Rate of Return

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# Rate of Return - PowerPoint PPT Presentation

Rate of Return . Nominal Rate of Return. Real Rate of Return. Return prior to correction for inflation Top Grossing Movies correct for inflation. Return after being corrected for inflation. Affecting Growth. Time. Money. Rate of Return. Rule of 72.

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Rate of Return

Nominal Rate of Return

Real Rate of Return

Return prior to correction for inflation

Top Grossing Movies

correct for inflation

Return after being corrected for inflation

Affecting Growth

Time

Money

Rate of Return

Rule of 72

Money doubles at a point in time determined by dividing 72 by the interest rate you earn

72 / % RR= time double money

72 / 2% = 36 years

72/ 4% =18 years

72/ 6% = 12 years

72/ 8% = 9 years

Personal Savings Rate

12%

10

8

6

4

2

0

–1

1946

1951

1956

1961

1966

1971

1976

1981

1986

1991

1996

2001

2006

What is a stock?
• A share of ownership in a corporation.
• IPO – initial public offering- first time a stock is offered to the public for purchase.

The Golden Rule of Investing

The greater the risk the greater the reward or failure

Silver Rule of Investing

Bonds

Corporate, Municipal, Federal Loan

Corporate

T-bills

T-Notes

T-Bonds

Municipal

The Golden Rule Of Investing

The greater the risk, the greater the chance of reward or failure

5 Types of Risk

1. Financial

2. Market Price

Value loss on Market

Loss of value or loss of that investment all together

5 Types of Risk

Liquidity

Ability to Turn Investment to Cash

Inflation Risk
• The risk that money invested today will lose value due to higher inflation
• You want Investment to have Rate of Return Higher
• than Inflation
Fraud Risk
• Misrepresented investment.
• Scam artists take your money
Markets
• NYSE (1792) Co. with \$40 mill. in assets
• \$2 mill. In earnings
• AMEX (1950) small and mid cap.
• Too Small to be on the NYSE
• NASDAQ (1971) Same requirements as
• NYSE, but mostly technology
• OTC Risky penny stock Check Yo Self
• Regional Philadelphia, Chicago, Cincinnati, Boston, Pacific (L.A. & San Francisco)
Indexes(Tell us the health of the economy)Dow Jones Industrial Average
• An average of 30 industrial stock prices used to indicate the general level of stock prices in the New York Stock Exchange.
IndexesThe S&P 500
• An average of 500 popular stock prices used to indicate the general level of stock prices in the New York Stock Exchange.
Prudent Strategies to Deal with Risk

2. Diversify

• Diversify across asset classes
• Stocks and bonds
• Diversify within asset class
• Stock from different industries

There is no such thing as a free lunch in investing

The greater the risk the higher the expected return.

Investors are paid to take risk

“High Risk , High Return, Low Risk, Low Return”

Investment Risk
• Financial Risk: not getting your money back at all.
• Market Price Risk: the price of an investment will go down
• Liquidity Risk: Ability to turn your investment into cash
• Inflation Risk: the value of your investment decreases due to inflation.
• Fraud Risk: losing investment due to misrepresentation
What is a stock?
• A share of ownership in a corporation.
• IPO – initial public offering- first time a stock is offered to the public for purchase.

\$15,922

Small stocks 12.7%

\$3,077

Large stocks 10.4%

Gov’t Bonds 5.4%

T-Bills 3.7%

Inflation 3.0%

\$72

\$19

\$11

81-Year Horizon: 1926 – 2006

\$10,000

\$1,000

\$100

\$10

\$1

\$0.10

1926

1936

1946

1956

1966

1976

1986

1996

2006

2 Ways to make money on stocks

Capital Appreciation

• An increase in the stock price
• 100 shares @ \$10=\$1,000 Total Market Value
• 100 shares @ \$20= \$2,000 TMV
• Gain

Dividends

• Profits are issued to stock holders
• 1 million in profit
• 1 million shares outstanding
• Each share is issued a \$1 dividend
Stock Market Exchange
• NYSE- 3,000 mainly large to mid size co
• NASDAQ-5, 000 small size co
• National Association of Securities Dealers Automated Quotation System
Bonds
• Bonds- lending an entity money for Specific
• length of time
• Interest rates
• Amount (usually \$1,000 increments)
• Corporate Bonds – to lending to firms
• Municipal Bonds- State and local governments (munis)
• Federal Government Bonds- backed by the US Treasury dept.
• T-Bills 3-6 months
• T-Notes 1-7 years
• T-Bonds- Long term (\$10,000)
• US Saving Bonds- variety
Immediate Gratification!
• Many people are “hardwired” for now consumption
• Experiments:
• Choice: \$100 today or \$120 in three days
• majority of people choose \$100 today!
• forego annualized 2,400% rate of return
Truth or Consequences
• \$6,000 outstanding credit card debt.
• Few can afford to pay in full,

so…..

