1 Introduction To Financial Markets & Investing Matthew Lawson, M.D.
2 Getting Started A true story Internal Medicine Intern Recently married Husband has Financial Planner assigned through his employer Neither of the two have any retirement savings Motivated by they previous talk they decide to open a Roth IRA and start investing They meet with his Financial Planner
3 Getting Started The Financial Planner tells them the following Get started by buying a mutual fund, I recommend Franklin Large Cap Value A Managed by Franklin Templeton, a large mutual fund company The fund invests in Large Companies based in the United States that are relatively undervalued Over the last year it has slightly outperformed the S&P 500 index (11.92% vs %) The fund has over $186 million in assets Has average fees 1.33% and 5.75% front end load Is this a good investment?
4 Topic Outline Introduction to Financial Markets and Investing Stocks & Bonds The Exchange & Indexes Mutual Funds Do Your Homework Getting Started Rules to Live By
5 Stocks & Bonds What is a stock? Simply put, a stock is a piece of paper (called a stock certificate) that represents fractional ownership of a company. If you own 100 shares of Disney Stock (symbol DIS - $34.72 on 4/13/07) Your Disney stock is worth $3,472 Disney is valued at $71.12 Billion Therefore you own about % of the company You are also entitled to a $0.31 per share dividend
6 A Stock is Born Imagine 40 years ago when Disney was planning to open a new theme park Average new park costs millions of dollars just to get started They will need money up front to: buy property draw up plans fund construction market the new park pay people to wear mouse suits
7 A Stock is Born Where to get the money to start? Companies have several options to raise cash Private loan (such as a bank loan) Issue Bonds (essentially public loans) Bonds are loans from individual investors and institutions to a company with expectation that the money will be paid back over a certain time period with a certain interest rate Issue Stock the company sells ownership shares to the public to raise capital At the initial offering the customer purchases shares of the company for a given price The company keeps the money to use and spend The investor (now part owner) is entitled to a share of the profits as well as some say as to how the company is run
8 Stocks & Bonds Stocks Represent OWNERSHIP Entitled to a share of the profits if the company is financially successful Entitled to vote at shareholder meetings (you have a voice as to how the company is run) If the company fails you get paid back last Higher risk, higher reward Bonds You are a LENDER You have loaned your money to a corporation (you are acting like a bank) You expect your money to be returned plus interest (nothing more) Not entitled to any profits If the company fails you get paid back first Lower risk, lower reward
9 Stocks & Bonds A stock is a piece of paper (called a stock certificate) that represents fractional ownership of a company. A bond is a piece of paper (a contract) that describes a loan made to a company and the expected interest payments. Stocks and bonds have value The piece of paper is actually worth something (like the title of your house) The underlying company has real products, assets, and liabilities This underlying value is the basis of stock & bond trading
10 The Market Stock certificates and bonds are traded daily at stock exchanges, like the New York Stock Exchange Stocks are traded between a buyer and a seller The underlying company is not involved Remember, the company collected money at the when the shares were issued the initial offering The stock price fluctuates throughout the day based on the principles of supply and demand
11 The Market Daily Chart
12 The Market - Exchanges All buying and selling of stock takes place on a stock exchange There are three dominant exchanges NYSE The New York Stock Exchange Oldest US exchange, trades still done face to face NASDAQ A virtual exchange with all trades done via a computerized process AMEX American Stock Exchange Companies are listed on one of these major exchanges and have a ticker symbol Ticker symbols are one to four letter abbreviations for companies Companies are generally listed on one exchange Disney DIS (NYSE) Dell Computer DELL (NASDAQ) The SEC is a governmental oversight agency Efficiency and Fairness
13 The Market - Indexes Indexes help track the price movement of groups of stocks (barometer for the market) Indexes are groupings of stocks that are tracked in an effort to determine the direction of the stock market There are hundreds of Indexes DJIA Dow Jones Industrial Average 30 largest industrial corporations historical significance S&P 500 Standard and Poor s most influential corporations in the US Wilshire 5000 Total Market Index Index of small, medium, and large US companies Russell 2000 Russell 1000 Small company index Large company index
14 Mutual Funds To recap: Stocks represent company ownership Bonds represent debt securities They trade daily on exchanges Indexes are yardsticks for measuring stock performance Mutual funds Mutual funds are collective investment pools that allow many investors to pool resources for common investment goals Investors pool money into the fund A fund manager directs the investment Each fund has an Objective and Strategy The manager buys stocks and/or bonds to meet the investment goals Thousands of mutual funds are available for you to purchase Huge variety of goals
15 Mutual Funds Mutual Funds allow a number of smaller investors, who would otherwise only be able to afford stock in a few companies to pool resource and diversify their investment.
