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INVESTING

INVESTING. TOPICS WHAT IS INVESTING? REASON FOR INVESTING KINDS OF INVESTMENTS INVESTMENT STRATEGIES INTEREST RATES PRESENT AND FUTURE VALUES INVESTMENT ISSUES. WHAT IS INVESTING?.

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INVESTING

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  1. INVESTING TOPICS WHAT IS INVESTING? REASON FOR INVESTING KINDS OF INVESTMENTS INVESTMENT STRATEGIES INTEREST RATES PRESENT AND FUTURE VALUES INVESTMENT ISSUES
  2. WHAT IS INVESTING? TAKING RISK WITH YOUR MONEY TO EARN MORE THAN INFLATION INFLATION ERODES THE PURCHASING POWER OF YOUR MONEY EXAMPLE: INFLATION = 4% NEED TO EARN MORE THAN 4% TO HAVE MONEY GROW IN PURCHASING POWER
  3. REAL INTEREST RATE GAINS FROM INVESTMENTS USUALLY QUOTED AS A PERCENT – PERCENT GAIN ON MONEY INVESTED EXAMPLE: EARN $100 ON INVESTMENT OF $1000 – GAIN OF 10% THIS IS “NOMINAL INTEREST RATE” SUBTRACT INFLATION RATE TO GET “REAL INTEREST RATE” 10% - 4% INFLATION RATE = 6% REAL INTEREST RATE
  4. HAVE TO WORRY ABOUT TAXES ALSO TAX IS ON THE NOMINAL INTEREST RATE EXAMPLE: TAX RATE OF 25% 10% - (0.25 X 10%) = 7.5% THEN 7.5% - 4% INFLATION RATE = 3.5% AFTER-TAX REAL INTEREST RATE
  5. TOTAL INVESTMENT RETURNS OVER MANY YEARS ARE “MULTIPLICATIVE”, NOT “ADDITIVE” FORMULA: (1+ PROPORTIONAL CHANGE) X (1+ PROP. CHG) X (1+ PROP. CHG) …….ETC. EXAMPLE 1 YR. 1: 10%; YR. 2: -15%; YR. 3: 12%; YR. 4: -8% (1.10) X (0.85) X (1.12) X (0.92) = 0.96 MEANS LOST 0.04, OR 4%, OVER THE FOUR YEARS RATE OF RETURN OF -4%
  6. ANOTHER EXAMPLE YEAR 1: -3% YEAR 2: 17% YEAR 3: -2% YEAR 4: 5% (0.97) X (1.17) X (0.98) X (1.05) = 1.17 MEANS GAINED 0.17, OR 17% OVER FOUR YEARS
  7. THE BIG TRADEOFF IN INVESTING – RISK VERSUS REWARD (INTEREST RATE EARNED) TO EARN HIGHER REWARD, MUST TAKE MORE RISK IN INVESTING. RISK IS CHANCE OF LOSING MONEY IF WANT SAFETY IN INVESTING – MUST ACCEPT LOWER REWARD
  8. TYPES OF INVESTMENTS FOUR FUNDAMENTAL TYPES STOCKS INFLATION HEDGES CASH LONG TERM BONDS NOT MUTUAL FUNDS
  9. STOCKS TECHNICALLY, A CLAIM ON THE NET ASSETS OF A COMPANY OVER LONG TERM, BEST PERFORMER OF INVESTMENTS VERY VOLATILE – NOTHING GUARANTEED – SO HIGH RISK WATCH INDIVIDUAL STOCKS AS WELL AS MARKET AVERAGES
  10. INFLATION HEDGES INVESTMENTS THAT DO BEST WHEN INFLATION IS RISING TYPICALLY INCLUDE REAL ESTATE, PRECIOUS METALS, AND COLLECTIBLES – ALL ITEMS WITH LIMITED SUPPLY
  11. “CASH” INVESTMENTS NOT LITERALLY CASH, BUT INVESTMENTS THAT CAN BE EASILY CONVERTED TO CASH MONEY MARKET FUNDS CD’S SHORT TERM BONDS
