C HAPTER 11. Investing Basics and Evaluating Bonds. “If a little money does not go out, great money will not come in.” -- Confucius. The Answer is…. “A Voluntary Tax on Stupid People”. What is the Question?. Silly, the Question is…. “What is the. Lottery?”.
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Investing Basics and Evaluating Bonds
“If a little money does not go out, great money will not come in.”
“A Voluntary Tax on Stupid People”
What is the Question?
“What is the
A Voluntary Tax on Stupid People
So Why Aren’t the Nations Preparing for This!?
And You Ain’t Gonna’ Win the Lottery!
So Start Saving Now
But, of course, if the asteroid does hit, we will have plenty of warning for you to go out and spend all your savings on a really great time!
Now, let’s get serious…
Which one is your favorite?
Or so says our book…
I simply do not agree with the concept of an “emergency fund” of three to nine months of living expenses. As long as you have access to cash via a home equity line of credit, for example, there is no good reason to keep $20,000 to $30,000 or more in a savings account earning 2%. Instead, use the money to pay down high interest debt, especially credit card debt.
P.S. The Wealthy Barber agrees with me.
P.P.S. You are adequately insured, right?
Exceptions: Salespeople and the self-employed
“I am not so much concerned with the return on my money as I am with the return of my money.”
What is your tolerance for risk? (Page 340) Unfortunately, you can’t know until you have some skin in the game … and then lose some skin!
Pay Yourself First
Account Statement Examples
a.k.a. Retirement Account, Education Accounts, MSA HSA
a.k.a. Regular account
All contributions are post-tax dollars
Most are pre-tax; Some are post-tax
Strict limits on contributions
No limit on contributions
Strict limits on investment types
No limits on investment types
Tax-deferred (pre-tax) or
Pay taxes every year on gains
Although there are many subtle and not-so-subtle differences, the major differences are how they are taxed by the IRS, how much money you can contribute, and what you can have in the account.
Account Statement Examples
But the whole $100 still goes into your account!
So Why Bother Contributing to a Roth IRA?
529 plans were set to expire in 2011 but have been extended indefinitely.
Okay. Now, What Do We Invest In? (In other words, what investments do we put in our taxable or tax-qualified accounts?)
Fancy term for “You can lose a lot of money!”
“But you got me all excited about buying stocks and bonds all by myself! Besides, in their commercials on TV, Ameritrade and Scottrade show everyday, hard-working Americans just like me happily and profitably buying and selling stocks all the time.”
STOCKS BONDS “CASH”
Balanced mutual funds
Bond mutual funds
Stock mutual funds
Money market mutual funds
a “mutual” fund
Professional Money Management
More about choosing a good mutual fund when we get to Chapter 13.
Investing a fixed amount ($50, $100, etc.) periodically is called “dollar cost averaging.”
We will examine all of these in more detail
Investment companies that pool investors' money and invest in a diversified portfolio of securities. Investors get diversification and professional money management.
The correct answer is (D). Investment company is the legal term; mutual fund is the popular term.
Represent ownership in a corporation. Investors receive dividends and capital gains (or capital losses).
The correct answer is (B). Stock investors are part-owners of corporations.
Fixed-income securities that represent loans to corporations, municipalities (state & local governments & agencies), and the Federal government. Investors receive interest and a promise to repay the loan.
The correct answer is (C). Bonds are “fixed-income” investments.
Investments with very little risk, and correspondingly, very little return. They are usually guaranteed or pretty darned close. There is a huge opportunity cost if you leave your money here for the long-term.
The correct answer is (D). Low risk, low return.
What are reasonable expectations of returns from the following investments?
8% - 10%
4% - 8%
2% - 5%
7% - 8%
When an entity sells bonds, it is borrowing money.
Almost every election year in California, the voters are asked to approve a “bond proposition” for parks, schools, water projects, transportation, emergency and public safety equipment, etc. The State of California then sells the bonds to pay for the project and must pay the interest and pay back the principal over 30 years.
Bonds are “debt financing.” Corporations, municipalities, or the Federal government borrow for many of the same reasons that individuals borrow for – to finance their operations.
Stocks are “equity financing.” A corporation is selling a piece of itself to finance the operations of the company. (Governments do not issue stocks because they can not sell pieces of themselves.)
1.0 – Your Federal marginal tax rate
Example: 6% yield, 25% tax bracket
Taxable equivalent yield = 0.06
1.0 - 0.25
= 0.08 = 8%
Federal income tax free municipal bonds
1.0 - Your combined marginal tax rate
(Federal & state)
Example: 6% yield, 25% Fed, 8% state
Taxable equivalent yield = 0.06
1.0 – (0.25+0.08)
= 0.0895 = 8.95%
If you purchase bonds from your state, they are usually “double tax-free.”
Federal & state income tax free.
Think of the ratings as “idiot lights” on your car’s dashboard. By the time the agency downgrades the bond to C or D, it is already too late!
When interest rates fall,
…bond prices rise,
Juan Zapata-Tyme bought a corporate bond paying 8% four years ago. Today, corporate bonds that are like Juan’s bond are paying 6%. Would Juan be able to sell his bond for more than he paid for it, less than he paid for it, or the same amount he paid for the bond?
The correct answer is (A). If interest rates go down, bond prices go up. The bond would sell at a premium.
L. Coco bought a Treasury bond paying 5% two years ago. Today, like Treasury bonds are paying 7%. Would Señor Coco be able to sell his bond for more than he paid for it, less than he paid for it, or the same amount he paid for it?
The correct answer is (B). If interest rates go up, bond prices go down. The bond would sell at a discount.
Face value - Market value
Number of periods
Face value + Market value
Example: 6%, Selling at $900, 10-year maturity
$1,000 - $900
$1000 + $900
= 0.074 = 7.4%
$ Amt Annual Interest +
Very few small investors participate in the bond markets. Bond traders normally deal in the millions of dollars and want you to pony up at least $25,000, preferably $100,000 or more. The major exceptions are Federal Treasury bonds. The small investor is welcome at www.treasurydirect.gov.
Although it is very easy to buy Treasury bonds directly from the Federal government at www.treasurydirect.gov