Personal Financial Planning Types of Investments Stocks Bonds Mutual Funds Real Estate Savings/Certificates of Deposit Collectibles Stocks Stock: An investment that represents ownership in a company or corporation. Over the long-run, these investments tend to pay dividends to the share holders, and, given that the value of the stock fluctuates on the market, they allow owners the opportunity to sell their stock at a profit. Dividends: A portion of corporate profits declared by the Board of Directors to be distributed to shareholders. Capital Gains: Profit earned by selling stock at a price that is higher than the price for which it was originally purchased. Types of Stock: Types of Stock There are many types of stock; however, all stock must be designated as either common or preferred. Common Stock (Shares): Shares that i) receive a vote at the annual shareholders meeting, and ii) receive only dividends that are left over after preferred stock has received its dividends. Preferred Stock (Shares): Shares that i) do NOT receive a vote at the annual shareholders meeting, but ii) receives dividends before common stock receives dividends. Stock Indices A stock index is a composite figure of current stock values for a specific collection of stocks that are traded on a particular index. The goal of a stock index is to provide a general overview of a particular market s performance. While some indices track a large number of stocks, others track a small but strategic number of stock. Four Popular Indicators S&P/TSX [Cdn.] Lists the 251 leading Canadian stocks account for about 70% of market capitalization for all Canadian-based companies listed on the TSX Dow Jones Industrial Average ( DOW ) [US] Lists the 30 leading industrial blue chip stocks Standard and Poor s 500 Composite Index [US] Covers market activity for 500 stocks More accurate than DOW because it evaluates a greater variety of stock National Association of Security Dealers Automated Quotations ( NASDAQ ) [US] Monitors fast moving technology companies Speculative stocks, show dramatic ups and downs 1
Ups and Downs The term bull market means the market is doing well because investors are optimistic about the economy and are: i) purchasing stocks, or ii) holding on to the stocks they own. Purchasing Stock The term bear market means the market is doing poorly and investors are either: i) not purchasing stocks, or ii) selling stocks they own. Brokers A broker is a person who is licensed to buy and sell stocks, provide investment advice, and collect a commission on each purchase or sale. Purchases stocks on an organized exchange (stock market). Over ¾ of all stocks are bought and sold on an organized exchange. Types of Brokers Full-service brokers Cost: Commissions are typically based on a percentage of your purchase (or sale) price. Discount brokers Cost: Between $10 and $20 for a trade of 1,000 shares or less, and on average, discounters charge one-third the price of full-service brokers. Online brokers Cost: At $9 to $15 a trade, it doesn't get any cheaper than this. Two Markets for Stock Primary Market: Describes the market for new shares released for sale to the public by a corporation. Occurs when investors buy shares made available through a brokerage firm that facilitates the initial release of stock. This is called the initial public offering. Secondary Market: Describes the market for previously owned shares that are bought and sold on public stock exchanges. Members of the public cannot buy or sell shares on the stock market directly. Rather, they must buy and sell through a brokerage firm. Organized Exchanges Minimum requirements for a stock to ensure only reputable companies are used. Each exchange has a limited number of seats available which brokerage firms purchase to give them the legal right to buy and sell stocks on the exchange. 2
Toronto Stock Exchange (TSX) Lists 1,577 companies largest stock exchange in Canada (3 rd largest in North America, 7 th in the world by market capitalization) Based in Toronto A broad range of businesses from Canada and abroad world leader in the mining, oil, & gas sector New York Stock Exchange (NYSE) Oldest and largest, began in 1792 1,366 seats available 2,800 companies Average stock price is $33.00 Strict requirements National Association of Securities Dealers Automated Quotations (NASDAQ) stocks were originally traded in an over the counter electronic market, but the NASDAQ has slowly moved away from OTC trading 4,000 small companies Company requirements are not as strict more volatile because companies are young and new Average stock price is $11.00 Video: Over-the-counter Trading Investment Strategies Short-term Investment Strategies buying on margin short-selling market order stop order Long-term Investment Strategies diversification dollar-cost averaging buy and hold Short-term Investment Strategies