Chapter 11,12,13 (Chapter 11: Investment Planning (11-1 (11-1 d Different…
Chapter 11: Investment Planning
The Objectives and Rewards Of Investing
Investor vs speculators
Belts and Suspenders
With Savings and Capital Accumulation programs, It's also important to have insurance
11-1 a How Do I Get Started
Beginner Basics: stocks, bonds, and mutual funds
Mutual fund or exchange-traded fund
Professional management and diversification
Wall Street Journal, CNN.com, local newspaper
11-1 b The Role of Investing in Personal Finance Planning
Accumulation method for goals
Coming Up with the Capital
Accumulated amount wanted
Determine the expected rate of return
How much you need to put in largely depends on how much you can earn on investments:
higher rate of return, less you'll have to put in
There are two ways of coming up with the capital needed to reach a targeted sum of money:
1 Lump-sum investment
You use compound value concept and future value factor to know how much you need.
Say I have $10,000 and want to use it for kid's college in 18 years, the cost of which I estimate to be $330,000.
How much will I need? Say a 6% I/y, 18 N, -301,460 FV CPT PMT: 9,754.20 is needed to be put away a year, this amount + $28,540 (the original 10,000)
2 Systematic savings plan (annual)
Yearly savings = Future amount of money desired/future value annuity factor
An Investment Plan Provides Direction
Knowing how much you'd have to save a year, you have to set up a systemic savings plan. Monthly to make amount yearly:
Find the annual payment necessary to fund a target amount by putting calc in annual compounding mode. Determine the amount with...
N=years in investment horizon,
I/Y=Expected average annual rate of return on investments
11-1 c What Are Your Investment Objectives
Aggressive vs Conservative?
High dividend/interest return
Shelter from Taxes
If you own and rent real estate = depreciation deductions?
11-1 d Different Ways to Invest
A form of equity, each share of stock = fractional ownership position in a corporation, no maturity
Participation: dividends and/or appreciation in share price
THESE ARE LIABILITIES, loans, IOUs of the issuer
Stated return: interest, typically every six months plus the return of the principal (amount you paid originally) at the time of maturity
The price of bonds, like common stock prices, fluctuate
Preferred and Convertibles
HYBRID, each share characteristics of bonds and stocks
Position of corporation
Like premium stock: Has stated (fixed) dividend rate that is paid before the dividends to holders of common stock are paid
Usually a fixed income obligation that carries a conversion feature permitting the investor to convert it into # of stock
Aka it has the fixed income benefits (interest) of a bond while offering the price appreciation (capital gains) potential of common stock
Mutual Funds, Exchange Traded Funds, and Exchange Traded Notes
A portfolio of securities managed and invested in by an organization
Become part owner
Wide variety of opportunities and services available
Sold based on underlying value of portfolio at purchase
Exchange traded funds (ETFs)
Represent portfolios of securities
Usually set up to track a basket or index of securities or a particular sector (like utility or telecommunications stocks)
Can also include bonds and real estate.
Can only be sold or bought at the end of the day, but investors can trade ETFs throughout the trading day, like individual shares of stock can
ETFs provide more favorable tax treatment than mutual funds though
Exchange traded notes (ETNs)
Senior, unsecured, unsubordinated debt securities issued by an underwritten bank
They are debt securities with a maturity date and are backed by the credit of the issuer
HOWEVER if the bank underwriting the ENT goes bankrupt, the ENT might lose value like a senior debt security would
Like ETFs, most ETNs are designed to reproduce the returns on a market benchmark, net of investment management fees
The bank promises to pay an amount based on the value of the index, net of fees, upon maturity
ETFs only face the risk of market fluctuations while ETNS face both market risk and the risk that the issuing bank will default
Tax advantages over mutual funds
Speculating in raw land to limited partnership shares in commercial property. The returns:rents, capital gains, certain tax benefits
11-2 Securities Markets
11-2 a Primary and Secondary Markets
new securities, one party of transaction is the issuer (new car, only sold once))
Corp gets investment banking firm, which specializes in underwriting (selling) new security issues
The investment banker advises and sells or gives to sell
Normally involves several brokerage firms each selling a portion
Large? An underwriting syndicate forms
Potential buyers in a new issue are given a prospectus
previously issued (outstanding) securities are bought and sold in the secondary market, where the securities are “traded”
Free transactions among investors, money for them only
Major segment: those securities that are listed and traded on the (NASDAQ) market
National Association of Securities Dealers Automated Quotation System
Over-the-counter (OTC): smaller, unlisted securities.
