Investment Basics C H A P T E R P L A Y L I S T S O N G : F o r t h e L o v e o f M o n e y b y T h e O ' J a y s

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1 Investment Basics C H A P T E R P L A Y L I S T S O N G : F o r t h e L o v e o f M o n e y b y T h e O ' J a y s McGraw-Hill/Irwin Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

2 Learning Objectives LO 11-1 Distinguish between savings and investments. LO 11-2 Analyze the risk and return on varying investment products. LO 11-3 Interpret the hierarchies of the investment pyramid. LO 11-4 Examine the importance of varying your investments. LO 11-5 Compare portfolio asset allocations for the different personal finance life stages. 11-2

3 Savings vs. Investments Who is rich? He that is content. Who is that? Nobody. ~ Benjamin Franklin How much money should you have in savings vs. investments? What is the difference? Savings is not to make you rich, but it is to keep you from being poor. ~ J.B. Quinn Savings No or low-risk investments with low returns. 11-3

4 Should You Save or Invest? Figure

5 Impact of Inflation on Savings Inflation is the overall increase in the price of goods and services over time Savings - retain your purchasing power by having your interest rate remain the same or higher than the inflation rate Investing - beat the inflation rate and grow your value in real terms Bureau of Labor Statistics Consumer Price Index page Consumer Price Index from 1913 present 11-5

6 BLS CPI Home Page 11-6

7 Insured Savings FDIC Federal Deposit Insurance Corporation NCUA National Credit Union Association United States Treasury Bills, Notes, and Bonds Backed by the full faith and credit of the United States government Risk Premium The difference between the risk-free rate of return and the expected yield of an investment with risk. 11-7

8 Making $en$e How does an investment differ from savings? How much money should you have in savings before you venture into investments? What is a risk premium? 11-8

9 Risk of Investing Investing has risk the chance of losing some or all of your investment To compensate for risk and entice an investor, investments with risk must pay a premium Risk premium compensation for taking on the risk Zero risk FDIC, NCUA, U.S. Treasury bills, notes, and bonds risk-free rate 11-9

10 Types of Risk Default Risk or Credit Risk Risk that the company invested in may declare bankruptcy 2009 Chrysler bankruptcy: bondholders received $0.26 for every dollar they invested Bondholders could lose their entire investment FDIC and NCUA will insure deposits up to $250,

11 Types of Risk Interest Rate Risk Risk taken on when you lock into a fixed-rate investment for a specific length of time 11-11

12 Types of Risk Interest Rate Risk Risk taken on when you lock into a fixed-rate investment for a specific length of time 11-12

13 Types of Risk Market Risk The risk that the value of your investment will decrease due to changes in the market Gold prices Housing market Oil prices 11-13

14 Liquidity Risk The risk that you will not be able to cash out your investment quickly enough to either meet cash flow needs or to prevent a loss. Types of Risk 11-14

15 Analyzing Your Risk Tolerance How much can you afford to lose? Rule of thumb: The higher the risk, the higher the potential return and the less likely you are to achieve the higher return Risk tolerance quizzes Rutgers University s Investment Risk Tolerance Quiz money.msn.com 11-15

16 Investment Pyramid 11-16

17 Diversification of Assets Diversification Spreading out the risk across multiple investments Why is diversifying your investments important? Portfolio Holding more than one investment Asset Allocation The types of assets you are holding in your portfolio Diversified Balanced Funds Both equities and bonds Targeted and automatic asset allocation mutual funds 11-17

18 Asset Allocation for Target Date Funds T. Rowe Price Balance Fund (RPBAX) Vanguard Target Retirement Fund Asset Allocation Tool 11-18

19 Portfolio Evaluation Re-evaluate your investment goals, risk tolerance, portfolio returns, and asset allocation at least once a year and rebalance your portfolio Pick an easy date to remember to rebalance your portfolio Birthday January 1 st Other special days 11-19

20 Life Stages and Accounts How Should the Assets Be Allocated? Independent (16-24) 529 College Savings Account Retirement Savings Roth IRA 401(k) Early Family (25-44) Roth IRA, 401(k) 529 College Savings Account House Down Payment Auto Down Payment 11-20

21 Life Stages and Accounts How Should the Assets Be Allocated? Empty Nest (41-65) Retirement funds Investment funds Funds used within the next 10 years Retirement (66+) Retirement funds Investment funds Funds used within the next 10 years 11-21

22 Learn LO 11-1 Distinguish between savings and investments. LO 11-2 Analyze the risk and return on varying investment products. LO 11-3 Interpret the hierarchies of the investment pyramid. LO 11-4 Examine the importance of varying your investments. LO 11-5 Compare portfolio asset allocations for the different personal finance life stages

23 Plan & Act To assess your risk tolerance, take the Market Psych Questionnaire (Worksheet 11.1) Given your risk tolerance and current goals, draw up your own investment pyramid (Worksheet 11.2) 11-23

24 Evaluate Are you making the appropriate allocations in building your emergency fund? Outline your investment strategy. Does this support your overall SMART goals? 11-24

25 Continuing Case Blake bought into a stock mutual fund as a retirement investment 6 months ago. Ever since then, he has watched the prices slowly drop each month. He is afraid that it will soon be worthless. He is tempted to cash in the stock and move what funds are left to another instrument. What advice would you give him? 11-25