CHAPTER 11FUNDAMENTALS OF INVESTINGDid you know??*In 1637, in the Netherlands, a single tulip bulb was worth the cost of the best house in Amsterdam.* One hundred hundred shares of AT&T purchased in 1983 at a cost of $6,140 is now worth about $74,562, representing a 17.7 percent annual return.INVESTMENT DEFINED:● Investment: The commitment of funds (capital) to achievement of long term goals or objectives. ○ Investments serve as a vital role in financial planning because they concern the management of wealth.The are the key to long term-financial success. ● Purpose of investment:Individuals invest to make money. more specifically, they invest to: achieve financial goals; increase current income; gain wealth and financial security; and have funds for homes, children’s college educations, and retirement.● Importance of investing: Investing has always been an important part of building wealth but in recent years it has become more critical because of ○ rising prices (inflation)○ In many jobs salary raises are barely keeping pace with inflation. To get ahead people need to invest. PREPARATIONS FOR INVESTING● Stable life● Net Worth: so you know how much you take in each month, how much you spend, and how much you have left to invest.● Regular Savings: money set aside for emergencies● No credit card debt: credit cards should be paid off or under control● Employer sponsored retirement plan: These plans have tax advantages and most employers match at least part of your contributionFOUR STEPS IN INVESTING● Setting goals/ Developing Investment Attitude○ One of the most important factors affecting goals is current income, but as a student you are in a different situation...It should be based on your anticipated income after you graduate.○ Questions to help in setting goals:■ What do I really want?■ How much money will it take to get there?■ How much money do I have (or will I have)?■ How long will it take to get the money?■ How much risk can I take?■ Am I willing to give up things I want now to live better in the future?■ Given my circumstances, what can I realistically expect?○ In a poll of 2000 freshman, 81 percent said owning a home is very important and 46 percent said individual retirement accounts (IRAs) and pensions are important. Only 31 percent said stocks, bonds & mutual funds are important.● Assessing Risk and Return○ The first question refers to investment horizon. How do you need to save or invest to get something you want? ○ Expected Returns: Anticipated future returns○ Current Income: Money received from investments○ Capital Gains: refers to the income that results from an increase in the value of an investment.○ Capital Losses: refers to the lost income that results from a decrease in the value of an investment. ○ Return: The total income from an investment based on current income plus capital gains or minus capital losses.○ Total Return: The best measure of a return, The annual return on an investment including appreciation and dividends or interest. It tells how well an investment is performed in a year.○ Yield: Return on a capital investment. Most commonly the word yield is used to refer to bonds. ○ Current yield: is the annual interest on a bond, divided by market price. It is the actual rate of return.○ Investment Risk: Uncertainty over an investment’s actual return.● Selecting Investments & Allocating Assets○ Eventually what investors seek is a comfortable, workable level of assets.○ Asset Allocation: A target mix of stocks, bonds, and cash investments, such as treasury bills, CD’s and money market funds. ○ Diverisfy: Investors should Diversify their investments which means to put money into different forms of investing, such as stocks, bonds, mutual funds & real estate. It is an investment strategy that is employed to balance risk by ensuring that “not all your eggs are put into one basket”○ Portfolio: is created whereby the assets held by an investor are evaluated and managed as a group.○ INVESTMENT LADDER: Tradeoffs between risk and return■ Step 4: Speculation● Options, commodities, junk bonds, penny stocks, collectibles, metals, gems, futures contracts■ Step 3: Growth● growth stocks, growth mutual funds, raw land, real estate, convertible bonds.■ Step 2: Safety & Income● Preferred stocks, corporate bonds, gov. and municipal bonds, other than savings bonds, utility stocks, and some REITS (Real estate Investment Trusts)■ Step 1: Security● Cash, CD’s, Gov savings bonds, insurance, retirment plans, U.S. treasury securities, money market funds, savings accounts.■ (The first step is the safest, money is the most secure. As you move up the ladder, more risk may be encountered, but also the possibility of a higher rate of return.) ● Managing Investments○ How much should be invested?○ How long should investments be held? ○ Who should be involved in investment decisions and processing *buy & holds(long term strategy involving keeping investments for many years? There are 80,000 reps to choose from in the U.STYPES OF INVESTMENTS● Savings: The goal of savings is to accumulate funds in a risk-free, conservative manner based on interest.● Stocks, Bonds, Mutual Funds, and money market instruments:○ Stocks: represent ownership in such corporationsas Intel, Pepsi-Cola, and IBM○ Bonds: Investments in which you lend money to some organization (corporation or government) for a period of time.○ Dividends: Distributions of money from a corporation or government to investors.○ Mutual funds:groups of stocks, bonds, or other securities managed by an investment● Real estate ● Social security ● Company pensions ● Large holdings ● Your own business ● Anticipated inheritance ● Precious metals and collectables ● Annuities INVESTING STRATEGIES & TERMS● Risk and investment ● Dollar cost averaging: systematic investing of equal sums of money at regular intervals regardless of price fluctuations in an investment ● Dividend Investment Plans (DRIPs) ○ Automatic reinvestment of shareholder dividends to buy additional stock ● Direct investment plans ○ Investors buy stock directly from a corporation ● Employee stock ownership plans ○ Program in which employees can buy stock in the company they work for at a reduced price or with matching funds for employers CHAPTER 12 STOCKSCOMMON STOCKSIssuers of Common stock: ○ Ex: The Buckle, Inc.
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