11-2 b Broker Markets and Dealer Markets
Majority of small individual investors deal here, in the secondary market
Two segments: broker markets and dealer markets
Security Dealers/market makers
Made up of both the NASDAQ and the OTC
Mass telecommunications network.
the price at which one can sell a security
the price at which one can purchase a security
Buyer and seller gets together, floor of exchange
Consists of national and regional “securities exchanges"
Besides ICE, a handful of regional exchanges are also part of the broker market. The number of securities listed on each of these exchanges typically ranges from about 100 to 500 companies.
Boston, National, Pacific, and Philadelphia exchanges
Primarily securities with local and regional appeal
ExxonMobil, Walmart, Pfizer, IBM, Coca-Cola, Home Depot, UPS
The biggest dealer market: NASDAQ
Three-sub-markets: the NASDAQ Global Market, the NASDAQ Global Select Market, and the NASDAQ Capital Market.
Apple, Microsoft, Facebook, Intel, Cisco Systems, eBay, Google.
Lists c. 3,300 companies with a market value of more than $12.2 trillion from all over the world.
Mostly small companies that either can’t or don’t comply with NASDAQ listing requirements
OTC Bulletin Board (OTCBB)
Electronic that links the market makers who trade the shares of small companies.
SEC, audited financial statements, federal securities law.
Unregulated seg of the market no SEC complicance
11-2 c Foreign Securities Markets
Over 100 other countries others
Biggest NYSE, NASDAQ, then Tokyo
11-2 d Regulating the Securities Markets
Securities Act of 1933
Full disclosure of information on new security issues to SEC
Securities Exchange Act of 1934
SEC power to regulate organized securities exchanges and the OTC market by extending disclosure requirements to outstanding securities.
Investment Company Act of 1940
investment companies can't pay excessive fees to advisors
Can't charge excessive commission fees to share purchasers
The Sarbanes-Oxley Act of 2002 (SOX)
is to eliminate corporate fraud through accounting
Accountability, confirmation through annual eval, tops certify
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010
Volcker Rule, which prohibits depository banks from proprietary trading
Financial Stability Oversight Council, the Office of Financial Research, and the Bureau of Consumer Financial Protection
Other significant legislation
The Maloney Act of 1938: Self regulation
National Association of Securities Dealers (NASD): all brokers and dealers in the OTC market
The Securities Investor Protection Act of 1970
created the Securities Investor Protection Corporation (SIPC),
Protects investors against failure of brokerage firms like the FDIC
11-2 e Bull Market or Bear?
11-3 Making Transactions in the Securities Markets
11-3 a Stockbrokers
Selecting a Broker
stocks but also bonds, convertibles, mutual funds, options, other sec
Full Service, Discount, and Online Brokers
Full services, commission fee
Low overhead, fewer services, 30-80% savings
SIPC Securities Investor Protection Corporation
11-3 b Executing Trades
11-3 c Types of Orders
11-3 d Calculating Investment Returns
11-4 Becoming an Informed Investor
11-4 a Annual Stockholder' Reports
11-4 b The Financial Press
Dow Jones Industrial Averages
Standard & Poor's Indexes
The NYSE, NASDAQ, and Other Market Indexes
11-4 c Advisory Services
11-5 Online Investing
11-5 a Online Investor Services
Investment Research and Screening
Starting Online Investing
Set aside some money to get started and choose a broker. You don’t need much—your initial deposit can be as little as $50. Choose an online broker with no minimum deposit.
Learn the key investing jargon. Some useful sources are Investopedia (www.investopedia.com) and InvestorWords (www.investorwords.com)
Practice with a paper account before investing real money.
Try out different investment strategies using investment tracking programs like Icarra (www.icarra.com)
Gradually add more money to your account
Monitor your portfolio’s performance
Keep up with financial news.
