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Investment Fundamentals Chapter 13. Personal Finance FIN 235. General Objectives. Reasons for Establishing Investment Plans/Programs Funding investment programs Understanding the relationships between; risk, return, liquidity, income, and growth How to manage risk

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investment fundamentals chapter 13

Investment FundamentalsChapter 13

Personal Finance

FIN 235

general objectives
General Objectives
  • Reasons for Establishing Investment Plans/Programs
  • Funding investment programs
  • Understanding the relationships between; risk, return, liquidity, income, and growth
  • How to manage risk
  • Considering bonds as part of your portfolio
    • Government
    • Corporate
  • How to evaluate bond investments
funding investment programs
Funding Investment Programs
  • Systematic savings plans
    • Many start with a savings account
    • Regular weekly or monthly deposits
    • Regular payroll deductions
  • Participation in 401(k) plan at work
    • Many employers make contributions or add based on employee contribution.
    • Setting aside a small percentage of pay (3 to 5%)
  • The most important factors:
    • Start early
    • Don’t use funds during accumulation period except for emergencies
    • Early withdrawals subject to penalties and taxes
establishing investment plans programs
Establishing Investment Plans/Programs
  • Establishing Investment Goals
  • Performing a Financial Checkup
    • Work to Balance Your Budget
    • Obtain Adequate Insurance Protection
    • Start an Emergency Fund
    • Have Access to Other Sources of Cash for Emergency Needs
  • Getting the Money Needed to Start an Investment Program
    • Priority of Investment Goals
    • Employer-Sponsored Retirement Plans
  • The Value of Long-Term Investment Programs
    • Financial Independence
    • Maintaining your lifestyle in retirement
understanding the relationships
Understanding the Relationships
  • Safety and Risk; run in opposite directions
  • Components of the Risk Factor
    • Inflation Risk (maintain purchasing power)
    • Interest Rate Risk (change in values as rates change)
    • Business Failure Risk (investment goes sour)
    • Market Risk (ups and downs of the market)
  • Investment Income (interest, dividends)
  • Investment Growth (capital gains)
  • Investment Liquidity (sell quickly and cheaply)
managing risk
Managing Risk
  • Portfolio Management and Asset Allocation
    • Asset Allocation (stocks, bonds, international, cash)
    • The Time Factor (short or long term)
    • Your Age (get more risk averse as you get older)
  • Your Role in the Investment Process
    • Evaluate Potential Investments
    • Monitor the Value of Your Investments
    • Keep Accurate Records
    • Do some research before you commit to a course of action
bonds as part of your portfolio
Bonds as Part of Your Portfolio
  • Advantages
    • Known payouts (interest payments, principal at maturity)
    • Risk a function of credit ratings (AAA – D)
  • Disadvantages
    • Interest Rate risk
    • Default risk
    • Costly to trade (liquidity may be a problem)
  • Government Bonds
    • No defaults
    • Lower rates
    • Semi-annual coupons
    • Municipal bond interest exempt from federal taxation
bonds as part of your portfolio1
Bonds as Part of Your Portfolio
  • Corporate Bonds
    • Better yields
    • Increased chance of default (especially lower rated bonds)
    • Quarterly coupons
    • Secured and unsecured categories as well convertibles
  • Basic Bond Strategies (if trading)
    • If rates expected to rise, keep maturities short
    • If rates expected to fall, go long maturities
    • Inflation expectations is major factor in forming rates
evaluating bond investments
Evaluating Bond Investments
  • Returns: Stocks vs. Bonds
    • Since 1926: Bonds average 5.6% per year, Stocks 10.4%
    • Over a 30 or 40 year investment period, the roughly 5% difference in returns can add up to s significant amount
    • Example: Invest $200 per month for 30 years
      • Bond Portfolio = $186,198
      • Stock Portfolio = $492,554
    • Annuity Example: Payout the above accumulation for 25 years
      • Bond ($186,198); monthly check = $1,154.56
      • Stock ($492,554); monthly check = $4,615.47
concluding comments
Concluding Comments
  • Bonds may be safer than stocks, but the returns are significantly lower.
  • Government Bonds are safer than Corporate Bonds but the returns are slightly lower.
  • Timing is important when adding bonds or bond funds to your portfolio.
    • Expectations about future inflation is a key decision criterion
    • Global economic conditions are also a factor.
homework
Homework
  • Do The Math: 1, 4, 6
  • Be Your Own Personal Financial Planner
    • 2 – Readiness to invest (w/s 49)
    • 4 – Your long-term investment strategy (w/s 51)
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