Financial Institutions vs. Financial Markets

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1 Learning Objectives 1. I will gain an understanding of the different types of investment. 2. I will gain an understanding of the expected rate of return, risk, and liquidity for specific types of investments.

2 Financial Institutions vs. Financial Markets A financial institution collects funds from the public and places them in financial assets (deposits, loans, etc.) think of a bank

3 Financial Institutions vs. Financial Markets A financial market describes any marketplace where buyers and sellers trade assets, such as stocks and bonds They are characterized by trading regulations and/or fees for trading them Examples of financial markets include the New York Stock Exchange (NYSE) and the bond market

4 Key Financial Terms Investment: Putting money someplace with the intention of making a financial gain Most often, people are saving for their retirement Examples include: stocks, bonds, mutual funds, and real estate

5 Key Financial Terms Portfolio: A collection of investments owned by one individual or organization Financial advisors suggest diversifying your portfolio to have multiple types of investments

6 Key Financial Terms Rate of return: Return on an asset over a given period divided by the market value of the asset This is paid in dividends or interest and is expressed as a percent The three factors that influence rate of return are risk, liquidity, and time

7 Key Financial Terms Risk: The chance of losing all or part of the value of an investment Conservative (low) risk investments have a low rate of return Speculative (high) risk investments can lead to great returns or heavy losses

8 Key Financial Terms What risk is best for you? Depends on several factors Young investors can afford riskier investments If you are closer to retirement, you should balance your risk with some safer investments

9 Risk versus Reward High risk Medium risk Low risk Oil and gas commodities Penny stocks Real estate Blue chip stocks Mutual funds Variable life and annuities Municipal bonds Money market funds Certificates of Deposit (CDs) Bonds Treasury bonds

10 Key Financial Terms Liquidity: How accessible the investment/savings is and how easily it can be converted to cash Money in savings can easily be withdrawn for spending, but a house takes time to convert into cash

11 Key Financial Terms Time: The length of time an investment is held usually influences the rate of return Longer held investments usually produce a higher rate of return than those held for a shorter period of time

12 Key Financial Terms The Rule of 72: divide 72 by the interest rate you expect to earn This will tell you how long it will take to double your money Example: 72/6% = 12 years to double your money Example: $100 earns you 5% interest After one year you have $105 After two years it becomes $ After 25 years it will be almost $340

13 Key Financial Terms Costs: Charges, fees, or other expenses associated with buying, selling, or holding an investment For example, such costs include account maintenance fees, broker charges for buying and selling stocks, closing costs for buying or selling a house, minimum balance requirements, and mutual fund management fees

14 Investing 101

15 Think about 1. Why should you save and invest? 2. When should you start saving/investing? 3. What should you invest in? Why? 4. What is the difference between buying stock and buying bonds? 5. How much money do you anticipate needing for college? How do you plan to pay for it?

16 Basic Tips Know your income and expenses for each month Pay yourself first! Use automatic withdrawals or transfers to a savings or retirement account Participate in an employer-sponsored 401 (k), 403 (b) or 457 (b)

17 Basic Tips Cut back on expenses so you can invest If you bought a $2 pop each day for 1 year you could have saved $730 If you had invested that original amount at 5% interest, it would be over $3,150 after 30 years

18 Basic Tips Pay off credit cards and high interest debt Pay off the card with the highest interest rate Always know what you owe

19 Saving versus Investing Savings is money put into safe places that allow you to access your money at any time Examples: Savings accounts, checking accounts, and CDs

20 Saving versus Investing Investing means putting your money into securities and mutual funds (real estate, etc.) This money is not insured and can be lost but there is the opportunity to make money on your investments

21 Types of Investments: What should I invest in? WHAT SHOULD I INVEST IN?

22 Cash Cash: There are no costs associated with holding cash, but there is also no return and its value diminishes due to inflation It may seem that holding cash has no risk; however, cash is vulnerable to loss or theft

23 Checking accounts Checking accounts: Allows the account owner to deposit and withdraw funds Account owners have the privilege of writing checks on their accounts and using ATM cards and debit cards to access funds Accounts in FDIC member banks are insured up to $250,000 Your principal will always be available to you, but you will receive little or no return

24 Savings Accounts Savings accounts: Accounts in which people can deposit their money for future use and earn interest Accounts in FDIC member banks are insured up to $250,000 You will never lose your principal, but your return will be relatively small

25 Money Market Deposit Accounts Money market deposit accounts: Operates like a savings account but with a higher minimum investment They are usually FDIC insured up to $250,000 and offer limited checkwriting privileges, so your money is fairly accessible

26 CDs Certificates of deposit (CDs): A saving alternative in which money is left on deposit for a stated period of time to earn a specific interest rate Pay fixed or variable interest (which can be reinvested to accrue compound interest)

27 CDs Longer maturity dates pay higher interest rates They are very safe and offer a greater return than a savings accounts, but access carries a penalty if money is withdrawn before the specified time

28 Real Estate Real estate: Residential or commercial property The recent housing bubble illustrated the risk in real estate Risk depends on the market and economic conditions

