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Personal Finance Bennie Waller [email protected] 434-395-2046 Longwood University 201 High Street Farmville, VA 23901 Bennie D Waller, Longwood University Investments Bennie D Waller, Longwood University Investing Understand the difference between investing and speculating. An investment is an asset that generates a return. For example, many stocks pay dividends and bonds pay interests. Speculation is in essence a gamble on what might happen in the future. For example, buying a piece of real estate because you heard a rumor that Microsoft was moving into the area. Gold coins Baseball cards Speculation revolves largely around supply and demand Invest, don’t speculate Bennie D Waller, Longwood University Investing Starting your investment program Pay yourself first. Make investing automatic. Take advantage of Uncle Sam and your employer. Windfalls Make two months each year investment months. Bennie D Waller, Longwood University Investing Securities – stocks and bonds issued by companies to raise capital Securities markets – where you buy and sell securities Primary market – where companies take the company “public” (IPO) Seasoned new issues – Investment banking Secondary market – marketplace where previously issued securities trade Organized exchanges, (NYSE) OTC – NASDAQ Bennie D Waller, Longwood University Investing Regulation of Securities markets SEC Insider trading Churning Types of Orders Market order – buy/sell at current market price Limit order – trade made only at certain price Stop-loss order – order to sell if price drops some specified amount Bennie D Waller, Longwood University Investing Short selling – very dangerous! If you believe that stock will drop, you borrow stock from broker account and sell it. IF stock price does drop, you buy it back at the lower price and return to broker account HOWEVER, if price goes up, you must buy it back at higher price and return to broker account. Bennie D Waller, Longwood University Investing Full service brokers Get paid on commissions Discount brokers – execute trades, but no advice Cost of trading includes Commissions to buy/sell stock Transaction fees Day trading is not investing Good sources of investment information Financial news Yahoo! Finance WSJ Bennie D Waller, Longwood University Investing Derivative securities – a security whose value is dependent upon the value of some underlying asset, e.g., MBS Bennie D Waller, Longwood University Investing Options – a security (financial instrument) that gives the owner the right to buy or sell an asset (typically common stock) for a specified price over a specified period of time. Call option – gives the owner the right to purchase an asset at a given price (strike price) before the expiration of the option. e.g., if you believe that a stock will increase in price, you could purchase a call option. If the stock goes above the strike price, the option could be exercised and the underlying stock purchased. Put option – give the owner the right to sell an asset at a given price before the expiration of the option. Bennie D Waller, Longwood University Investments Investment goals should consist of short-term (<1 year), intermediate (1-10 yrs.) and long term (>10 yrs.) Basic Investment choices Lending (Debt) investments – Bonds (corporate or government) Savings account Ownership (Equity) investments – ownership in an income producing asset Stocks Real estate Bennie D Waller, Longwood University Investments Returns on investments Holding period return Tax considerations Capital gains (or loss) – Income – Stocks – dividend payments Bonds – interest payments Real Estate – rental payments Bennie D Waller, Longwood University Interest rates Interest rates Affect the value of assets Interest rates are affected by a number of factors. The Federal Reserve, which is charged with maintaining the stability of the nation's financial system, raises or lowers short-term interest rates in an effort to maintain that stability (bankrate.com) Nominal Interest rate 𝑅𝑎𝑡𝑒 = 𝑟 = 𝑟 ∗ + 𝐼𝑃 + 𝑅𝑖𝑠𝑘 𝑃𝑟𝑒𝑚𝑖𝑢𝑚 𝑟 ∗ + IP + DRP + LP + MRP Bennie D Waller, Longwood University Interest Rates Normal Yield Curve - A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity dates. Bennie D Waller, Longwood University Risk/Return Expected return is a function of risk. “The risk curve is upward sloping” The more risk you assume, the more return you should expect to earn! The objective is to optimize the trade-off between risk and return. Bennie D Waller, Longwood University Risk and Return Both kickers made 10 field goals. Which one would you want on your team? Why? A B Bennie D Waller, Longwood University Risk and Return E(Return) A The “Risk Curve” is upward sloping Time Bennie D Waller, Longwood University Risk and Return E(Return) The “Risk Curve” is upward sloping B Time Bennie D Waller, Longwood University Risk/Return 18% Small-Company Stocks Annual Return Average 16% 14% 12% Large-Company Stocks 10% 8% 6% T-Bonds 4% T-Bills 2% 0% 5% 10% 15% 20% 25% Annual Return Standard Deviation Bennie D Waller, Longwood University 30% 35% Risk/Return Sources of Risk Interest rate risk Inflation risk Liquidity risk Business risk – risk associated with particular business Market risk – overall market fluctuations Diversification – the reduction of risk by investing in different assets. “Don’t put all of your eggs in one basket” Bennie D Waller, Longwood University Diversification Bennie D Waller, Longwood University Asset allocation The Early years (<54) Your investment horizon is significant, so you can handle fluctuations in the market. A typical portfolio might include 80% in stocks, 20% bonds. The Golden Years (55-64) Preserve wealth and plan for retirement Move out of stocks (due to volatility and investment horizon) and into bonds. (e.g., 60% stocks, 40% bonds) Retirement You will be spending more than saving. Income should be primary investment objective. Continue to move into bonds and other liquid assets. Bennie D Waller, Longwood University Asset allocation Calculating returns Holding period return Bennie D Waller, Longwood University Investments Market efficiency – asset prices reflect information. Be mindful of trying to “beat” the market Don’t get overconfident (arrogance) – trading too often “Disposition” effect – no one wants to be a loser “House money” effect – don’t take irrational risk “Herd behavior” effect – Bennie D Waller, Longwood University Thank You Bennie D Waller, Longwood University