Your Money Spending it, Borrowing it, Saving it, Protecting it
The stock market • Stock: Equity or ownership in a corporation. • Why stock? Buy it because you expect it to increase in value, or expect the corporation to pay part or all of their profits (dividends) • Some stocks provide both: appreciation in value (growth) and income • Corporation gets proceeds from initial sale (initial public offering (IPO) only
Stocks… • All proceeds from subsequent sales go to the owner of the stock (stockholder) • Price of the stock, as with other commodities, depends on the supply of and the demand for the stock
Market for shares P S Q* = total # of outstanding shares D Q* Q
Common vs. preferred stock • Common stocks: Most stocks; no guarantee of making money (growth or income) • Value of common stocks may increase or decrease • May or may not receive dividends risky endeavor, compensated with potential return (growth or income) • Preferred stock (less risky) certain dividend guaranteed; but only that income but limited growth (capital gain)
Chips and splits • Blue chips: typically used to denote stocks in large companies that were most valuable • Generally largest, most consistently profitable firms • Not necessarily the case today • Stock splits: change in the number of total outstanding shares
Stock split • When the price of stock gets fairly high, company may decide to ‘split’ the share to reduce the price of each share result: more shares, lower price • E.g. share sells for $100. You own 10 shares. Total value = $100 x 10 = $1000 • Company decides a ‘2 for 1’ split those with 1 share now have 2, total value same. • New price = $1000/ (2x 10) = $50 each
Price changes • Price of a stock can change at any time (market price risk) • Can use a supply and demand diagram to understand the change • Notice that many people on ‘Atkins’ diet. So you want to invest in Atkins Nutritionals, Inc. Others may think the same, demand for Atkins stock increases. (D1) • If hear that Atkins is bad for you, then want to get rid of stock. (D2)
Market for Atkins stock P S Q* = # shares outstanding P1 P* D1 D P2 Q* Q
Value of stock • Price of stock is one measure of value. • Return on investment: another measure of value = the amount earned on the stock (profit/ investment) • Cyclical stocks: company performance depends heavily on that of the economy. If economy is doing well, so will these e.g. Airlines, Hotels
Value of stock • Factors that determine stock value: • Earnings (growth rate) • Competition in industry • Availability of new markets • Management strengths and weaknesses • Overall environment of economy Bottoms-up analysis
Buying stocks • About 43% of Americans own stock • Owned either directly or through mutual funds, pensions or insurers • Types of investors: • Institutional: invests own assets or those of others it holds in trust e.g. mutual funds, pension funds • CalPERS (California Public Employees’ Retirement System) worth $207 B as of 1/06; 64% in stocks
Buying stocks • Individual investors: account for 45% of all trades; average $10 000 • Investment styles: • Buy and hold: long-term view, buy stock and wait for it to appreciate • Day trading: extremely short-term view, looking to make quick profits (less than 17% of individuals made profit this way) • Investment clubs: get together with some friends, pool your money, make investments • Beardstown Ladies
Buying styles • Dollar- cost averaging: regardless of the price of the stock, you buy the same amount each month. At times you pay more, at times less, but works out on average.
