An Introduction to Investing Fin 303 Fall 2015 James Dow Overview 1. Before You Invest 2. Some Basic Concepts 3. Asset Allocation 4. Investing Using Mutual Funds 5. Investing In Individual Securities 6. Good Habits For Investors 1. Before You Invest Have a Financial Plan Be Properly Insured Have Emergency Funds Determine Your Savings Goals 1
What Are Your Savings Goals? Short-Term Goals Down Payment on a House? Travel? Longer-Term Goals College Education for Children? Retirement? Your Goals Can Affect Your Investing Decisions Short-Term Goals Usually easy to figure out what you need Invest in low-risk assets (more about this later) Long-Term Goals Harder to determine the amount you need Be less conservative with your investments How Much to Save for Retirement Determine Expected Expenditures Sources of Retirement Income Social Security Pensions Individual Savings 2
Calculate Annual Savings Start with needed annual income when you retire. Calculate the amount of savings needed when you retire. Calculate the amount to save each year. Online calculators and FIN 303 can help you. Employer-Sponsored Programs Defined Benefit: Amount paid is guaranteed by the company. It depends on salary and number of years with the company Defined Contribution: Individual makes contributions. Amount paid depends on how well the investments do. Self-Directed Accounts Traditional IRA Roth IRA Keogh Plans Annuities 3
Now What? You know how much you need to save. You ve signed up for a savings plan with your employer. How do you invest the money? 2. Some Basic Concepts What is Return? What is Risk? What is the Risk-Return Tradeoff? What is Diversification? What is Return? Where do returns come from? Current Income Capital Gains Compounding: Interest earns interest. Returns are uncertain: Investors refer to expected or average returns. 4
What is Risk? How likely is it that your return will be higher or lower than you expect. Some assets (such as bank accounts) have little risk. Other assets (such as stocks) will have greater risk. What is the Risk-Return Tradeoff? Assets with higher risk will generally offer a higher expected return. You can choose: investments with high risk and high return investments with low risk and low return but probably not low risk and high return There are a range of assets Small-Company Stocks Expected Return Long-Term Bonds Large-Company Stocks Short-Term Bonds Bank Accounts Risk 5
What is Diversification? Don t put all your eggs in one basket. You can reduce risk without hurting your expected return. 3. Asset Allocation What can you invest in? What is the right mix of investments? Who do you invest with? What Can You Invest In? Bank Accounts Common Stock Bonds Real Estate Other Assets 6
Bank Accounts Are convenient Are insured Are low risk But do not offer the best returns Not the best choice for long-term investing Common Stock A share represents ownership in the company. Stocks generate capital gains (or losses). Stocks may also pay dividends. Bonds An IOU issued by companies and governments. Pay interest and can generate capital gains or losses. Less risk than stock but also a lower expected return. 7
Real Estate Income Properties Commercial Properties Residential Properties Single-Family Homes REITs What is the right mix of assets? Asset allocation refers to how you allocate your wealth across different assets. For example: 60% Stocks 30% Bonds 10% Short-Term Assets (Cash) How to determine the best allocation? The appropriate allocation depends on: Your investing horizon Your tolerance for risk You can find programs online that will suggest allocations for you. 8
An Example The Hudsons 30 years until retirement Average tolerance for risk Recommended allocation is 55% stocks 30% bonds 10% real estate 5% cash Malkiel, Random Walk Down Wall Street, 2003 Who can you invest with? Mutual Funds Stock Brokers Through Your Employer 4. Investing Using Mutual Funds What are mutual funds? What is a mutual fund family? Why mutual funds? How to invest in mutual funds? What kind of fees are there? 9
What is a Mutual Fund? It is a financial company. Allows small investors to pool their money. Professional managers at the fund choose how to invest the money. They invest in stocks, bonds and other assets. Why Mutual Funds? Advantages Can invest small amounts Easy to be diversified Convenient Professional management Disadvantages Less flexibility in choice of securities May have tax disadvantages What is a Mutual Fund Family? Most mutual fund companies offer a number of different individual funds. Each fund will have it s own specific investment goals and strategies. You will need to choose which specific funds to invest in. 10
How to Invest? Buy shares in the mutual fund. When you want to collect your return, you redeem your shares (sell them back to the mutual fund). Net Asset Value (NAV) NAV = (value of all the securities in the fund s portfolio)/(# of shares). Funds generally will sell and redeem shares at the NAV. If the value of the securities increases, the value of your shares will increase too. Holding shares in a mutual fund is just like owning the underlying assets. Fees Fees reduce whatever return you earn shop around. One-Time Fees Annual Fees 11
One-Time Fees (Loads) Loads are like sales commissions. Front-end loads are charged when you first buy the shares. Back-end loads are charged when you redeem the shares. No-load funds do not charge loads. Sometimes fees are charged if you redeem the shares soon after you buy them. Annual Fees Management fees The mutual fund company will take a percentage of the asset s value each year this is how they make their money. 12(b)-1 Fees fees for marketing and promoting. How to get information Online! A prospectus provides the details. What to look for: What does the fund invest in? Does it match your investing plan? What are the fees? How has it performed in the past? 12
Types of Funds Money Market Funds Low risk but low return You can write checks Bond Funds Corporate bond funds High-yield bond funds Municipal bond funds International bond funds Types of Funds (cont d) Stock funds Growth Income Value Sector International Mixed/Balanced Types of Funds (cont d) Index Funds Follows some index (S&P500) Stocks or bonds Low fees and highly diversified Good choice Asset Allocation Funds Real Estate Funds 13
Implementing your investment plan using mutual funds Start with an asset allocation. Choose 3-5 funds that match your asset allocation. Look for diversified funds (internationally too) Take advantage of index funds. Shop around for low fees. 5. Investing in Individual Securities What if you want to pick your own stocks? Go to a stockbroker Open an account Place an order for shares Types of Brokers Full-Service Brokers Discount Brokers Online Brokers Differ in terms of cost, information provided and handholding. 14
Why brokers? You have a specific reason for buying a stock. You have a large amount of wealth and need specialized advice. Mutual funds are fine for the typical investor. Stock Picking Judging whether a particular company s stock is going to do well in the future. Can be fun and profitable. You ll get lots of advice be skeptical. If you take this approach, do your research. 6. Good Habits for Investors Have a plan. Save, save, save. Get the big picture right, don t stress about the little things. Be diversified Have the right asset allocation 15
More Good Habits Avoid unnecessary taxes Avoid excessive fees Take a long-run approach Keep trading to a minimum Don t obsess about the short-run fluctuations of the market. 16