Buying on margin describes a short-term investment strategy where the investor borrows money from their brokerage firm to purchase securities. When an investor borrows money from his broker to buy a stock, he must open a margin account with his broker, sign an agreement, and abide by the broker's margin requirements. The loan in the account is collateralized (backed up) by the investor's securities and cash. If the value of the stock drops too much, the investor must deposit more cash in his account, or sell a portion of the stock, in order to maintain the required margin percentage. In the US, there is a 50% margin requirement. Ex. If you want to purchase $2,000 worth of stock, you can borrow up to $1,000 to make the purchase. 3
1. BMO InvestorLine maintains the right to change margin requirements at anytime without notice. 2. The amount of funds the client must provide. 3. Securities eligible for reduced margin must be included in the S&P/ TSX 60 or S&P 500. 4. Margin requirements fluctuate with the market value of the shorted stock. Short selling is a short-term investment strategy wherein an investor sells shares of stock that they don t own with the intent to buy them back later at a lower price. Let s use an iphone as an example. Your friend buys new an iphone for $600.00. You borrow the iphone and sell it for $600.00. The price at the stores falls to $500.00. You buy a new iphone for $500 and give that one back to your friend. You just made an easy $100.00!!! Market Order: An order that an investor makes through a broker or brokerage service to buy or sell an investment immediately at the best available current price. A market order is the default option and is likely to be executed because it does not contain restrictions on the buy/sell price or the timeframe in which the order can be executed. Long-term Investment Strategies Stop Order: An order to buy or sell a security once its price reaches a particular point, thus ensuring a greater probability of achieving a predetermined entry or exit price, limiting the investor's loss or locking in his or her profit. Once the price reaches the predefined entry/exit point, the stop order becomes a market order. [See video.] Limit Order: An order to NOT buy or sell a security once its price surpasses a particular point. Once the price surpasses the predefined entry/exit point, the limit order stops any further purchases or sales. Diversification is a long-term investment strategy wherein the investor spreads out his investments amongst a variety of assets in order to reduce risk. IOW don t put all your eggs in one basket! Dollar Cost Averaging describes spending an equal amount of money on the same stock at regular intervals. For example, investing $1,000 in Apple Corp. every month. This process mathematically forces the investor to buy more units when the price is low and fewer units when the price is high. Given that the investor buys more units at lower prices and fewer units at higher prices, the approach of buy low is mathematically forced upon the investor. This is a good approach for investors who don t want to monitor their investments all the time and would prefer to simply automate their investing. 4
Here we have a single, lump-sum investment of $12,000.00 made at the beginning of the year. Single Lump- Sum Investment Months Investment Unit Price Units Purchased January $12,000.00 10 1200 February March April May June July August September October November December Totals: 12,000.00 10 1200 Value at $10.00/unit $12,000.00 as at next January Imagine the stock price remained at $10.00 a unit by the following January. The value of the investment is flat. Here we have a regular investment of $1,000.00 each month over the course of the year. Dollar- Cost Averaging Investments Investment Unit Price Units Purchased January $1,000.00 10 100.0 February 1,000.00 8 125.0 March 1,000.00 6 166.7 April 1,000.00 8 125.0 May 1,000.00 10 100.0 June 1,000.00 12 83.3 July 1,000.00 10 100.0 August 1,000.00 8 125.0 September 1,000.00 6 166.7 October 1,000.00 8 125.0 November 1,000.00 10 100.0 December 1,000.00 12 83.3 Totals: 12,000.00 10 1400.0 Value at $10.00/unit $14,000.00 as at next January Imagine the stock price remained at $10.00 a unit by the following January. The value of the investment is up! Here we have a single, lump-sum investment of $12,000.00 made at the beginning of the year. Single Lump- Sum Investment Months Investment Unit Price Units Purchased January $12,000.00 10 1200 February March April May June July August September October November December Totals: 12,000.00 9 1200 Value at $9.00/unit $10,800.00 as at next January Imagine the stock price dropped to at $9.00 a unit by the following January. The value of the investment is down by $1,200.00. Here we have a regular investment of $1,000.00 each month over the course of the year. Dollar- Cost