Chapter 13: Investing Fundamentals

Establishing Investing Goals:

1. Must be specific and measurable
a. How, what risks are involved? Reasonable?
b. Short term (less than two years), intermediate (2-5 years) and long term
(more than 5 years)
Performing a Financial Checkup:
1. Work to balance your budget
a. No sense to start an investment program until credit card and installment
purchases are reduced or eliminated.
b. Limit consumer credit payments to 20% of your net (after tax) income
2. Obtain Adequate Insurance Protection
a. Meet insurance needs before investing
3. Start an Emergency Fund
a. EF: an amount of money you can obtain quickly in case of immediate
need. Deposit in saving account with high yield or money market mutual
fund that allows immediate access.
b. That amount should equal to 3-9 months’ living expenses
4. Have access to other sources of cash for emergency needs
a. Establishing a line of credit at a bank, saving and loan associations, credut
union or a credit card company.
b. Line of credit: us a short term loan that is approved before the money is
actually needed.
c. L of C having a ceiling or max. amount.
Getting the Money Needed to Start an Investment Program:
1. Priority of Investment Goals:
a. What are you willing to sacrifice to provide funding for your investments?
Varies with people
The Value of Long-Term Investment Programs:
1. rate of return and the length of time your money is invested do make a difference
2. Investments with higher return is not guaranteed, here is risk involved.
3. To avoid or postpone tax, IRA, a Roth IRA, a 401(k) or 403(b)
Factors Affecting the Choice of Investments:
1. Safety and Risk
a. Safety in an investment means minimal risk of loss; risk means a measure
of uncertainty about the income. Ranging from very safe to very risky
b. Very safe investments: government bonds, saving accounts, certificated of
deposits, and certain stocks, mutual funds and corporate bonds. Sometimes
real estates
c. Speculative investments: is a high risk investment made in the hope of
earning a relatively large profit in a short time.
i. Speculative stocks, certain bonds, some mutual funds, some real
estate, commodities, options, precious metals & stones,
collectibles.
2. The risk-return tradeoff
 a. There is some risk associated with all investments: experience two types:
i. Risk of not receiving periodic income payments
ii. Risk that investment may decrease in value
3. Evaluating your tolerance for risk:
a. The potential return to any investment should be directly related to the risk
the investor assumes.
b. Calculating return on an investment
i. Rate of return: the total income you receive on an investment over
a specific period of time divided by the original amount invested.
Components of the risk factor: Evaluate changes in the risk factors
1. Inflation risk
a. Inflation is rise in the general prices (reduces your buying power)
i. During periods of high inflation, there is a risk that the financial
return on an investment will not keep pace with the inflation rate.
2. Interest rate risk
a. The interest rate risk associated with government or corporate bonds or
preferred stock is the result of changes in the interest rates in the economy.
i. Value of these investments decreases when interest rates increases.
ii. Value of these investments increases when interest rates decreases.
3. Business Failure Risk
a. If the business operates at a loss, interest payments or repayments of
bonds is at question.
4. Market Risk
a. Prices may fluctuate because of the behavior of investors in the
marketplace.
5. Global Investment Risk
a. Investing in global securities creates additional risk.
b. Must be evaluated just like domestic investments
c. Changes in the currency exchange rate may affect the return on your
investment
Investment income:
1. If investment income is a primary objective, choose municipal bonds, corporate
bonds, preferred stocks, utility stocks, mutual funds, and real estate rental
property.
2. Investment growth
a. Sacrifice immediate cash dividends for greater dollar value in the future
3. Investment Liquidity:
a. Liquidity: the ability to buy or sell an investment quickly without
substantially affecting the investment’s value.
i. Ranges from near-cash investments to frozen investments
Asset Allocation and Investment Alternatives:
1. Asset allocation: the process of spreading your assets among several different
types of investments (sometimes referred to as asset classes) to lessen risk.
a. Measure of safety and reduces risk. Ranging from large-cap, small-cap,
stocks, foreign stocks, high-quality stocks.
2. The time factor
 a. When do you need your investment money is crucial in deciding which
you will pick (5-10 years, stocks and mutual funds; short-term government
bonds, high-rated corporate bonds, and CODs)
b. Your age: final factor to consider when choosing an investment.
i. Substrate your age from 110, the difference is the percentage of
your assest that should be invested in growth investments.
Sometimes, using 100 to be conservative.
Different Investment alternatives:
1. Stocks or equity financing
a. Equity capital: money that a business obtains from its owners.
i. By partners; stockholders
b. Two factors to consider:
i. A corporation is not required to repay the money obtained from the
sale of the stock or to repurchase the stock at a later date.
ii. No legal obligation to pay dividends to stockholders. Dividends: a
distribution of money, stock or other property that a corporate pays
to stockholders.
1. In a bad year. Board of directors can vote to omit dividend
payments
c. Two types of stocks:
i. Common stock: a share represents the most basic form of corporate
ownership
1. a source of income if the company pays dividends
2. growth potential if the dollar value of the stock increases
3. growth potential if the company splits its common stocks
(no guarantee that stock’s value will increase after split)
ii. preferred stock: they receive cash dividends before common
stockholders are paid any cash dividends.
2. Corporate and government bonds:
a. Corporate bonds: a corporation’s written pledge to repay a specific amount
of money, along with interest.
b. Government bond: the written pledge of a government or a muncipiality to
repay a specified sum of money, along with interest.
i. You are loaning money to corporate or government
3. Mutual funds: an investment alternative chosen by people who pool their money
to buy stocks, bonds, and other securities selected by professional managers
employed by an investment company.
4. Real Estate: location, location and location
5. Factors the reduce investment Risk:
a. Monitor the value of your investments
b. Keep accurate and current records.
c. Other factors that improve investment decisions:
i. Having professional help with financial plan