Lecture on investments for personal finance class

1. INVESTMENTS
Objectives:
- Understand reasons to save and invest
- Understand Risk/Reward Tradeoff
- Understand the difference between
stocks & bonds
- See examples of low risk, medium risk,
and high risk investments

2. How are savings & investments related?
• Why is saving important?
• What is the difference between saving and
investing?
• Investing is a strategy to earn more on your
money than the rate of inflation.
• Investments lead to wealth – the
accumulation of assets over time

3. Emergency Fund
• An emergency fund is money set aside for
unplanned expenses.
• An emergency fund of $1,000 is a good first goal.
• If you never let your checkbook balance go
below $1,000, that can be a $1,000 emergency
fund.
• You should work toward having 3 to 6 months
living expenses in an emergency fund.
• Liquidity is a measure of how quickly an asset
can be turned into cash.
• An emergency fund needs to be liquid.

4. Investments & Goals
• Short term goals
– Emergency fund
– Vacation fund
• Medium Term goals
– Buying a car
– College education
– Wedding
• Long term goals
– Babies ($475,680 birth to age 17)
– House
– retirement

5. Build Financial Security
• The ability to meet current and future needs
while living comfortably
• Takes time to build

6. Retirement & Beyond
• Retirement is the period of time when you
are not working but are able to meet
expenses through other income sources such
as:
• Employer-provided retirement plans
• Social Security
• Savings & investments

7. Start Early

8. Investing $1200/year for 20 years

9. Estate Planning
• An estate is all that a person owns (assets)
minus their debts at the time of their death.
• Who should get this money?
• If you don’t make a will before you have your
first baby, do it then.

10. Health Care Power of Directive
• If you are unable to make medical decisions
for yourself, who do you want making them
• Important for anyone over 18 to have

11. Durable Power of Attorney
• A person who can sign for you, get money
out of your account, pay bills for you, etc.
• Often used for elderly people who need
assistance
• Sometimes recommended for students away
at college

12. How is risk related to reward?
• The perfect investment:
– The principal is completely safe
– The rate of return is very high
– The investment is liquid
– You can invest quickly and easily
– The costs of investing are low
– The earnings and long term gains are tax-free
• The bad news: There is no perfect investment

13. How does your principal grow?
• You deposit more money
• Interest is added to the principal
– compounding

14. Return on Investment (ROI)
• The amount that the savings or investment
grows is called the return.
• The Return on Investment (ROI) is a
measurement of return expressed as a
percentage.
• Example:
– Investment Cost $500
– Return: $18
– ROI $18/$500 = 3.6%

15. Another Example
• Purchase an investment for $500.
• Sell it a year later for $540
• Sales Price – Money Invested x 100
• Money Invested
• 540-500 = 40 = .08 * 100 = 8%
• 500 500
• Now do ROI worksheet

16. What types of risk do investors face?
• Inflation risk
– If you purchase a 4 year investment at 1%, and
inflation is 5% per year, your money has lost value
– Current CD Rates
• Industry risk
– Ethanol is turning corn into fuel
– Corn is more in demand so corn prices go up
– Catfish farms feed corn to the fish, but their feed
prices skyrocketed.
– Catfish farming industry devastated
• Political risk
• Stock risk – individual companies rise and fall

17. Tax Advantages of Investing
• Tax deferral – postponing taxes
– IRAs, 401k’s, and 403b’s are retirement funds that
are not taxed until money is withdrawn.
– When you are making less money because you are
retired, your tax rate will be lower.
– Your interest and dividends accumulate faster if
money is not withdrawn for taxes

18. Tax Advantages of Investing
• Tax exemption
– Series EE and Series I savings bonds are tax free if
they are used for education
– Municipal bonds are tax exempt
– More valuable for people in higher income
brackets
– Rates are lower than corporate bonds because
these are tax exempt

19. Employer Sponsored Plans
• Some employers encourage you to save by
matching part or all of your retirement savings.
• If your employer offers this, make every effort to
take advantage of it.
• Employees sometimes must be vested to claim
the employer share of this. Vesting often
happens after 3 to 5 years of employment.
• If you leave the company before you retire, you
can get a cash payout (and pay taxes) or roll it
over to an IRA.

