CHAPTER 13
Investment Fundamentals
Lecture outline
I.Explain how to get started as an investor.
A.First: make sure the basic needs are covered (savings, credit, insurance).
Second: budget, including setting aside savings for investments.
B.From savings comes investment money.
Set financial goals—short, intermediate, long-term goals—be specific.
Set up automatic investment program, especially employer retirement programs.
C.Place Figure 13.1 on overhead or screen to show rates of return for various types of investments.
Explain risk premium.
II.Discover your own investment philosophy.
[Comment: I find Figure 13.2, pyramid in book, too busy to put on screen; make a simplified version using just a few asset classes.]
A.Higher risk = higher return over time, though great risk short term may be experienced.
B.Risk = deviation from what’s expected.
1.Most investors shun risk.
2.Risk diminishes for long-term investors.
C.Conservative investment philosophy.
Moderate investment philosophy.
Aggressive investment philosophy.
D.Investors tend to react to events instead of investing proactively—yesterday’s rate of return is not a good predictor for tomorrow’s rate of return.
E.Active investing.
Passive investing—most effectively done with index mutual funds.
III.Identify the kinds of investments that match your interests.
A.Owning.
Lending.
B.Short, intermediate, long-term investments to match your financial goals.
Review components of total return for the most common asset classes—back to Figure 13.1, which is ideal for this.
IV.Describe the major factors that affect the rate of return on investments.
A.Unsystematic risk = diversifiable.
Systematic risk (= market risk) = nondiversifiable.
B.Specific risks can be:
1.Business, financial risk.
2.Inflation risk (deflation).
3.Time risk—time horizon for financial goals are important.
4.Business cycle risk—economic cyclicality can affect some stocks and not others.
5.Market volatility—individual stocks can have high price swings.
6.Liquidity risk—individual stocks, mutual funds versus real estate.
7.Marketability—much like liquidity.
8.Procrastination—see Table 13.3—the biggest risk of all!
C.Transaction costs—commissions.
Leverage—real estate investments.
Tax consequences of investing.
V.Decide which of the five long-term investment strategies you will utilize.
A.Bull and bear markets.
B.Market timing.
C.Being out of the market is more detrimental to investment returns than staying in the market.
D.Time is on your side—not timing.
E.The five strategies:
1.Buy-and-hold—avoids market timing,
2.Dollar-cost averaging—investors cheer in down markets!
3.Portfolio diversification—see Figure 13.4.
4.Asset allocation—variant on the previous strategy. Important aspect is to be invested across asset classes—review your rebalancing philosophy.
5.Modern portfolio theory evolves from asset allocation—simulations may help in estimating whether financial goals will be achieved.
F.When to sell?
G.Advice:
1.DO NOT just invest leftover dollars—set up automatic savings program.
2.DO NOT be too conservative. Time is your friend—timing is not!
3.DO NOT fail to review and rebalance your investments.
VI.Create your own investment plan.
A.Set up a table of dollars to set aside—how much goes into the different types of financial goals?
B.Make sure to match investments with those goals—see Table 13.6.