Reading stock tables • WSJ – business publication • Most often used by professionals • Also can find many places online e.g. money website • 52 wks Hi & Lo – for the past 52 weeks • Yld % - dividend as % of current price • PE – Price/ Earnings ratio – relationship between stock price and earnings for the last 4 quarters often used to compare stocks (here past earnings not future) • Forward PE – uses expected earnings (forecast)
Reading stock tables • Volume - # of shares traded the previous day (x 100 to get actual shares) • Large volume typically indicates some information revealed • Hi, Lo, Close – stock price of previous day • Net change – compared to closing from previous day • Sym – stock symbol (unique to company)
Keeping up with the (Dow) Joneses… • Stock market activity is reported daily in averages and indexes designed to assess the state of the economy • Price changes of one stock matters more to stockholder, but market as a whole is a measure of economic activity • Market activity typically reported via indexes:
Indices… • DJIA (Dow Jones Industrial Average) – the Dow – most widely reported; composed of prices of 30 major industrial companies • S&P 500 (Standard & Poor’s 500) - a representative sample of 500 leading companies in leading industries of the U.S. economy
More indices… • NYSE composite index: all stocks traded on the NYSE • Russell 2000: follows 2000 of the smallest companies • Wilshire 5000: nearly all stocks traded in US markets
What’s good for the index is good for the… • Why indexes? They serve as important tools for measuring the overall health of stock market; also benchmarks for comparing your own portfolios • This past year: • DJIA: last 52 wks ~8% • S&P 500: 52 wks ~10%
Up and down and up and down and… • Stock market has cycles (ups and downs) – hard to predict these, but can be explained • As people invest in the market – generally market goes up • As people pull out of the market – generally it goes down • Few other factors (political, social and economic also affect peoples’ decision to invest) • Risks: • Financial: probability that initial investment not recovered • Liquidity: ability to turn money into cash • Inflation: higher the inflation, lower the real rate of return • Fraud: schemes and scams • Market Price Risk
Bulls and bears and lions and… • Bull market: rising market (values are increasing, indexes are increasing) • Typically a reflection of a booming economy as well people are spending money, low unemployment • Bear market: falling market (approx 20% of value) • Usually bear markets last shorter than bull markets • Though drops is market occur quickly (1929 (12.8%), 1987(22.6%)), rises tend to take a while
Let the chips fall where they may… • Blue chip stock performance during the two crashes: • 1929 (market -12.8%): • AT&T: - 12.7% • Kodak: -18.7% • Sears: -12.5% • 1987 (market -22.6%): • AT&T: - 21.2% • Kodak: - 30.2% • Sears: - 25.3%
Reflecting the economy • Stock market activity affected by economy, since companies affected by economy • Business cycles in the economy (ups and downs in GDP) related to cycles in stock market
Scenario • Imagine a scenario: • Profits decrease in a company (people sell shares in the firm, ‘wealth’ of stockholders decreases) • Firm slows down, lays off employees • Unemployment rises • Wages fall people less ‘wealthy’ (those laid off sell their shares) • Company makes money higher profits (market value increases (stock price) for those holding shares)
Scenario • More workers hired since company doing well • Unemployment decreases • Wages rise people wealthy again (invest once again in stock market, where prices have been rising) • Profits decrease cycle starts all over
How to smooth cycles? • Interest rates play a huge role in the economy affects borrowing by corporations, individuals affects economy (lower spending, lower GDP) • Fed controls interest rates • How? Increases rates to cause economic slowdown, lowers rates to encourage economic growth, through money supply and rate it charges bankers
Fed and stocks • How does the Fed influence the stock market? • Raises interest rates to combat inflation • Higher rates, negative impact on people wanting to invest in stock market stock prices fall • Economy slows down (higher rates) prices and wages fall companies start coming back to profitability
Can Anyone tell you how to spend your money? (Ch 9) • Pecuniary emulation • ‘Keeping up with the Joneses’ wondering how they could afford it? • People spend their money differently, but there are average patterns. Table 5 (p 45) • Majority of expenses: Shelter, Transportation
Spending patterns • As income rises, most expenditures as a percent of income decrease (total amount spent does not change too much) except for insurance, pension & SS (usually a certain % spent, regardless of income), savings & taxes more money, ability to save more • Also varies with age • As age increases, spend more (%) on food, utilities and health care; less on taxes, SS
Back to money… • Paper bills get worn out pretty quick. • Need to be replaced. • Average lifespan of $1: between 13 – 18 months. • How does new currency get into your hands? • The treasury ships new money to the Federal Reserve banks.
New Money • Federal Reserve banks return old money to the treasury, who shred and burn it. • The Fed then distributes the money to individual banks in its regions. • The banks send back old worn out bills back to the Fed branch. • The banks distribute the new money to its customers (in exchange for old ones, of course!) • They get used, world goes around ($$)…
Other forms of money • Currency is not the only type of money. • Checks • Debit cards • Not credit cards • 1998: 70% of all households have at least 1 credit card • Estimated that roughly 84% of those pay their bill in full monthly.