In addition, read as much as you can on how to invest
11-6 Managing Your Investment Holdings
11-6 a Building a Portfolio of Securities
all you’re really doing here is deciding how to cut up the pie. You still have to decide which particular securities to invest in. Once you’ve decided that you want to put, say, 20 percent of your money into intermediate-term (7- to 10-year) bonds, your next step is to select those specific securities.
Reasons to reexamine your investments:
Deviates from your target allocation for that class by more than about 5 percent
Getting close to goals
11-6 b Asset Allocation and Portfolio Management
Asset Allocation: a plan for dividing a portfolio among different classes of securities in order to preserve capital by protecting the portfolio against negative market developments
11-6 c Keeping Track of Your Investments
a portfolio is a collection of investments assembled to meet a common investment goal.
Of course, it’s possible to have a balance of both income and growth (capital gains) in a portfolio; but most often, that involves “tilting” the portfolio in one direction (e.g., toward income) or the other (toward growth).
Chapter 12 Investing in Stocks and Bonds
12-1 The Risks and Rewards of Investing
12-1 a The Risks of Investing
Purchasing Power Risk
Interest Rate Risk
12-1 b Returns from Investing
Earning Interest on Interest: Another Source of Return
Key Investing Concepts:
12-1 c The Risk-Return Trade-Off
12-1 d What Makes a Good Investment?
Approximate Expected Yield
Required Approximate Yield
the minimum rate of return an investor feels should be earned in compensation for the amount of risk assumed
You can easily find the exact expected return on this investment by using a financial calculator.
First, put the calculator in the annual compounding mode. Then—to find the expected return on a stock that you buy at $60 a share, hold for three years (during which time you receive average annual dividends of $2.15 a share), and then sell at $95—use the keystrokes shown above, where:
N = number of years that you hold the stock
PV = the price that you pay for the stock (entered as a negative value)
PMT = average amount of dividends received each year
FV = the price that you expect to receive when you sell the stock (in three years)
You’ll notice there is a difference in the computed yield measures (17.83 percent with the approximate procedure versus 19.66 percent here). That’s to be expected because the former is only an approximate measure of performance, whereas this is an exact measure
12-2 Investing in Common Stock
12-2 a Common Stocks as a Form of Investing
Issuers of Common Stock
Any company, any line of business
Publicly traded issues
One share of stock held= one vote
In some cases, common stock may be designated as nonvoting at the time of issue, but this is the exception rather than the rule.
Annual stockholder's meeting
Basic Tax Considerations
BEWARE OF COMMON INVESTING MYTHS
During volatile markets it makes sense to sell your stocks and wait for calmer conditions.
Gold is a good addition to any portfolio.
The S&P 500 is the best place for long-term stock investors.
Far less should be invested in stocks during retirement.
Level of current income offered
Hit it big
12-2 b Dividends
Common stocks provide income in the form of dividends, usually paid quarterly, and/or capital gains, which occur when the price of the stock goes up over time.
annual dividend yield per share/market share per share of stock
new shares of stock distributed to existing stockholders as a supplement to or substitute for cash dividends
Same value tho
12-2 c Some Key Measures of Performance
How much in stockholder funds finances firm
Net PROFT Margin
Return on Equity (ROE)
How well the business is doing, through managing assets, operations, and capital structure
Think Roe v Wade, how well is it doing today
Earnings per Share
net profit after taxes - preferred dividend paid/number of shares of common stock outstanding
dividing market price per share by earnings per share
measurement, an index, of performance
Want low volatility beta
12-2 d Types of Common Stock
Blue Chip Stocks
Income Stocks vs Speculative Stocks
Cyclical Stocks or Defensive Stocks
Cyclical: automobiles, steel, and lumber
Large Caps, Mid Caps, and Small Caps
12-2 e Market Globalization and Foreign Stocks
American Depositary Receipts (ADRs)
International mutual funds
The U.S. share of the world equity market fallen to around 43 percent.
12-2 f Investing in Common Stock
Advantages and Disadvantages of Stock Ownership
Many stocks are actively traded, so highly liquid
Market and company information is easily accessible
Potential returns: dividend and price appreciation
Difficulty of timing the purchase and sales
Uncertainty of dividends
Goals in investing in common stock
(2) to accumulate capital
(3) to provide a source of income.