Averaging Investments Investment Unit Price Units Purchased January $1,000.00 10 100.0 February 1,000.00 8 125.0 March 1,000.00 6 166.7 April 1,000.00 8 125.0 May 1,000.00 10 100.0 June 1,000.00 12 83.3 July 1,000.00 10 100.0 August 1,000.00 8 125.0 September 1,000.00 6 166.7 October 1,000.00 8 125.0 November 1,000.00 10 100.0 December 1,000.00 12 83.3 Totals: 12,000.00 9 1400.0 Value at $9.00/unit $12,600.00 as at next January Imagine the stock price drops to $9.00 a unit by the following January. The value of the investment is still up! Advantages of Dollar Cost Averaging: This is a good approach for investors who don t want to monitor their investments all the time and would prefer to simply automate their investing. This approach takes advantage of market volatility (sudden changes in stock value, in both directions) more than any other strategy. The buy and hold technique describes a long-term investment strategy wherein the investor buys a stock and holds onto it for a number of years. During that time you are paid dividends and the price of the stock tends to go up over the long-run. (See Andex Chart below.) In fact, dollar-cost averaging is not particularly effective if the stock price remains stable over a long period of time. 5
Bonds A security representing a loan of money from a lender to a borrower for a set time period, which pays a fixed rate of interest. Bonds are issued by governments or corporations in order to raise capital. Bonds do not represent ownership they represent a liability on the books of the issuing entity. Essentially, bonds are loans. In the primary market (when bonds are first issued to buyers & dealers), bonds have the following features: Face Value: original purchase price of the bond Term: period of time before the bond can be redeemed to the issuer Coupon or Interest Rate: amount of interest that will be paid to the bearer upon the redemption date In the secondary market (where previously issued bonds are bought and sold), bonds have only a market value. Features of a Bond Interest Rate Term Face Value In the secondary market (where bonds are traded between bond purchasers), bond prices move inversely to interest rates. When interest rates go up, bond prices go down, and vice versa. As an example: Bond Prices and Interest Rates Imagine Sally buys a 5-year bond for $10,000.00 with a 5% interest rate. However, after the bond is issued, interest rates on new bonds rise to 6%. If Sally wants to sell her bond now, she has to somehow compete with new bonds that now pay 6%? Here s what Sally will have to do Her old bond is paying 1% below the market rate (5% vs. 6%). Sally can t change the maturity date, the face value, or the interest rate on the bond that s all fixed by the original issuer. Sally can, however, change the price she is willing to accept for her bond. Thus, Sally s bond would have to be sold at a discount in order for the buyer of the bond to receive a competitive rate. Note: This is called discounting the bond. Let s do the Math The annual payment of $500.00 ($10,000.00 x 5%) can t change, nor can the face value. Thus, the final redemption value of $10,500.00 will remain fixed so we must somehow make $10,500.00 become 6% of the new buyer s purchase price. How do we make $10,500.00 become 6% of the payment? We discount (i.e. reduce) the price of the bond! Thus, we ask: What is $10,500.00 one hundred and six percent of? Voila! $10,500.00 / 1.06 = $9,905.06 Note: If interest rates went down, the bond would sell at a premium. 6
Mutual Funds Real Estate An investment that pools money from several investors to buy a particular type of investment, such as stocks. An investor buys pieces of property, such as land or a building, in hopes of generating a profit. Savings / Certificates of Deposits A deposit that earns a fixed interest rate for a specified length of time. The longer the time period the greater the rate of return. There is a substantial penalty for early withdrawal. In Canada, Guaranteed Investment Certificates (GICs) are a popular term for certificates of deposit. Guaranteed Investment Certificates (GICs) are a nonredeemable type of debt security providing a guaranteed return to investors by paying a fixed rate of interest for a fixed period of time. Commonly issued by trust companies or banks. Considered on of the most secure investments. Offer a lower rate of return than stocks or bonds. Collectibles Risk vs. Return Unique items that are relatively rare or highly valued. Art work Baseball trading cards Coins Automobiles Antiques u On average, stocks have a higher potential rate of return than bonds or savings certificates. u Higher rate of return = greater risk Uncertainty about the outcome of an investment u Stocks provide portfolio diversification Money invested in a variety of investment tools Investors can purchase a variety of stocks 7