Final Exam Study Guide Chapter 11 Fundamentals of Investing Investment defined o 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 investing o Stable life Living in a place you plan to stay for awhile Have a job Moving expenses paid for you Have insurance Car runs 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 invest o Regular savings o No credit card debt Plan and money set aside for emergencies Need to be a saver before you become an investor Interest paid on credit cards is money down the drain that can rarely be recouped through investments o Employer sponsored retirement plan Should be enrolled Have tax advantages and most employers match at least part of your contribution Four steps in investing o 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 Given my circumstances what can I realistically expect Am I willing to give up things I want now to live better in the future 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 Current income Anticipated future returns Money received from an investment Capital gains Capital losses Return Total return Yield Current yield Investment risk Asset allocations Diversify Taxes on the profit from the sale of an asset Lost income resulting from a decrease in an investment s value Total income from an investment Annual return on an investment including appreciation and dividends or interest Return on a capital investment typically bonds Rate of return determined by dividing a bond s annual income amount by its current market value Uncertainty over an investment s actual return o 3 Selecting investments and allocating assets Target mix of different types of investments Putting money into different types of investments Combined holdings to increase diversification and to reduce risk Active portfolio management involves buying and selling Portfolio o 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 selling o Speculation Commodities Junk bonds Penny stocks Collectibles Options Metals Gems Futures contracts o Growth Growth stocks Growth mutual funds Raw land Real estate Convertible bonds o Safety and income o Security Cash CDs Gov savings bonds Insurance Retirement plans U S treasury securities Money market funds Preferred stocks Corporate bonds Gov and municipal bonds other than savings bonds Utility stocks Some REITS real estate investment trusts Savings accounts Types of investments o 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 Ownership in a corporation represented by shares Investments involving lending money to organizations Groups of stocks bonds or other securities managed by an investment Stocks Bonds Mutual funds company Money markets You lend money to an organization such as a bank certificates of deposit or the government Offer security and liquidity o 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 investments o Social security Those close to retirement already in retirement Will receive a lifetime of social security checks Those further away security May or may not receive checks depending on the future of social 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 receive o 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 power o Large holdings o Your own business 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 company 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 corporation o 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 out o 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 dealers o 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 lives o Transaction costs involved in investing Transaction costs Charges for buying and selling securities Investing strategies and terms o Risks and investment Risk of losing money by being too aggressive Risk of losing buying power by being too conservative o Tradeoffs between risk and return Realized return Actual return on investments o Tax shelters Tax free or tax exempt No taxes Tax sheltered No taxes are charged on profits until a later date Investors in
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