Final Exam Study GuideChapter 11: Fundamentals of Investing• Investment definedo Investment Commitment of funds to achievement of long-term goals Purpose of investment• Achieve financial goals• Increase current income• Gain wealth and financial security• Have funds for homes, children’s college educations, and retirement Importance of investing• Rising prices (inflation)• Salary raises are barely keeping pace with inflation. To get ahead, people need to invest. Also, downsizing, early retirements, and job instability have given people more reasons to invest• People are living longer, their money has to last longer• Worries that Social Security will not exist by the time it will be needed• Turn toward self-directed retirement plans• Preparations of investingo Stable life Living in a place you plan to stay for awhile Have a job Moving expenses paid for you Car runs Have insurance Student loans paid off/under control Etc.o Net worth Estimate of what you own, what you owe Know how much you taken in each month, how much you spend, and how much is left to investo Regular savings Plan and money set aside for emergencies Need to be a saver before you become an investoro No credit card debt Interest paid on credit cards is money down the drain that can rarely be recouped through investmentso Employer sponsored retirement plan Should be enrolled Have tax advantages and most employers match at least part of your contribution• Four steps in investingo 1. Setting goals/developing investment attitude 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?o 2. Accessing risk and return Investment horizon• How long do you need to save or invest to get something that you want? Expected returns• Anticipated future returns Current income• Money received from an investment Capital gains• Taxes on the profit from the sale of an asset Capital losses• Lost income resulting from a decrease in an investment’s value Return• Total income from an investment Total return• Annual return on an investment, including appreciation and dividends or interest Yield• Return on a capital investment, typically bonds. Current yield• Rate of return determined by dividing a bond’s annual income amount by its current market value Investment risk• Uncertainty over an investment’s actual returno 3. Selecting investments and allocating assets Asset allocations• Target mix of different types of investments Diversify• Putting money into different types of investments Portfolio• Combined holdings to increase diversification and to reduce risk• Active portfolio management involves buying and sellingo 4. Managing investments How much should be invested How long should investments be held• Buy and hold. This is a long-term strategy involving keeping investments for many years• More activity. In short-term strategies the performance of individual investments often leads to changes Who should be involved in investment decisions and processing buy and holds• One has to select the broker, firm, or institution to use for buying & sellingo Speculation Options Commodities Junk bonds Penny stocks Collectibles Metals Gems Futures contractso Growth Growth stocks Growth mutual funds Raw land Real estate Convertible bondso Safety and income Preferred stocks Corporate bonds Gov. and municipal bonds other than savings bonds Utility stocks Some REITS (real estate investment trusts)o Security Cash CDs Gov. savings bonds Insurance Retirement plans U.S. treasury securities Money market funds Savings accounts• Types of investmentso Savings Goal is to accumulate funds in a risk-free, conservative manner based on interest (amount earned on the amount placed in the investment) over time.o Stocks, bonds, mutual funds, money markets Stocks• Ownership in a corporation represented by shares Bonds• Investments involving lending money to organizations Mutual funds• Groups of stocks, bonds, or other securities managed by an investment company Money markets• You lend money to an organization such as a bank (certificates of deposit) or the government• Offer security and liquidityo Real estate Rental property• Serves as source of income and a hedge against inflation Own land or own and live in a house• Hedge against inflation As a general rule real estate increases in value and you will make a profit, but there are no guarantees Less liquid, less readily turned into cash, than most other forms of investmentso Social security Those close to retirement/already in retirement• Will receive a lifetime of social security checks Those further away• May or may not receive checks, depending on the future of social security. Alternatives are being considered for full or partial funding• Partial checks• Delaying the receiving of checks to a later age• Reducing percentage that non-working spouses receiveo Company pensions Can provide a monthly check at retirement May not have built-in inflation protection, can be a set number of dollars per month without change Fixed pension• Less buying powero Large holdings Less common, but what it means is that executives and family owners of companies may have a lot of money tied up in stock in that companyo Your own business Risky, but can be thought of as an investment since owning a stake in your own business is similar to owning stock in a large corporationo Anticipated inheritance Will can change or final health expenses and taxes can take away any money that was left in an estate, but it can work outo Precious metals and collectibles Gold, silver, art, antiques, stamps, collectibles, and jewelry that serve as a hedge against inflation Important to know your subject and to buy from reputable dealerso Annuities Contracts bought from life insurance companies in which the company promises the insured a series of periodic payments If company is secure, annuity pays as long as a person liveso Transaction
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