• they make minimum payment each month
• they pay interest at very high rates on balance.
• Immediate gratification is a powerful force!
Why Plan, Save and Invest?
• Create an emergency fund
• Achieve goals
• Build wealth
Personal Savings Rate

12%

10

8

6

4

2

0

–1

1946

1951

1956

1961

1966

1971

1976

1981

1986

1991

1996

2001

2006

Tale of Two Savers

Ana

Shawn

How much did each save initially?

\$24,000 or \$2,000 a year for 12 years

\$64,000 or \$2,000 a year for 32 years

How much did each have in the end?

\$993,306.59

\$442,503.09

Started saving at age 22

Started saving at age 34

Why?

Save Early and Save Often!

3 factors that effect the growth of savings and investing

Time: the earlier you save, the more savings you will have.

Investment Size: the more you save each year from your income, the more savings you will have.

Rate of Return: the higher the rate of return, the more savings you will have.

Simple Interest

\$1,000 in savings at 5% interest

Compound Interest

Interest Earned on Interest

\$1,000 savings @ 5% interest

Rule of 72

a rule for determining how long it may take for money to double at a particular rate of return.

72/ R= years it takes for money to double

Vocabulary

Rate of return- (ROR)the additional money earned on an investment in percentage terms for a given time period.

Real rate of return-(RROR)the ROR adjusted for inflation

Real Interest Rate- is the rate adjusted for inflation at which interest is paid by a borrower for the use of money that they borrow from a lender.

Nominal Interest Rate- is the rate at which interest is paid by a borrower for the use of money that they borrow from a lender.

Prudent Strategies to Deal with Risk

• All money in one stock?
• Could spill all the eggs
It Can Be Tempting!
• Great if you “hit it big”
• Wal-Mart
• If you had purchased \$1,000 of Wal-Mart stock in 1970 at its IPO
• held it through 1999, would have grown to:
• Over 6,000,000
• Not so great if things go south
• Enron
Prudent Strategies to Deal with Risk

2. Diversify

• Diversify across asset classes
• Asset Allocation
• Stocks, bonds, CDs
• Diversify within asset class
• Stock from different industries
Asset Allocation
• Asset allocation refers to the process of dividing an investment amongst various assets or asset classes (fixed income, equity, commodities, etc.) in order to diversify and subsequently reduce investment risk.
The Bulls, The Bears, and The Pigs
• Bulls–a stock market with rising prices.
• Buying on margin can increase gains in a bull market.
• Bears–a stock market with falling prices
• Selling short can increase gains in a bear market.
Investing

Do’s

Invest in something you don’t understand

Expect too much too soon

Be greedy

Time the market

Don'ts

• Start early and often
• Invest for the Long Term
• Know your objectives and risk tolerance
• Be aware of broker fees
• Be skeptical of rumors and fads
Individual Retirement Accounts (IRA)
• Retirement account that gives you a tax incentive for participating.
• Benefits:
• Reduces taxable income
• Tax deferred growth
• No penalty for withdrawing if you are 59 ½
• Rules vary for withdraws for first time home buyer, paying for college, medical expenses or disabled.
• Drawbacks:
• Early withdrawal penalties 10% plus taxes
• Contributions stop after you are 70 ½ yrs old
• Withdrawals are taxed
• Forced withdrawals after you reach 70 ½ years
Roth IRA
• Similar to IRA; except you pay taxes on the money now (not tax deductible)
• Benefits:
• No penalty for withdrawing if you are 59 ½
• Rules vary for withdraws for first time home buyer, paying for college, medical expenses or disabled.
• May not be required to withdraw funds at any age
• May contribute forever
• Drawbacks :
• Not deductible
• Early withdrawal penalties 10%
• Account must be open five years to qualify for tax-free provisions
401K
• A tax deferred retirement fund, sometimes matched by employers.
• Benefits:
• Tax deferred growth
• Reduces taxable income
• No penalty for withdrawing if you are 59 ½
• Withdraws for medical expenses, disability
• Drawbacks:
• Early withdrawal penalties 10% plus taxes
• Limits on contributions
• Withdrawals are taxed
• Forced withdrawals after you reach 70 ½ years
• Roth 401K-new