  12. LONG TERM BONDS PAY A FIXED INTEREST RATE FOR A SPECIFIED TIME PERIOD ONCE “LOCK-IN” THE INTEREST RATE, IF RATES ON NEW BONDS DROP, YOUR BOND INCREASES IN VALUE YOU HAVE A 10%, $1000 BOND AND GET $100 INTEREST NEW RATES ARE 5%, YOU STILL GET 10%, SO YOUR BOND IS NOW WORTH $2000
  13. LONG TERM BONDS, CONTINUED BUT OPPOSITE HAPPENS IF NEW INTEREST RATES ARE HIGHER YOU HAVE A 10%, $1000 BOND – GET $100 INTEREST BUT NOW NEW RATES ARE 20% YOUR BOND IS NOW ONLY WORTH $500
  14. DIFFERENT INVESTMENTS DO WELL AT DIFFERENT TIMES STOCKS BEST WHEN ECONOMY IS GROWING WITH LOW INFLATION INFLATION HEDGES BEST WHEN INFLATION IS RISING CASH BEST WHEN ECONOMY IS ENTERING A RECESSION LONG TERM BONDS BEST WHEN ECONOMY IS IN A RECESSION AND INTEREST RATES ARE FALLING
  15. INVESTMENT STRATEGIES ACTIVE MANAGEMENT – MOVE MONEY BETWEEN INVESTMENTS CONSTANTLY SEEKING THE BEST RETURN PASSIVE MANAGEMENT – ALLOCATE SOME MONEY TO ALL MAJOR INVESTMENTS AND ONLY MOVE AT MAJOR LIFE STAGES (“BUY AND HOLD”; DIVERSIFY)
  16. WILL THE “MARKET” ALWAYS KNOW MORE THAN THE INDIVIDUAL INVESTOR? IS WHAT IS WIDELY EXPECTED “BAKED IN” TO INVESTMENT RETURNS EVEN BEFORE THE EVENT HAPPENS? EXAMPLE: EXPECT ECONOMY TO IMPROVE NEXT YEAR AND GAS AND OIL PURCHASES TO INCREASE; STOCK VALUES FOR OIL COMPANIES MOVE UP TODAY
  17. THE TWO “E’s” OF INVESTING: “ECONOMICS” AND “EMOTION” ECONOMICS: GAUGING AN INVESTMENT BY ITS ECONOMIC FUNDAMENTALS EMOTION: IGNORING FUNDAMENTALS AND INVESTING ON “FEELING” IF “EMOTION” DOMINATES, CAN LEAD TO “SPECULATIVE BUBBLES”, WHICH ULTIMATELY BURST EXAMPLE: RESIDENTIAL HOUSING MARKET
  18. RELATED INVESTMENT CONCEPTS MUTUAL FUNDS– A WAY OF INVESTING; NOT A TYPE OF INVESTING; PROFESSIONAL MANAGER SELECTS SPECIFIC INVESTMENTS USING MONEY FROM MANY PEOPLE INDEX FUNDS – MUTUAL FUND FOCSUING ON A PARTICULAR ECONOMIC SECTOR – MANY DIVERSIFIED HOLDINGS TAX FAVORED INVESTMENTS –IRAS, 401k PLANS, MUNICIPAL BONDS
  19. ROLE OF INSURANCE A WAY TO HANDLE RISK OF LOSS PRINCIPLE OF “POOLED RISK” - EVERYONE FACES CHANCE OF THE LOSS, BUT NO ONE KNOWS WHO GETS THE LOSS TYPES: AUTO, HEALTH, HOME, DISABILITY, LIFE
  20. SIMPLE INSURANCE EXAMPLE FOUR PEOPLE, EACH FACING A POTENTIAL LOSS OF $10,000 NO ONE KNOWS WHO WILL LOSE EACH PAYS AN INSURANCE PREMIUM OF $2500 – GOES TO THE PERSON LOSING $10,000
  21. WHY PREMIUMS VARY HIGHER PREMIUMS CHARGED TO PEOPLE MORE LIKELY TO SUFFER LOSSES FOR AUTO INSURANCE -- THE YOUNG AND & INEXPERIENCED -- WITH BAD DRIVING RECORDS -- DRIVING CERTAIN VEHICLES FOR HEALTH INSURANCE -- OLDER INDIVIDUALS -- PEOPLE WITH “PRE-EXISTING” CONDITIONS