20. Investment Strategies
• Investment tracking – making investment
choices by following the prices of stocks and
other investments over time.
• Market timing – buying and selling stocks
based on what the market is expected to do
• Dollar-cost averaging – investing the same
amount of money on a regular basis such as
monthly

21. How can you reduce investment risk?
• Build an investment portfolio that is
diversified
• A stock is an ownership interest in a publicly
held company
• A bond is a debt instrument issued by a
corporation or government
• High and low risk
• Some international eventually
• Real estate

22. Consider the market
• A bull market exists when stock prices are
steadily increasing
• A bear market exists when stock prices are
steadily decreasing

23. Consider economic conditions
• Economic growth is a period of time when
people are working (low unemployment rate),
profits are good, wages are rising, and people
are optimistic.
– If you think a decline is coming, consider selling
• Economic decline is when the economy is
slowing down, the market for investments is
declining, and prices may be falling
– Usually a good time to buy stock (if you have the
money)

24. Choices

25. LOW RISK SAVINGS OPTIONS
& INVESTMENTS
Lower Risks Mean Lower Rewards

26. Savings & Checking Accounts
• Banks are FDIC insured. As long as the
Federal government is operating, you will not
lose your principal.
• Very liquid – quick and easy to get money out
• Low returns
– checking
– savings

27. Money Market Accounts & Funds
• Offered by banks and brokerage firms
• Very liquid
• Offer higher rates of interest in exchange for
larger than normal deposits. Minimum balance
might be $1000 or $5000.
• A money market fund is a type of mutual fund
that invests in low risk securities such as U.S.
Treasury bills. Not FDIC insured, but generally
considered safe.
• Number of withdrawals per month is usually
limited.

28. Certificates of Deposit
• Money set aside for a specific period of time
at a fixed interest rate
• Higher interest rates than savings accounts or
money markets, but less liquid
• FDIC insured – principal is very safe
• If you redeem a CD early you pay an early
withdrawal penalty
• A jumbo CD is for a large amount, usually
$100,000 or more, and pays higher interest

29. Life Insurance Savings Plans
• “Permanent” life insurance has a savings
feature that gains in cash value.
• Low rates of return.
• Illiquid
• Not FDIC insured – if the insurance company
goes under, this disappears

30. Bonds
• A bond is a loan that a buyer makes to a bond
issuer
• The face value is the amount the bondholder
will be repaid on the maturity date.
• A discount bond is one that is sold for less
than its face value. (interest rate is low)
• A premium bond is one that would be sold for
more than face value. (interest rate is high)

31. Corporate Bonds
• Corporations issue these to raise money
• Corporate bonds pay a coupon rate, which is the
fixed rate of interest that is paid semiannually
for the life of a bond.
• At maturity, the bond can be redeemed for face
value.
• Offered for sale in multiples of $1,000 to $5,000.
• Wide variety of terms
– Short term: 1-2 years
– Medium term: 3-10 years
– Long term: >10 years

32. Corporate Bond Terms
• A callable bond has a clause that allows the
issuer to repay the bond early.
– If interest rates go down, the corporation will call
the bond and issue bonds at a lower rate.
– Usually pays a higher interest rate because of the
additional risk.
• A convertible bond can be exchanged for
shares of common stock at the option of the
bondholder.

33. Corporate Bond Terms
• A zero coupon bond is a discount corporate
bond that does not provide the typical
semiannual interest payments.
– Sold at a deep discount and grows in value over
time
– Good for long term investments like a child’s
education or retirement

34. Bond Risks
• Some bonds have low risk, some have high risk
• Standard & Poor’s and other organizations rate
bonds
• Investment-grade bonds have high ratings (AAA,
AA, A, and BBB)
• Speculative-grade bonds have low ratings (BB
and lower). Also called junk bonds
• Which type of bond pays higher interest?
• Corporate bonds are riskier than government
bonds and pay more.