1) to use the stock as a warehouse of value , and
12-2 g Making Investment Decisions
Putting a Value of Stocks
How much are you willing to pay
Timing Your Investments
You believe strongly that the market is headed down in the short run.
You feel uncomfortable with the general tone of the market
Behavior Matters: Investors Tend to Overreact
Constructively decide to do nothing.
Money is like soap
Resist the urge to sell stocks in a declining market.
Be Sure to Reinvest Your Dividends
Dividend Reimbursement Plan (DRB)
Return is taxable the year they're received
12-3 Investing in Bonds
12-3 a Why Invest in Bonds
Fixed income securities
High Capital gains
Whenever market rates fall
When interest rates rise, bond prices fall. Conversely, when interest rates fall, bond prices rise
12-3 b Bonds vs Stocks
Money in stocks taxed as general income
Bonds downside: poor comparative returns
Less return for less risk
12-3 c Basic Issue Characteristics
Types of Issues
Equipment trust certificate
Replaced with lower coupon
Basic Issue Characteristics
12-3 d The Bond Market
2,3,5 year maturity
Sold in minimum denominations of $1,000
Exempt from state and local taxes, but interest is not exempt from federal tax
20,30 year maturity
Treasury inflation-indexed bond
Agency and Mortgage Backed Bonds
Not issues by US Treasury and has higher market rates
Mortgage backed bonds
Issues of states, counties, cities, and other political subdivisions such as school districts and water and sewer districts
Federal tax free except for capital gains
Compare to fully taxable equivalent yield
Yield on municipal bond/1-tax rate
Generally issues as serial obligations but can also be
General obligation bond
Only corporate issuers
Common stock conversion
Indication of how much the bond would be traded for if sold on share value
How much the convertibles will actually go for
Price potential of a common stock along with the downside risk protection of a corporate bond.
Rail and transportation bonds
12-3 e Bond Ratings
Standard & Poor's
Grade based system grading servicing debt ability
Speak of stability and ability of company
Aaa through Baa; or AAA through BBB
Investment grade bonds
Ba/B or BB/B
Higher rating lower the yield of an obligation, all things being equal
Whereas an A-rated bond might offer a 5 percent yield, a comparable AAA-rated issue would probably yield something like 4.25 or 4.50 percent.
12-3 f Pricing a Bond
Bond Prices and Accrued Interest
Regardless of the type, all bonds are priced as a percentage of par
a quote of, say, 85 translates into a price of 85 percent of the bond’s par value. In the bond market, 1 point = $10
Dirty (full) price
12-3 g Bond Prices and Yields
Current Yield and Yield to Maturity
= annual interest income/market price of a bond
Chapter 13: Mutual Funds, ETFs, and Real Estate
13-1 Mutual Funds and Exchange Traded Funds: Some Basics
13-2 Types of Funds and Fund Services
13-2a Types of Funds
Aggressive Growth Fund
Equity Income Funds
Growth and Income Funds
Three advantages over individual bonds
And third, bond funds automatically reinvest interest and other income, thereby allowing the investor to earn fully compounded rates of return.
Second, they offer a cost-effective way of achieving a high degree of diversification in an otherwise expensive investment (1-5k)
First, bond funds generally are more liquid.
Government bond funds
invest in U.S. Treasury and agency securities
Mortgage-backed bond funds
put their money into various types of mortgage-backed securities
High-grade corporate bond funds
invest chiefly in high-grade securities rated triple-B or better
High-yield corporate bond funds
which are risky investments that buy junk bonds for the yields that they offer, which can be higher than standard bonds
Convertible bond funds
invest in securities that can be converted or exchanged into common stocks
Municipal bond funds
which invest in tax-exempt securities
Intermediate-term bond funds
which invest in bonds with maturities of 7 to 10 years or less
Money Market Mutual Funds
Socially Responsible Funds
Asset Allocation Funds
13-2b Services Offered by Mutual Funds
Automatic Investment Plan
Automatic Reinvestment Plan
offered by just about every open-ended mutual fund
systematic withdrawal plan
automatically receive a predetermined amount of money every month or quarter, plus return that goes back into buying more shares
The only limitation is that the investor must confine the switches to the same family of funds
Standard tax deductible IRA or Keogh
ROTH IRA account
Choosing best fund
Decide how much money you want to invest in mutual funds
Decide on your asset allocation
Decide length of time before you need the money and risk tolerance
Common rule of thumb for retirement savings is that the percentage in bonds should equal your age, and the rest should be in stocks
Diversify your investments over different types of mutual funds
Put together a list of available mutual funds.