16 Mutual Funds Types of Mutual Funds Stock Funds Asset Class (Large Cap, Mid Cap, Small Cap) Value vs. Growth Active Management vs. Index Fund Domestic vs. International Specialty funds (Technology, Healthcare, etc) Bond Funds Money Market Funds A great place to keep emergency cash There are literally thousands of mutual funds!
17 Mutual Funds - Fees Fund managers charge fees for their services Management Fee 12b-1 Fee (advertisement) Expense Ratio (management + 12b-1) Percentage of fund assets spent from all sources Sales Fee (called a load) Goes directly into the pocket of the broker Front Loaded Back Loaded
18 Mutual Funds - Fees No load funds also exist! Many mutual fund companies offer funds with no load and low expense ratios Fidelity, Vanguard, T Rowe Price, and hundreds more! Brokers will tell you the load funds are worth the extra sales fee and perform better This is not true The best predictor of performance low expenses I will never pay a load, and you shouldn t either!
19 Mutual Funds Exchange Traded Funds Exchange Traded Funds ETFs Traditional mutual funds can only be bought and sold once a day There are particular regulations regarding how their gains are taxed The last decade has seen the emergence of exchange traded funds Mutual Funds pools of money from many to achieve a goal Trade on an exchange like a stock must pay a commission Have certain tax advantages (these are lost in Roth IRA) Many new index funds are available as ETFs (low fees)
20 Recap Stocks represent company ownership Bonds debt securities (you loan money) Stocks and bond trade on exchanges Indexes are barometers of the market Mutual Funds pooled assets with common investment objectives Traditional & ETFs I m ready to buy stock, what next?
21 Do Your Homework Before you spend your hard earned cash Do I want a stock or a fund? Where can I learn about stocks? Where can I learn about funds? Are there rating services for funds? In general, you need to fully understand a stock s business model or a fund s investment goal before you invest
22 Do Your Homework The best free source of financial news Yahoo! Finance finance.yahoo.com Investment education Stock information and quotes Mutual fund information Up to date financial news Can create portfolios and watch lists I log in about 20 times a day, often from my cell phone
23 Do Your Homework
24 Do Your Homework Consider a subscription to a financial magazine, then read it cover to cover every month. Money Magazine Kiplinger s Personal Finance SmartMoney Magazine For the advanced reading Barron s Online (or in print)
25 Do Your Homework Stocks Key things to know about stocks Market Capitalization (size) Total outstanding shares x price per share Large Cap Mid Cap Small Cap > $10 B $2 - $10 B < $2 B Share Price what one share costs now P/E ratio (price to earnings ratio) (share price) / (earning per share) The lower the P/E ratio the less expensive the stock Earnings Growth Rate PEG ratio (P/E ratio) / (earnings growth) And there is a whole lot more that we will skip
26 Do Your Homework Funds Key things to know about mutual funds Management company and manager Manager s track record Investment Objective Fee Structure Expense ratio & Average Expense Ratio for that type Morningstar Rating Comparison to other funds with similar objectives Fund performance compared to an index Must be an appropriate index (not just the S&P 500)
27 Do Your Homework Funds You can get information from the fund company For example consider Fidelity Investments Fidelity offers 4,600 funds to their clients MOST are funds managed by other companies Fidelity is a Fund Supermarket They offer 1,400 No Transaction Fee funds (this means there is NO LOAD or charge to buy the fund) There are other companies that are similar fund supermarkets Vanguard T. Rowe Price E Trade They all offer free information on their mutual funds
28 Do Your Homework Stocks What does the company do? Do they make money? Or do they expect to make money soon? Is the price of the stock fair compared to how much money they make? What are their future prospects? Does the stock fit into your overall investment plan? Mutual funds What is the fund objective? What are fund fees? No load or transaction fee Low expense ratio What has past performance been? Vs. and index? How is the fund rated? Who is the manager? Does the mutual fund fit into your overall investment plan?