35. Government Bonds and Securities
• Issued by the U.S. Treasury or by U.S.
government agencies
• Low risk when held to maturity
• Most are state and local tax free, so they are
a tax shelter – an investment that allows you
to legally avoid or reduce income taxes.

36. Government Bonds and Securities -
Examples
• Series EE Savings bonds
– Interest added monthly and paid when redeemed
– Interest is tax-free if used to pay for education
– Can hold up to 30 years
• I Savings Bonds
– Similar to Series EE but a combination of a fixed rate and
a variable rate adjusted annually based on inflation
• Treasury Bills “T-bills”
– Sold in terms of 4 to 52 weeks
– Sold at a discount from the face value. You might pay
$980 for a bond and redeem it 4 weeks later for $1000.

37. Government Bonds and Securities -
Examples
• Treasury Notes “T-notes”
– Sold in terms of 2 to 10 years
• Treasury Bonds
– 30 year terms
– Interest rates usually higher because of the longer
terms
• Treasury Inflation-Protected Securities (TIPS)
– Guaranteed to keep pace with the rate of inflation
as measured by the Consumer Price Index (CPI)
– Terms of 5 to 30 years

38. State and Local Securities
• Municipal Bonds
– Issued by states, counties, cities, and towns
– Used to pay for roads, public buildings, etc.
– Low risk – governments seldom go bankrupt
– Most are exempt from Federal, state, and local
taxes
– Good investments for people in high tax brackets

39. Annuities
• An annuity is a contract purchased from an
insurance company that guarantees a series
of regular monthly payments for a set time.
– Often used to provide retirement income
– Only as safe as the company you invest with
– Sometimes tax deferred – pay taxes when you
collect the payments

40. MEDIUM RISK INVESTMENTS
Higher Risks Mean Higher Rewards

41. Mutual Funds
• A mutual fund is a professionally managed
group of investments bought using a pool of
money from many investors.
• Contain stocks, bonds, and other investments,
so they are diversified, which lowers risk
• Mutual funds are an example of indirect
investing – you buy shares of the fund instead
of individual stocks and bonds.
• Different funds have different strategies
• Investors can do asset allocation – choosing a
combination of funds within a single mutual
fund company. For example:

42. Mutual Fund Type Description
Balanced funds Diversified portfolio that includes low, medium, and high
risk stocks, with a balance between growth and income
Bond funds Invest in a variety of bonds
Global funds Invest in international companies
Growth funds Invest in companies that are expected to grow over the
long run. Often high-risk in the short run
Income funds Invest in bonds and stocks that produce steady and
reliable dividends and interest payments
Index funds Invest in entire market (lots of stocks or lots of bonds)
Vanguard Stock Index Fund
Money market funds Invest in short-term securities that go up or down with
current interest rates and the economy
New venture funds Invest in new and emerging businesses and industries.
High risk, high return choices
Precious metal funds Invest in companies that are associated with precious
metals such as gold, silver, and platinum
Stock funds Invest primarily in stocks. Can be categorized into types
of stocks – blue chips, technology, medical, etc.

43. Personal Residence
• Possibly the best investment you will ever
make
• Usually takes several years to make a profit
• Good tax shelter. The first $250,000 of profit
is tax exempt when you sell your house (or
$500,000 for a married couple)
• Anything over that is subject to capital gains
tax

44. Individual Retirement Accounts
• An IRA (Individual Retirement Account)
allows individuals to deposit money into an
account during their working years for
withdrawal when they are retired.
• Managed by the investor
• Maximum contribution in 2016 is $5,500

45. Types of IRAs
• Traditional
– Tax deferred
– You can deduct the amount you deposit if your
adjusted gross income is below $117,000 (or
$184,000 if married filing jointly)
– you must begin withdrawals by age 70 ½
• Roth
– Contributions are taxed but earnings are not
• Spousal
– Set up by a working spouse for a spouse who has no
income
– Can be traditional or Roth