29 Commodities Commodities such as gold and silver, are speculative In general, their values grow in times of economic uncertainty but returns are relatively low during steady economic times

30 Collectibles Collectibles vary greatly in value and popularity as do their potential for risk and return Some art, coins, and stamps may increase in value and provide a return, while others collectibles, for example, Beanie Babies, may not

31 Stocks and the Stock Market Stock: A type of security that represents ownership in a business When a company issues stock, it is selling ownership rights The investors who buy the company s stock are called shareholders Some stocks are riskier than others

32 Stocks and the Stock Market Generally, the lower the price, the higher the risk Potential returns on stocks are greater than those from bonds or insured savings to account for the greater risk

33 Stocks and the Stock Market Preferred stock: gives shareholders a share of profits with no voting rights Pays dividends Have priority over common stockholders Dividends do not increase if stock increases in value

34 Stocks and the Stock Market Common stock: represents ownership in a corporation Exercise control by electing a board of directors The last to be paid if the company is liquidated

35 Stocks and the Stock Market Income stocks: Shares in what investors consider to be very stable and profitable companies, and they usually pay dividends

36 Stocks and the Stock Market Growth stocks: Shares in companies that might be smaller, younger companies, but have the potential to grow much larger in the future These stocks are less likely to pay dividends (because they often reinvest profits for growth) They are considered to be more risky than income stocks

37 Stocks and the Stock Market Stock market: This is where the buying and selling of stocks and bonds takes place

38 Stocks and the Stock Market Types of Exchanges The NASDAQ Stock Market is the largest electronic stock market in the U.S. Handles billions of shares per day

39 Stocks and the Stock Market The NYSE handles exchanges involving about 2 billion shares of stock each day The stock market is regulated by the Securities and Exchange Commission (SEC) that was created during the Great Depression-era

40 Stocks and the Stock Market Dow Jones Industrial Average (Dow): A popular index of stock prices consisting of 30 large well-known companies in major sectors of the economy Examples: Apple, Exxon Mobile, Microsoft, McDonald s, Nike, GE, Home Depot, Walmart, Verizon, and Coca-Cola

41 Bonds Bond: A loan in which the borrower promises to pay the lender a fixed rate of interest and repay the principal at the date of maturity Think of a bond as an IOU that pays interest

42 Bonds U.S. savings bonds: Debt securities issued by the U.S. government Buying a bond is essentially the same as lending money to the U.S. government You can purchase a bond for as little as $25 Bonds are backed by the full faith and credit of the U.S. government, making them one of the safest investments

43 Bonds U.S. Treasury bond: Bonds backed by the full faith and credit of the U.S. government These are the safest bonds to invest in; you will not lose your principal and there is no chance of default

44 Bonds When the government spends more than it collects in taxes and other revenues, it issues Treasury bonds to borrow the money to pay the difference The return is usually greater than from savings accounts or certificates of deposit

45 Bonds Corporate bonds: Debt issued by corporations If a company wants to borrow money to finance a project, it might borrow from the public by issuing a bond The return on a corporate bond will be greater than on a government bond because there is a risk of default They are rated from AAA to BBB

46 Bonds Municipal bond: Issued by state and local governments for public projects, such as building schools, bridges, and highways These bonds are usually tax-exempt and that is attractive to investors

47 Mutual Funds Mutual funds: Collections of financial assets such as stocks and/or bonds that provide a means of diversification Some funds are more risky than others because they have a more uncertain future value

48 Mutual Funds Returns on mutual funds vary based on the financial assets held by the fund Mutual fund companies charge investors fees to manage the portfolio of investments, and these fees can vary widely based on the fund

49 Saving for Retirement SAVING FOR RETIREMENT

50 Social Security Social Security is a government program that provides cash payments to retired workers; it is a pay-as-you-go plan It is funded by taxes paid by workers and their employers This means that the Social Security taxes you pay each year are not saved for your future retirement This money is paid out in benefits to current retirees

51 Company Retirement Plans A pension plan is a retirement plan to which the employer makes contributions for the future benefit of its employees Today, the most common company retirement plan is the 401(k) plan In a 401(k) plan, employees have money automatically taken out of their paychecks and put into retirement investment accounts

52 Company Retirement Plans Employers may also contribute to the plan by matching all or part of an employee s contribution One benefit of a 401(k) plan is that participants may subtract their contributions from their taxable income when they file their tax returns The effect is to lower the amount of income tax they are required to pay Risk depends on how it is invested: stocks, bonds, and /or mutual funds

53 Personal Savings The third source of retirement funds is personal savings Such savings may include a variety of financial assets, including private retirement plans plans that are not employersponsored

54 Personal Savings An Individual Retirement Account (IRA) is a retirement plan sponsored by the federal government Anyone who earns income can put money into an IRA

55 Personal Savings To encourage people to do so, the government has built tax advantages into IRA plans Depending on the type of plan they choose, participants may either deduct the amount of their IRA contributions from their taxable incomes or take money out of their accounts tax free when they retire For this reason, IRAs are often referred to as tax-sheltered savings accounts