29 Review Stocks company ownership Bonds debt securities Mutual funds pooled resources for common investment objectives Stock Exchanges Indexes yardsticks for performance Do your homework read something before your spend you cash!
30 Getting Started How to start investing You need a Brokerage Account Savings Account save money, earn interest Checking Account use money, write checks Credit Card Account spend money and pay later Brokerage Account allows you to buy stocks, bonds, mutual funds, other investments
31 Getting Started Brokerage Accounts Brokerage Accounts Allow you to buy and sell securities May be an account fee They charge a commission to buy and sell stocks (may range from $5 to $500 per trade) May allow you to buy no transaction fee mutual funds, or buy funds with a load Regular brokerage account vs. IRA (difference in how taxes are paid)
32 Getting Started Brokerage Accounts Brokerage Accounts Open an Account Preferably in an IRA Many companies to choose from Fund the account Lump sum or recurring monthly investment Invest the money Start with a low cost mutual fund Don t pay a load!
33 Getting Started Diversify Diversification A way to protect your investments by spreading assets among different investments Company Size (Large cap, Mid cap, Small cap) Investment Style (Growth vs. Value) Domestic vs. International Stocks vs. Bonds Real Estate Diversification is critical in long term investment success and helps to reduce investment risk
34 Getting Started Historical Returns What investments, stocks or bonds, have the best potential to perform well in the future? Higher Risk Small Cap Stocks 12.2% Large Cap Stocks 10.2% Government Bonds 5.4% Treasury Bills 3.7% 10.7% Mid & Small Stocks 9.1% International Stocks 9.0% Large Cap Stocks 4.8% Long Term Bonds Inflation 2.9% Source: Ibbotson Associates ( ) Lower Risk Source: Schwab Center for Investment Research: Long Term Market Return Estimates (Jan 2007)
35 Getting Started Ready to Buy You ve opened your IRA You are ready to invest, you ve done some homework, you understand diversification now what!? I would start with a mutual fund that invests in large, U.S. based companies FFNOX Fidelity four in one fund FSLVX Fidelity large cap value fund IWB Russell 1000 index exchange traded fund IVV S&P 500 index exchange traded fund
36 Getting Started Ready to Buy Back to the initial example Planner recommends Franklin Large Cap Value A symbol FLVAX A Large Cap Value Fund Fees: Expense ratio of 1.33% Load 5.75% Ave Large Value is 1.34% Performance: 1 yr Fund: 11.92% 1 yr S&P 500: 11.83% Is the S&P 500 the best comparison for large value? 1 year return of Russell 1000 Value index was 16.83% Morning Star Rating 2 stars Is this a good investment?
37 Key concept: Getting Started Ready to Buy The majority of actively managed mutual fund underperform their respective indexes. The solution: Don t pay for underperformance Read prospectus and review prior results Compare to the most appropriate index! Consider index funds
38 Getting Started Ready to Buy After building up $5,000 to $10,000 in a large cap domestic mutual fund Diversify May add Mid cap or Small Cap fund May add international investments The decision should be based on your investment goal, time horizon, and risk tolerance
39 Rules to Live By Lifelong investing is the only reliable way to build wealth You can do it yourself if you do your homework starting with mutual funds Understand an investment before you buy Even if your financial advisor tells you it is a good buy Diversify your investments Large, Mid, Small Cap Foreign & Domestic, Growth & Value Don t overpay for underperformance Don t pay a load, look for low expenses
Mr. Kaufman Investing Notes: You want to invest in order to create wealth. Are you guaranteed to be wealthy if you invest? NO! However, if you do not save money and invest it then there is no chance for
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