46. SEP Accounts
• SEP (Simplified employee pension) plan is a
tax-deferred retirement plan for small business
owners and their employees.
• Similar to an IRA
• The amount of money that can be set aside is
higher than for an IRA
• The employer sets up a SEP IRA for each
employee and contributes to it
• Each employee chooses how to invest their own
money

47. Keogh Accounts
• A Keogh account is a tax-deferred retirement
plan for self-employed professionals
• Similar to a SEP but more complex to
establish
• Up to $195,000 per year can be contributed
• Often used by higher-income business
professionals such as doctors and lawyers

48. Retirement Plans Through Employers
• A defined-contribution plan is an employer-
sponsored retirement plan in which
employees can receive a periodic or lump-
sum payment for retirement.
• Employees are not promised a specific
amount – it will depend on how much they
put in and how their investments did.
• Employees invest part of their salaries.

49. Types of Defined-Contribution Plans
• 401(k)
– Used by employees of for-profit companies
– Sometimes employers match part or all of
employee contributions. (If they do, definitely
participate!)
• 403(b)
– Used by employees of government and nonprofit
organizations
– Never matched by employers

50. Defined Benefit Plans
• A defined-benefit plan is an employer-
sponsored retirement plan in which retired
workers receive a set monthly or lump sum
payment based on their wages earned and
number of years of service.
• Also known as a pension
• Disappearing because if the economy goes
bad or the company is doing poorly, it is very
difficult for them to make the payments
(General Motors, for example)

51. Portability
• Most retirement accounts are portable – you
can take the account with you when you
leave a job.
• A rollover is the process of moving a
retirement account balance to another
qualified account without incurring a tax
penalty.

52. Peer to Peer Lending
• In $25 increments loan money to individuals
over the Internet
• You get to see their credit scores and you
earn more interest for loaning to people with
lower credit scores
• Lendingclub.com is one website that does
this

53. HIGH RISK INVESTMENTS
Higher Risks Mean Higher Rewards

54. Direct Investing
• Direct investing is buying stocks and other
investments directly from companies
• When you buy stock in a corporation, you
become a stockholder. Stockholders own the
company.
• Stockholders hope to make money by:
– Dividends, usually paid 4 times a year
– Growth - Selling stock for more than they
purchased it for

55. Stock Terms
• Stocks are considered risky because an
individual company can fail.
• Stocks are considered long-term investments.
• Stocks are purchased through stockbrokers.
• Stock brokers have accounts at stock
exchanges such as the New York Stock
Exchange (NYSE) and the over-the-counter
market (NASDAQ)

56. Stock Terms
• Many companies have 2 kinds of stock:
• Common stock pays variable dividends and
gives owners voting rights.
• Preferred stock guarantees a fixed dividend
but does not provide voting rights. Generally
more expensive than common stock.

57. Futures Contracts & Commodities
• A futures contract is an agreement to buy or
sell a specific commodity at a set price on a
set date in the future.
• A commodity is an item that has the same
value across the market with little or no
difference in quality among producers.
– Soybeans, silver, cattle, coffee, pork bellies
• Futures contracts are used to hedge, or
reduce the likelihood of losing money in the
future.

58. Investment Clubs
• An investment club is a group of people who
pool their money together to buy and sell
investments.

59. Business Ownership
• Starting a business
– Sometimes the goal is an initial public offering (IPO)
• Buying a business
– A franchise is one way of doing this
• Investing in a business venture
– Venture capitalists use their own money to help new
businesses get started, and often offer advice too. In
return, they own part of the company
– A business owner who invests but lets others make
the decisions is a silent partner.

60. Other High-Risk Choices
• Real Estate
– Land
– Real Estate Investment Trusts (REIT) – a
corporation that pools the money of many
individuals to invest in real estate.
– Rental property
• Collectibles
• Precious metals and gems