholder to someone else to represent him or her and vote his or her shares at a stockholder’s meeting.
• Two ways to earn money
– value of stock increases (capital gain)
– stock pays dividends
http://www.finra.org/Investors/SmartInvesting/ChoosingInvestments/Stocks/
Diversify Among Industry Sectors
• Building/forestry
• Financial services
• Consumer growth
(e.g., soft drinks)
• Consumer staples
(e.g., food)
• Consumer cyclicals
(e.g., cars)
• Technology
• Capital goods
(e.g., machinery)
• Energy (e.g., oil)
• Materials (e.g.,
paper)
• Transportation
• Utilities
• Health care
• Conglomerates
Historically, common stocks have
out-performed all other types of investments,
over longtime periods BUT…it has not been a
smooth ride!
Historical Perspective
Historical Perspective:
The 2000s Year S&P 500 Return
2001 -11.90%
2002 -22.1%
2003 28.7%
2004 10.9%
2005 4.9%
2006 15.9%
2007 5.5%
2008 -37.0%
2009 26.5%
2010 15.1%
http://moneyover55.about.com/od/ho
wtoinvest/a/marketreturns.htm
http://www.extension.org/pages/1093
4/investing-unit-4:-common-stocks
Analyzing Stock Performance
Earnings per share (EPS)
– Formula: Corporation’s after-tax income
divided by number of outstanding shares
of common stock
– Example: $5,000,000/10,000,000 = $0.50
– EPS increase = generally a healthy sign
http://www.investopedia.com/terms/e/eps.asp#axzz1rXubLb9B
Analyzing Stock Performance
Price-Earnings Ratio (P/E Multiple)
– Price per share of stock ÷ firm’s earnings per share (EPS)
• Example: $10 price/0.50 EPS = a PE ratio of 20
– How much investors are paying for company’s earning
power
– Based on historical data; cannot make predictions
– P/E of 15 long-term average P/E
– Need to compare P/E of stock to firms in same industry
http://www.investopedia.com/terms/p/price-earningsratio.asp#axzz2345s7vD2
Time-Tested Stock Strategies
• Buy what you know or get to know (research)
• Buy and hold quality stocks
• Diversify among industry sectors
• Dollar-cost average
• Reinvest dividends and capital gains
• Don’t invest > 10% of total portfolio in your own employer’s stock
Bonds
• Debts (IOUs) of government and corporations
• Investors “loan” money and receive interest
• Major bond investment risks:
– Credit risk
– Interest rate risk
– Inflation risk
– Call risk
Bond Investor Decisions
• Decide on risk level
– Investment grade bonds: top 4 grades (BBB, A, AA, AAA)
– Junk bonds (high-yield bonds): lower rated and higher risk
• Decide on maturity
– Match to financial goals
• Determine the after-tax return
– Taxable versus tax-exempt
Federal Marginal Tax Brackets: http://njaes.rutgers.edu/money/taxinfo/
Bond Ratings Measure Default Risk
http://www.investopedia.com/terms/b/bondrating.asp#axzz1rXubLb9B
U.S. Treasury Securities
• Considered safest fixed-income investment
• Sold at periodic auctions; secondary market
• Earnings exempt from state and local tax
(principle of “reciprocal immunity”)
• $100 minimum with $100 increments
– Bills: Maturities up to 12 months; buy at discount
– Notes: 2-, 3-, 5-, 7-, and 10-year maturities
– Bonds: 30-year maturities (“long bonds”)
http://www.treasurydirect.gov
Corporate Bonds
• Corporation’s pledge to repay principal and periodic interest
• Considered safer than company stocks
• Face Value
– Dollar amount bondholder receives at bond’s maturity date
– Usually $1,000
• Coupon rate
– Stated interest rate
– Interest payments made every six months
– Example: $1,000 x 5.8% = $58 (in two $29 payments)
• Maturity Date = Date that face value is repaid; generally 1 to 30 years
http://www.investinginbonds.com/learnmore.asp?catid=5&subcatid=18&id=173
Investment Characteristics
Source: Focus on Personal Finance, Third Edition, McGraw-Hill
Investment Returns
• Rent – payment received in return for use of your
real estate, such as a building
• Interest – “rent” for the use of your money
• Dividend – portion of a company’s earnings that the
firm pays out to its shareholders
• Capital Gain – occurs only when investment is sold;
results from increase in value of initial investment.
