COA4131 Study Guide Test 3 Chapter 11 To build wealth one needs an investment plan and a good return on money Investment is the commitment of funds to the achievement of long term goals They are the key to long term financial success Individuals invest to make money they help money grow so that there is more to spend save and reinvest Before you start investing the following tasks should be completed o Your life is stabilized You have a job a place to stay your car runs etc o Have a net worth estimate and a budget so you know how much you take in each month how much you spend and how much you have left to invest o Have a regular savings plan and money set aside for emergencies o Credit cards should be paid off and under control o You should be enrolled in your employers sponsored retirement plan These plans have tax advantages and most employers match at least part of your contribution 4 steps in investing 1 Setting goals and developing an investment attitude 2 Assessing risk and return a Investment horizon refers to how long you need to save or invest to get something that you want b Expected returns are anticipated future returns c Current income refers money received from an investment d Capital gains refers to income that results from an increase in the value of an investment e Capital losses refer t o lost income resulting from a decrease in an investments value f The return is the total income from an investment based on current income plus capital gains or minus capital losses g The best measure of return is total return which is the annual return on an investment including appreciation and dividends or interest h Yield is return on a capital investment i Current yield is the annual interest on a bond divided by market price It is the actual rate of return Investment risk refers to uncertainty over what an investments actual return may be over a period of time j 3 Selecting the right investments and allocating assets a Asset allocation is a target mix of stocks bonds and cash investments b Investors should diversify their investments which means to put money into different forms of investing c A portfolio is created whereby the assets held by an investor are evaluated and managed as a group A portfolio is the combining of holdings to increase diversification and to reduce risk 4 Managing investments revolves around 3 questions a How much should be invested b How long investments should be held c Who should be involved in investment decisions and processing buy and holds The following questions are helpful in setting goals and developing an investment frame of mind 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 What can I realistically expect Steps in the investment ladder first step is the safest and as you move up the more risk 1 Security cash CDs government savings bonds insurance retirement plans U S treasury securities money market funds saving accounts 2 Safety and Income preferred stocks corporate bonds government and municipal bonds other than savings bonds utility stocks and some REITS 3 Growth growth stocks growth mutual funds raw land real estate convertible bonds 4 Speculation options commodities junk bonds penny stocks collectibles metals gems and future contracts Types of investments The goal of savings is to accumulate funds in a risk free conservative manner based on interest over time Stocks represent ownership in a corporation represented by shares Bonds are investments in which you lend money to some organization for a period of time Dividends are distributions of money from a corporation or government to investor Mutual funds are groups of stocks bonds or other securities managed by an investment company Money market instruments mean that you lend money to an organization such as a bank or the government They offer security and liquidity As a general rule real estate increases value and you will make profit but there are no guarantees Real estate is less liquid less readily turn into cash than most other forms of investments Those close to retirement or already in retirement will receive a lifetime of social security checks which the amount is determined by the government Company pensions can provide a monthly check at retirement but does not have built in inflation protection like social security Large holdings mean that executives and family owners of companies may have a lot of money tied up in stock in that company like bill gates and Microsoft Owning a business is risky but it can be thought of as an investment since owning a stake in your own business is similar to owning stock in a large corporation Anticipated inheritance is wills or final health expenses of those who intend on leaving you with their estate when they pass Precious metals and collectables serve as a hedge against inflation however they are often overestimated in the value of their collection Annuities are contracts bought from life insurance companies in which the company promises the insured a series of periodic payments and if the company is secure will pay as long as a person lives Conservative Moderate and Aggressive asset allocation Transaction costs are charges for buying and selling securities Investing Strategies and Terms Risk and investment o There are two kinds of investment risk the risk of losing money by being too aggressive and the risk of losing buying power by being too conservative Tradeoffs between risk and return o There is a difference between the expected return anticipated future return and the realized return the actual return o Investors want to maximize their return if they minimize risk they lower their expected return Tax Shelters tax liabilities Dollar Cost Averaging o If an investment is tax free or tax exempt the investor keeps the entire return free from o If an investment is tax sheltered there are no taxes due on the profits until on or more years in the future This allows the profits to grow untaxed o Dollar cost averaging is the systematic investing of equal sums of money at regular intervals regardless of fluctuations in the price of an investment For example putting 50 each month into a mutual fund or single stock such a Coca Cola over several years The investor buys whether the mutual fund or stock price is rising or falling Dividend investment plans DRIPS are automatic reinvestment of shareholder dividends to buy
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