Basics of Investing IIIScheduleSlide 3CURRENT EVENT / NEWSCrude Oil tops $100/barrel againEffectsFebruary 19LECTURE CONTENTToday’s LectureSlide 10Determining Your Financial GoalsDetermining Your Investment StyleThe Risk / Return TradeoffRisk ToleranceWhat is Your Risk Tolerance?Slide 16(Expected) Return vs. RiskPortfolio ManagementPortfolioAsset AllocationActive versus Passive ManagementSlide 22Distribution of Returns of Actively Managed FundsHow many stocks should I own?DiversificationSlide 26Diversification…What’s the Catch?ConcentrationSlide 29Other Investment Securities Mutual Funds & Exchange-Traded FundsVarious investment securitiesVarious Investment SecuritiesMutual Fund BasicsSlide 34Buying and Selling FundsAdvantages DisadvantagesChoosing Mutual FundsExchange-Traded FundsSlide 39Advantages over Mutual FundsSample ETF SymbolsAdditional Resources for ETF’sSlide 43Trading PsychologySlide 45Psychology & The Stock MarketNext WeekReadingBasics of Investing IIIEconomics 98 / 198Spring 2008Copyright 2008 Lawrence WuSchedule•Quiz•Current Events•Today’s Lecture Content•Next WeekQUIZCURRENT EVENT / NEWSCrude Oil tops $100/barrel again•After the February 7th low of $88.11, it began steadily rising again.•After the President’s Day weekend, the New York Mercantile Exchange rose prices by $4.51, 4.7%, to $100.01 for the March delivery.•Due in part to OPEC’s seasonal production cuts.•Also, the “Big Spring” refinery in Dallas, with a 70,000 barrel a day capacity was shut down due to blast.Effects•Analysts are unsure whether the market demand, due to the slowing economy, will legitimize the rise in price.•Inflation could rise due to “supply jitters”. •Drivers could see a an increased price at the pump due to the approaching spring “driving season”.* Information from Article titled “Supply worries spur crude back above $100 a barrel” from MarketWatch by DowJones; http://www.marketwatch.com/news/story/crude-makes-swift-climb-back/story.aspx?guid=%7B463E952B-0B60-48BA-901C-0874DDC7CE70%7DFebruary 19 - Dow Jones, S&P, and NASDAQ plummet as crude prices rise above $100 a barrel for the first time- crude oil closes above $100 a barrel -- crude oil closes above $100 a barrel -Why???1. Alon USA in Texas shuts down because of an explosion and a fire2. Speculation that OPEC will lower production3. March crude oil contract expires February 20 – crude prices rise due to short-covering in advance of the expirationLECTURE CONTENTToday’s Lecture•Basic investing concepts– Risk-Reward / Financial Goals / Understanding Your Appetite for Risk•Portfolio Management– Diversification– Concentration•Different investment securities– Bonds / CDs / Money Market–Mutual Funds / Exchanged-Traded Funds•Market PsychologyBasic Investing ConceptsDetermining Your Financial Goals•Investing is a long car trip. There needs to be a lot of planning that goes into it.– How much money do you want to make? By when?– Will you need to live off your investments in future years?–What will you be using your money for?•Having a good understanding of yourself will allow you to align your risk tolerance with various strategiesDetermining Your Investment Style•What kind of person and investor do you want to be?–Shooting for singles and doubles, aiming for slow and steady gains?– Sitting on the sidelines, relying on and cheering someone else?– Willing to take risks, go for homers, and achieve maximum gains?•Think about your risk tolerance, time horizons for your investments, and your time commitmentThe Risk / Return Tradeoff•“principle that expected return rises with an increase in risk”– Lower risk with lower returns– Higher risk with high returns•Important to know your personal risk tolerance when choosing investments– Balance between risk and rewardRisk Tolerance•Young people should be in stocks– Time is our best friend•BUT, need to be able to handle the market’s volatility– If not… then get out!Source: Investopedia. “Determining Risk and The Risk Pyramid.” May 2 2003What is Your Risk Tolerance?Source: Investopedia. “Determining Risk and The Risk Pyramid.” May 2 2003(Expected) Return vs. RiskPortfolio ManagementPortfolio•Definition: “collection of assets—such as stock, bonds, and mutual funds—held by an investor”•Portfolio Management– Deciding type of investment mix and allocation for your portfolio– Risk versus performanceAsset Allocation •Income•Balanced•GrowthActive versus Passive ManagementBuy, sell, buy, sell…versusBuy and sit?Active versus Passive Management•Examples (Active Management)– Buying / selling individual stocks– Discuss with your broker which stocks to buy– Choosing between different mutual funds•Example (Passive Management)–Buying an index fund that mirrors the S&P 500 – Having your portfolio match the index fund at all times (relatively hard and expensive)–Typically has lower feesDistribution of Returns of Actively Managed FundsHow many stocks should I own?Diversification versusConcentration“Don’t put all your eggs in one basket”DiversificationDiversification•Mixing a wide selection of investments within a portfolio– By industry, sizes, geographic locations, or other characteristics•Positive performance of some investments may neutralize the negative performance of othersDiversification…What’s the Catch?•Limits your upside potential– Hot stock makes up only 5% of your portfolio–50% increase will have small effect•Many investors tend to over-diversify–Harder to keep track, slower to react – Know a little bit about every industries– Over-diversification usually leads to underperforming the market (What’s the point then?)Concentration“putting your eggs in a few baskets that you know well and watching them very carefully”Concentration•Goal: Keep losses small and ride profits for big gains– Effect: big gains have major effect on your portfolio value•Increases risk– Potential for big profits/losses is magnified•Fund managers can’t do thisOther Investment SecuritiesMutual Funds & Exchange-Traded FundsVarious investment securities•Money market funds (~3-4%)– Type of risk-free debt investment that has slightly better returns than savings– Typically mature in less than 1 year– Very liquid (i.e. easy to buy/sell and convert to cash)– Usually automatically get this in a brokerage account •Certificate of
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