http://www.aarp.org/money/investing/investment_return_calculator/
Total Return
Measure of profit before taxes and fees
• Formula:
Gain or loss in value + investment earnings
• Examples:
– $1 per share dividend + $5 increase in share value = $6 per share TR before expenses
– $1 per share dividend + $5 loss in share value = <$4> share TR before expenses
– http://www.ehow.com/how_6500173_calculate-total-returns.html
Protect Your Money
• Learn how to spot investment fraud
– “Cold calls” with “limited time offers”
– E-mail spam promising high “guaranteed” returns
• Ask questions before investing
• Get written information on companies/investments
• Ask yourself: Why is a complete stranger giving me a “hot tip”?
http://www.finra.org/Investors/ProtectYourself/AvoidInvestmentFraud/
“Pump and Dump” Scams
• Promoter urges you to “buy
now or lose out”
• Price rises sharply
• Fraudsters sell at peak
• Price drops when the hype
stops
• Investors lose money
0
5
10
15
20
25
30
Day 1 Day 2 Day 3 Day 4 Day 5
Stock Price
http://www.sec.gov/answers/pumpdump.htm
Pyramid Schemes
Levels Number of Participants
1 6
2 36
3 216
4 1,296
5 7,776
6 46,656
7 279,936
8 1,679,616
9 10,077,696
10 60,466,176
11 362,797,056 - more than U.S. Population
12 2,176,782,336
13 13,060,694,016 - more than double World Population
Affinity Frauds
• Target members of a group
- Race - Profession
- Religion - Age
• Recruit group leader to spread the word
• Keys to scheme = trust
How to avoid: Ask questions! (about product, sponsor, salesperson, etc.)
Is It Too Good to Be True?
• High yield often means high risk
• Watch out for buzz-words: “guaranteed,” “limited
offer,” “safe as a CD,” or “risk-free”
• Beware of exotic, unusual products
Warning:
If it sounds too good to be true, it probably is!
Get the facts in writing OR hang up/delete
http://www.usa.gov/topics/consumer/scams-fraud/investment.shtml
In Summary
• Investments are designed to achieve long-term goals
• Two investment categories are ownership and loanership
• Net Worth = Assets – Debts
• Use the “Rule of 72” to estimate how money doubles
• A relationship exists between investment risk and reward
• All investments have some type(s) of risk
• Volatility is part of investing and should be expected
• If an investment sounds too good to be true, it probably is
Action Steps
• Write down financial goals with a date and cost
• Watch one or more investment videos or Web sites
• Calculate your net worth
• Take the Rutgers Investment Risk Tolerance Quiz
• Start a dollar-cost averaging investment habit
• Determine your current asset allocation
Investor Education Resources
• eXtension Ask an Expert and FAQs
– http://www.extension.org/personal_finance
• Better Investing
– http://www.betterinvesting.org
• American Association of Individual Investors
– http://www.aaii.com/
• Personal finance monthly publications
– Kiplinger’s Personal Finance, Money
• MyMoney.gov (federal government agencies)
– http://www.mymoney.gov/
Investor Protection Resources
• U.S. Securities and Exchange Commission
www.sec.gov
• State securities regulators: www.nasaa.org
• Central Registration Depository (CRD):
http://www.finra.org/Industry/Compliance/Registration/CRD/
• FINRA BrokerCheck®:
http://www.finra.org/Investors/ToolsCalculators/BrokerCheck/
• Securities Investor Protection Corporation (SIPC)
www.sipc.org
Investing For Your Future Home Study
Course (Cooperative Extension)
• Free of charge and downloadable
• Updated annually
• 11 units; do at your own pace
• Designed for beginning investors
• Monthly investment messages
• www.investing.rutgers.edu
FINRA Investor Education
Foundation Content Modules
• Free of charge and downloadable
• 11 content modules
• Designed for beginning investors
• Used for library investor education programs
• http://www.finrafoundation.org/resources/education/modules/
Questions? Comments
Experiences?
Part 2 Webinar:
Investing For Your Future 2:
Mutual funds and Tax-Deferred Investments
Please complete the webinar evaluation form