McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

C H A P T E R P L A Y L I S T S O N G :

“ F o r t h e L o v e o f M o n e y ” b y T h e O ' J a y s

Investment Basics

11-2

Learning Objectives

LO 11-1 Distinguish between savings and investments.

LO 11-2 Analyze the risk and return on varying investment products.

LO 11-3 Interpret the hierarchies of the investment pyramid.

LO 11-4 Examine the importance of varying your investments.

LO 11-5 Compare portfolio asset allocations for the different personal finance life stages.

11-3

Savings vs. Investments

Who is rich? He that is content. Who is that? Nobody.”

~ Benjamin Franklin

How much money should you have in savings vs. investments?

What is the difference?

“Savings is not to make you rich, but it is to keep you from being poor.” ~ J.B. Quinn

Savings – No or low-risk investments with low returns.

11-4

Should You Save or Invest? Figure 11.1

11-5

Impact of Inflation on Savings

Inflation is the overall increase in the price of goods and services over time

Savings - retain your purchasing power by having your interest rate remain the same or higher than the inflation rate

Investing - beat the inflation rate and grow your value in real terms

Bureau of Labor Statistics Consumer Price Index page

Consumer Price Index from 1913 – present

11-6

BLS CPI Home Page

11-7

Insured Savings

FDIC – Federal Deposit Insurance Corporation

NCUA – National Credit Union Association

United States Treasury Bills, Notes, and Bonds

Backed by the full faith and credit of the United States government

Risk Premium – The difference between the risk-free rate of return and the expected yield of an investment with risk.

11-8

Making $en$e

How does an investment differ from savings?

How much money should you have in savings before you venture into investments?

What is a risk premium?

11-9

Risk of Investing

Investing has risk – the chance of losing some or all of your investment

To compensate for risk and entice an investor, investments with risk must pay a premium

Risk premium – compensation for taking on the risk

“Zero” risk – FDIC, NCUA, U.S. Treasury bills, notes, and bonds – risk-free rate

11-10

Types of Risk

Default Risk or Credit Risk – Risk that the company invested in may declare bankruptcy

2009 Chrysler bankruptcy: bondholders received $0.26 for every dollar they invested

Bondholders could lose their entire investment

FDIC and NCUA will insure deposits up to $250,000

11-11

Types of Risk

Interest Rate Risk – Risk taken on when you lock into a fixed-rate investment for a specific length of time

11-12

Types of Risk

Interest Rate Risk – Risk taken on when you lock into a fixed-rate investment for a specific length of time

11-13

Types of Risk

Market Risk – The risk that the value of your investment will decrease due to changes in the market

Gold prices

Housing market

Oil prices

11-14

Liquidity Risk – The

risk that you will not be able to cash out your investment quickly enough to either meet cash flow needs or to prevent a loss.

Types of Risk

11-15

Analyzing Your Risk Tolerance

How much can you afford to lose?

Rule of thumb: The higher the risk, the higher the potential return and the less likely you are to achieve the higher return

Risk tolerance quizzes

Rutgers University’s Investment Risk Tolerance Quiz

money.msn.com

11-16

Investment Pyramid

11-17

Diversification of Assets

Diversification – Spreading out the risk across multiple investments

Why is diversifying your investments important?

Portfolio – Holding more than one investment

Asset Allocation – The types of assets you are holding in your portfolio

Diversified Balanced Funds – Both equities and bonds

Targeted and automatic asset allocation mutual funds

11-18

Asset Allocation for Target Date Funds

T. Rowe Price Balance Fund (RPBAX)

Vanguard Target Retirement Fund Asset Allocation Tool

11-19

Portfolio Evaluation

Re-evaluate your investment goals, risk tolerance, portfolio returns, and asset allocation at least once a year and rebalance your portfolio

Pick an easy date to remember to rebalance your portfolio

Birthday

January 1st

Other special days

11-20

Independent (16-24)

529 College Savings Account

Retirement Savings

Roth IRA

401(k)

Early Family (25-44)

Roth IRA, 401(k)

529 College Savings Account

House Down Payment

Auto Down Payment

Life Stages and Accounts How Should the Assets Be Allocated?

11-21

Empty Nest (41-65)

Retirement funds

Investment funds

Funds used within the next 10 years

Retirement (66+)

Retirement funds

Investment funds

Funds used within the next 10 years

Life Stages and Accounts How Should the Assets Be Allocated?

11-22

Learn

LO 11-1 Distinguish between savings and investments.

LO 11-2 Analyze the risk and return on varying investment products.

LO 11-3 Interpret the hierarchies of the investment pyramid.

LO 11-4 Examine the importance of varying your investments.

LO 11-5 Compare portfolio asset allocations for the different personal finance life stages.

11-23

Plan & Act

To assess your risk tolerance, take the Market Psych Questionnaire (Worksheet 11.1)

Given your risk tolerance and current goals, draw up your own investment pyramid (Worksheet 11.2)

11-24

Evaluate

Are you making the appropriate allocations in building your emergency fund?

Outline your investment strategy.

Does this support your overall SMART goals?

11-25

Continuing Case

Blake bought into a stock mutual fund as a retirement investment 6 months ago. Ever since then, he has watched the prices slowly drop each month. He is afraid that it will soon be worthless. He is tempted to cash in the stock and move what funds are left to another instrument. What advice would you give him?