Compare each fund’s historical performance with an appropriate benchmark: expense ratios, turnover ratios
Avoid “dog” funds.
The worst funds often have a record of higher expenses and costs. Measured using returns, expense ratios, and turnover.
13-3 Making Mutual Fund and ETF Investments
13-3a The Selection Process
Objectives and Motives for Using Funds
A way of accumulating capital over an extended time?
To speculate with your money in the hopes of generating high rates of return?
To conserve your capital by investing in low-risk securities where preservation of capital is no less important than return on capital?
What Ideal Funds Have to Offer
achieve maximum capital growth when security prices rise;
provide complete protection against capital loss when prices decline; and
achieve high levels of current income at all times. Unfortunately, such funds don’t exist.
Choosing Among the Alternatives
Fund's investment performance
(1) how the fund has performed over the past five to seven years;
(2) the type of return (income vs. capital gains) after investment management fees it has generated in good markets as well as bad;
(3) the level of dividend and capital gains distributions, which is an important indication not only of how much current income the fund distributes annually, but also of the fund’s tax efficiency (funds with low dividends and low asset turnovers typically expose their shareholders to lower taxes and consequently have higher tax-efficiency ratings); and
(4) the level of investment stability that the fund has enjoyed over time (or, put another way, the amount of volatility/risk in the fund’s return)
13-3b Getting a Handle on Fund Performance
The single variable driving a fund’s market price and return behavior is the performance of its securities portfolio
Measuring Fund Performance
Any mutual fund (open- or closed-end) or any ETF has three potential sources of return:
(1) dividend income
(2) capital gains distribution
(3) change in the fund’s share price.
13-4 Investing in Real Estate
13-4a Some Basic Considerations
Outlook for the national economy, interest rate levels, supply and demand for space, and regional considerations
The expected cash flows are determined by rent, depreciation, and taxes, and expected future sales price
The return on a real estate investment is determined by the relationship between the expected future cash flows relative to the initial investment, which is typically reduced by using a significant amount of borrowed funds.
Use of Leverage
Leverage involves using borrowed money to magnify returns.
Because real estate is a tangible asset, investors can borrow as much as 75 to 90 percent of its cost. .
As a result, if the profit rate on the investment is greater than the cost of borrowing, then the return on a leveraged investment will be proportionally greater than the return generated from an unleveraged investment
Appreciation in Value
In most cases, such appreciation has a much greater impact on rate of return than does the ongoing net annual cash flow from the property.
Cash Flow and Taxes
The after-tax cash flows on a real estate investment depend on the revenues generated by the property, on any operating expenses, and on depreciation and taxes.
Real estate typically provides large depreciation write-offs that tend to lower the taxable income of certain (qualified) investors.
For tax purposes, real estate is considered a passive investment.
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13-4b Speculating in Raw Land
Investors seek to generate high rates of return by investing in property that they hope will undergo dramatic increases in value
13-4c Investing in Income Property
Income Producing Property
real estate purchased for leasing or renting to tenants in order to generate ongoing monthly/annual income in the form of rent receipts
NOI (Net Operating Income)
Cap Rate (expected annual rate of return)
13-4d Other Ways to Invest in Real Estate
REIT (Real Estate Investment Trust)
90% of the market
Dividend yields way above common stock
Shares plus borrowed funds to create portfolio
Real Estate Mutual Funds
Real Estate Limited Partnership/Limited Liability Companies
LLCs (Limited Liability Companies)
has a managing member and other members—none of whom have any liability.
Investors buy units in an LP or LLC; a unit represents an ownership position that is similar to a share of stock. Real estate LPs and LLCs are highly illiquid and are felt to be far riskier investments than REITs. They tend to appeal to affluent investors who can afford the typical cost of $100,000 per unit or more.