  22. IF GOVERNMENT DOESN’T ALLOW THESE DIFFERENCES, THEN COSTS ARE SHIFTED EXAMPLE: AFFORDABLE CARE ACT LIMITS PREMIUM DIFFERENCES BASED ON AGE AND PRE-EXISTING CONDITIONS MEANS OLDER AND ILL INDIVIDUALS PAY LESS, AND YOUNGER AND WELL INDIVIDUALS PAY MORE
  23. LONG AND SHORT OF INTEREST RATES LONG TERM RATES – ON LONG LOANS – TEND TO BE HIGHER THAN SHORT TERM RATES – ON SHORT LOANS -- MORE CAN GO WRONG OVER A LONGER LOAN -- EXCEPTION – IN A RECESSION, SHORT RATES ARE HIGHER -- THE “YIELD CURVE”
  24. PRESENT VALUE BRINGING THE VALUE OF FUTURE DOLLARS BACK TO THE PRESENT (NOW) PRESENT VALUE WILL BE LESS THAN FUTURE VALUE (COULD INVEST NOW AND GROW TO BE LARGER IN THE FUTURE) USE A PROCESS CALLED “DISCOUNTING”
  25. PRESENT VALUE FORMULA PRESENT VALUE = FUTURE VALUE X (PRESENT VALUE FACTOR) PRESENT VALUE FACTOR BASED ON # YEARS IN FUTURE AND ASSUMED INVESTMENT INTEREST RATE, AND WILL BE LESS THAN 1.
  26. SOME PRESENT VALUE FACTORS(SEE PAGE 16 OF EVERYDAY ECONOMICS) INTEREST RATE (DISCOUNT RATE) YEARS IN FUTURE 3% 5% 7% 1 0.971 0.952 0.935 5 0.863 0.784 0.713 30 0.412 0.231 0.131
  27. EXAMPLE 1 BETTER TO HAVE $10,000 NOW OR $11,000 IN FIVE YEARS? USE DISCOUNT RATE OF 3% PV OF $11,000 IN 5 YEARS: $11,000 X 0.863 = $9493 BETTER TO HAVE THE $10,000 TODAY IF INVEST $10,000 AT 3% COMPOUNDED ANNUALLY, WOULD HAVE $11,593 IN FIVE YEARS
  28. EXAMPLE 2: PAYING EXTRA FOR A HYBRID CAR TODAYYR. 1YR. 2YR. 3YR.4YR.5 PAY $4000 SAVE SAVESAVESAVESAVE MORE $700 $750 $800 $900 $1000 PV AT 3% x 0.971 x 0.943 x 0.915 x 0.888 x 0.863 = $679.70 $707.25 $732 $799.20 $863 TOTAL PV = $3781.15 SAVINGS DON’T EXCEED HIGHER PRICE NOTE: OPPOSITE CONCLUSION IF JUST ADDED UNDISCOUNTED SAVINGS = $4150
  29. EXAMPLE 3: PRESENT VALUE OF LOAN PAYMENTS PRESENT VALUE OF LOAN PAYMENT, USING LOAN INTEREST RATE AS DISCOUNT RATE, IS THE LOAN AMOUNT EXAMPLE: BORROW $200,000 AT 5% INTEREST AND MAKE 360 MONTHLY PAYMENTS MONTHLY PAYMENT: $1073.64 PV OF THOSE 360 PAYMENTS OF $1073.64 IS $200,000 AMORTIZED VS. INTEREST-ONLY LOANS
  30. COMPOUND INTEREST SIMPLE INTEREST – EARN INTEREST ONLY ON AMOUNT INVESTED 10% ON $1000: $100 PER YEAR; AFTER 30 YEARS, HAVE $4000 COMPOUND INTEREST – EARN INTEREST ON AMOUNT INVESTED AND ON INTEREST EARNED 10% ON $1000, COMPOUNDED; AFTER 30 YEARS, HAVE $17,449
  31. INVESTMENT ISSUES ARE SOME INVESTMENTS “TOO BIG TO FAIL”? - GOVERNMENT SUPPORT? CAN INVESTMENTS BE MANIPULATED? SPECULATION? 3. DO INVESTORS NEED TO BE PROTECTED BY THE GOVERNMENT?
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