Federal Reserve System • Monetary Policy: the Fed injects and withdraws money from the economy in order to regulate it. • Money supply: the amount of money that people have available to spend (cash, checking accounts)
Federal Reserve system • If money supply is increased, typically economy grows quickly, companies hire more workers, people spend more • If money supply is decreased, economy slows down, unemployment increases etc. • More money there is in the economy, the higher is the price level, less purchasing power (inflation) • As fed changes money supply, the interest rate changes. Increase Ms interest rate falls, decrease Ms interest rate rises.
Do you need a budget? (Ch 10) • If living within paycheck, paying all bills on time, saving money and doing all without a budget, then one is not needed. • But, even if one of the above not met, then need a budget. • Four main elements to a budget: income, expense categories, time period and implementation.
Budget woes… • Income to Use: wages and salaries, rental income, regular investment income (bonds, dividends etc), pension income, and any other regular income received. • If want to account for taxes, use gross income, else use net income (after taxes). • Loans are not income expense
Budget expenses • Most important category • Categories need to be neither too broad nor too specific. • Break down of categories: • either as food, clothing, utilities etc • Or as based on locations (furniture,gas etc) • Pg 50
Budget • Time Period: monthly, weekly, yearly • Best to do monthly, since major expenses occur once a month: rent / mortgage, utilities, car payments, credit cards. • Some get paid once a month, others bi-weekly; either way make sure your expenses and income are of the same time period
Budget • Implementation: hardest part • Save receipts, cancelled checks for all payments made in a month • Account for all income.
Cars: To lease or own? • For same car, lease payments less than loan payments since not paying for whole car • Leasing: only paying for value of car during time you lease it (paying for the depreciation) • ‘Loaning’ : paying for whole value • Cars depreciate most in first two years typically when leased • When lease? If you want a new car every couple of years, businesses • Best strategy: Buy (new car) and hold (it for a long time)
How much debt is too much? (Ch 12) • If own a house, probably the largest share of your debt. • Other forms: student loans, credit cards, etc. • How much is too much? 20% rule • If credit payments (excluding mortgage) are more than 20% of take- home pay trouble! • Comes from typical spending patterns once all essentials accounted for, typically have 20% left over average
Example • Achilles takes home $2000 every month. He pays $300 for his 4-horsepower vehicle. He also owes $200 a month to a creditor, Lenderus. Is Achilles headed for trouble? • Achilles monthly credit payments: • $300+200 = 500 • Take home: $2000 • % = 500/ 2000 x 100 = 25% • According to the rule, he is headed for trouble.
Now you try it! • Patroclus takes home $1500 a month. He pays $175 for his wagon, gives $550 to Lenderus as mortgage payments, pays $50 towards his student loan, taken to study under Achilles. Is he, like his master Achilles, headed for trouble?
How you can get out of debt (Ch 13) • How do you get into trouble with debt? • Take on too much • Maintain your debt, but suffer drastic drop in income • 2nd alternative usually occurs during recessions, with layoffs. • How to get out of debt? • No more debt • Spending control reduce ‘other spending’ and pay off debt • Regular payment schedule to pay off debt entirely
How you can get out of debt • Step 1: No more debt! • Stay away from the mall, don’t look at ads! • Step 2: Reduce ‘other’ expenses • Like dieting: just ‘eat’ less! Hard to do • Start thinking of cheaper alternatives (watch Martha Stewart living) • Step 3: Rigid monthly plan • See table 9, pg 66
Example • Paul owes $8000 on his Visa. The annual percentage is 18%. He can afford $200 per month. How long before he pays it off completely? • Divide total debt by monthly payment. • 8000/ 200 = 40 • Locate the interest rate column on the table. • Look down column until number closest to step 1 result.
Example 2 • Suppose Peter wants to pay off his loan in 3 years. He owes $8000 as well and pays 18% interest to his credit card. What would he have to pay monthly to accomplish this task? • Find the interest rate column (18%). • Find the month row (36 months = 3 yrs). • Use the number (27.66) to calculate monthly payment: Debt/ number = Monthly payment • 8000/ 27.66 = $289.23
Now you try it! • I owe $14, 000 to my neighborhood ‘shark’ who is a nice guy and charges me 13% on my ‘loan’. How long before I can pay him off, if I pay him $155 per month? • I owe $6, 000 to my bank. They charge me 6%. What monthly payments do I need to make to pay off my loan in 5 years? Debt Calculator