LP (Limited Partnerships)
the managers assume the role of general partner. This means their liability is unlimited and that the other investors are limited partners who are legally liable only for the amount of their initial investment
Mutual Funds and Exchange Traded Funds: Some Basics
13-1a The Mutual Fund Concept
Created in Boston 1924
13-1b Why Invest in Mutual Funds or ETFs?
13-1c How Mutual Funds Are Organized and Run
Investing, recordkeeping, safekeeping, and others—are split among two or more companies.
13-1d Open-End versus Closed-End Mutual Funds
Another phrase for mutual fund
Over 95% of assets under management
Unlimited shares, as demanded by buyer
Never trading among individuals
Each open ended mutual fund buys back their shares when investors sell
Buy and sell based on NAV
NAV = price per share
Every buy and sell order is filled at closing price at the end of the trading day
Fixed number of shares
No issuing of new stock
No new money coming in, no new investments must be found
Trading in secondary market
Only investors trade through listed exchange, fund has no part
Discount of NAV
Price is NAV and supply and demand of market based
A representative sample of a section of the stock market
Money management of mutual fund
Liquidity of exchanged stock
Traded on list exchange like closed end mf
Can be sold anytime
Passively managed: low costs, low portfolio turnover, and low taxes (cause of low rate of capital gain)
Actively managed: higher costs, portfolio turnover, and taxes
Focus on outperforming passive management rather than index
Outperforms benchmarks through options, futures, and swaps
Domestic and international stock indexes and submarkets
And about any type of U.S. Treasury, corporate, or municipal bond index
Just about every major U.S. index has its own ETF, with a lot of minor indexes covering specialized market segments.
NASDAQ 100: Qubes
Biggest and oldest based on based on S&P: Spiders: SPDRs
About 91 percent of households that own mutual funds also own ETFs.
Number of shares can be increased or decreased with demand
NAV set at a fraction of the underlying index value at any given time.
13-1f Choosing between ETFs and Mutual Funds
What do you want? To invest in a specific thing or to keep price and tax low
Things one should consider
Broad or narrow focus?
Consider mutual funds for broad index investing and ETFs for more narrow, targeted investing
ETFs protect investors from capital gains taxes better than most mutual funds can
They trade less than the average actively managed mutual fund, which means that they should generate fewer taxable gains
13-1g Some Important Cost Considerations
With a closed-end investment company or an ETF, you pay a commission like any type of listed or over-the-counter (OTC) common stock transaction
An open end investment is more varied
Front-end loads refer to commissions charged at purchase of share
Maximum commission is 8.5%
No charge for selling
Low load mutual funds charge 2-3%
Back-end mutual fund
a commission for redeeming fund shares (redemption fee)
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Rear loaded (redemption fees) fees refers to commission upon selling share
No Load Funds
Charge nothing at all to buy their funds
Less than half of the funds sold today
12b1 Fees (Hidden Loads)
Aka the charge to get into a mutual fund; consist of commissions that are paid to the people who actually sold the mutual fund over the life of the mutual fund
annual charge and can amount to as much as 1 percent of assets under management (annual distribution fees)
There is no relationship between the size of the 12b-1 fees and the performance of the fund
assessed annually and usually range from less than 0.5 percent to as much as 3 or 4 percent of assets under management.
All funds—whether they’re load or no-load, open- or closed-end—have these fees
Some funds may charge an annual maintenance fee to help offset the costs of providing service to low-balance accounts
Keeping Track of Expenses
Every fund prospectus must contain a fee table, consisting of three parts to explain total fund fees
The first specifies all shareholder transaction costs
The second lists all annual operating expenses of the fund as % of average net assets
The third section gives the total cost over time of buying, selling, and owning the fund
Internet sites such as Quicken.com, Kiplinger.com, Morningstar.com
Or the mutual fund quotes that appear daily in (most) major newspapers and in The Wall Street Journal
13-1h Buying and Selling Funds
ETFs and closed end MF done through brokers and dealers
Open ended: discount or full-service broker, or directly from the mutual fund company
Viewing recent performance as overly representative of a mutual fund’s future performance
Investors might buy and sell mutual funds without adequately considering the effects of costs on their portfolio, believing Mutual Funds to be "safe"
People don't like taking losses more than they like realizing gains. Which leads to the holding of assets that have lost value too long and tend to take gains too soon.
Exchange traded fund (ETF)