“Assets”

“Liabilities”

What Is Wealth?
• Wealth = (What you own)

minus  (What you owe)

Balance Sheet

Total Liab + Net Worth \$100,000

Net Worth Statement(as of: January 12th, 2008)
• Assets
• Current Assets
• Check/savings accounts
• Securities
• Stock, bonds, mutual funds
• Real estate
• House value
• Long-term Assets
• Individual Retirement Acct.
• Personal property
• Automobile
• Furniture, Jewelry

_________

• Total Assets: \$100,000
• Liabilities
• Unpaid bills
• Utilities, medical bills
• Loans
• Credit card balance
• Automobile loan
• Mortgage loan bal.
• Total Liabilities: \$40,000

Net Worth \$60,000

(or one’s “wealth”)

What builds wealth?

How ?

Create a Plan

Where do you start?

Create a Financial Plan

Goals
• Short Term Goals – next 3 months
• Intermediate Goals – 3 months to 1 year
• Long term Goals - more than a year
We don’t plan to fail, we fail to plan!

Smart Goals

Dumb Goals

Dreamy

Unrealistic

Motivating

Bold

• Specific
• Measurable
• Attainable
• Realistic
• Timely
What to know about the future?
• Education matters
• Not all education is the same
• Hard skills
• Flexibility
• 4.9 years median job tenure
• Geography
• Skills that are transferrable from industry to industry
• Language skills
• Be financially prepared
• Recessions will occur; be prepared
Budgets
• Income >Expenses
• “Pay yourself first”: Money is taken from your paycheck to meet financial goals first, and then you budget from there.
• Financial Goals- Income toward important payments or contributions that will help you secure your financial Foundation. Ex: retirement, paying down debt, emergency fund
• Fixed Expenses - Expenses that continue at relatively stable levels, month after month or year after year regardless of the level of use. Ex: rent, utilities, insurance, “NEEDS”
• Variable (Flexible)Expenses- depends on the level of activity, can be changed. Ex: Dining, groceries, shopping, hobbies: “WANTS”
Credit
• It is the ability to obtain goods and services before paying for them, based on a promise to pay later.
• Mortgage
• Credit Card Life Time of Debt
• Car Loan
• Student Loans
Cs of Credit
• Character- trustworthiness
• Capacity-present and future ability to meet financial obligations
• Collateral – assets that can be used as a guarantee to a loan.
• Capital -deduces overall net worth
• Conditions -questions loan terms and general environmental concerns.

• Credit Uses
• Wants rather than needs
• Fast food and not paying off at end of month
• Good uses (Needs)
• Emergency
• Investment
• Insurance on loan
Credit
• 3 major credit reporting agencies
• Equifax
• Experian
• Trans Union
• 500-850 credit scores range, higher the number the better the score
Factors of credit scores (FICO score)

Past Payment History(35%)

Amount owed (30%)

Length of credit history (15%)

Amount of new credit (10%)

Applying for too many cards

Types of credit (10%)

Identity Theft #1 Crime in America

IT is a crime in which an imposter steals personal information, such as a social security #, driver license, bank account or credit card #.

Costing 9 million American 1.2 billion dollars annually.

3Ways to Handle Risk
• Avoid Risk- meanings removing yourself from a situation that endangers property and, well- being or life.
• Reduce Risk- means taking action to lessen the chances and the consequences of a bad outcome.
• Share Risk- means pooling resources with others to deal with loss, often through the purchase of insurance.
Types of Insurance
• Automobile
• Deductible: the higher it is, the lower the policy cost.
• Uninsured motorist
• Comprehensive/ Collision
• Health
• Homeowner’s
• Property damage (fire, natural disaster…)
• Renter’s
• Property damage
• Disability
• Life
How to pick an investment?