Download Chapter 14 - Technical Analysis

Fin2802: Investments
Spring, 2008
Dragon Tang
Lecture 25
Personal Finance
April 17/18, 2008
Readings: Chapter 26
Practice Problem Sets: 1, 12
Fin 2802, Spring 08 - Tang
Chapter 26: Personal Finance
1
Where Are We?
How?
Securities
Markets
Institutions
Trading
Delegated investment
Why?
Market efficiency
Historical performance
What?
Stock
Bond
Evaluation
International
So What?
Behavioral bias
Technical analysis
Do’s and Don’ts
Fin 2802, Spring 08 - Tang
Chapter 26: Personal Finance
2
Personal Finance
Objectives:
1. Analyze lifetime savings plans with inflation and taxes
2. Analyze the investment objectives of individual and
institutional investors.
3. Identify constraints on individual and institutional
investors.
4. Analyze and compare major types of investment policies.
Fin 2802, Spring 08 - Tang
Chapter 26: Personal Finance
3
Basic Considerations in
Developing a Plan
•
•
•
•
Fin 2802, Spring 08 - Tang
Time until retirement
Allocation to savings
Life expectancy
Rate of return
Chapter 26: Personal Finance
4
Figure 26.1 Long Life Expectancy is a Double-Edged Sword
5
Planning with Inflation
• Inflation reduces the retirement benefit
• To overcome inflation requires greater allocation
to savings or higher rates of return on
investment.
• Inflation has an added effect when taxes are
incorporated
Fin 2802, Spring 08 - Tang
Chapter 26: Personal Finance
6
Planning with Taxes
• Taxes further reduces the retirement benefits
available
• To overcome the impact of taxes requires larger
allocations to savings or higher returns on
investments
• Inflation combined with taxes further reduces the
benefits available
• Flat versus graduated tax rates
Fin 2802, Spring 08 - Tang
Chapter 26: Personal Finance
7
Tax Shelters
• Potential benefits for shelters
– Postponing payment of tax
– Additional earnings on the investment of
postponed tax payments
• Effectiveness of the shelter depend on
investment performance and variability in tax
rates
Fin 2802, Spring 08 - Tang
Chapter 26: Personal Finance
8
Tax Shelter Accounts
•
•
•
•
•
Traditional IRAs
Roth IRAs
401k and 403b plans
Progressive tax rates
Capital gains and ordinary income tax
considerations
Fin 2802, Spring 08 - Tang
Chapter 26: Personal Finance
9
Traditional vs. Roth IRA
Tax Shelters Under a Progressive Tax Code
Fin 2802, Spring 08 - Tang
Chapter 26: Personal Finance
10
Investing Roth IRA
Contributions into Stock and Bonds
Fin 2802, Spring 08 - Tang
Chapter 26: Personal Finance
11
Investing Traditional IRA
or 401k Contributions in Stocks and Bonds
Fin 2802, Spring 08 - Tang
Chapter 26: Personal Finance
12
Social Security
•Indexing Factor Series
•Average Indexed Monthly Income
•Primary Insurance Amount
•Performance issues (social security crisis)
Fin 2802, Spring 08 - Tang
Chapter 26: Personal Finance
13
Additional Considerations in Planning
•
•
•
•
Fin 2802, Spring 08 - Tang
Financing a child’s education
Rent or buy decision
Uncertain longevity
Marriage, bequests and
intergenerational transfers
Chapter 26: Personal Finance
14
The Investment Process
Four step process:
• Objectives
• Constraints
• Policies
• Monitoring
Fin 2802, Spring 08 - Tang
Chapter 26: Personal Finance
15
Investment Objectives
Balance Risk and Return:
•How much return do you need?
• How much risk can you stand?
• Tradeoff in the real-world
Life cycle is critical:
• Younger investors: more risk, higher returns
• Older investors: lower risk, lower returns
Fin 2802, Spring 08 - Tang
Chapter 26: Personal Finance
16
Amount of Risk Investors Said That
They Were Willing to Take by Age
Fin 2802, Spring 08 - Tang
Chapter 26: Personal Finance
17
The Individual Investor
• Building human capital
• Investing in a home
• Hedging with insurance
• Saving for retirement
Who should manage your portfolio?
Yourself
Professional investors
(e.g., personal trusts, mutual funds)
Fin 2802, Spring 08 - Tang
Chapter 26: Personal Finance
18
Institutional Investors
•Pension Funds
- Defined Contribution
- Defined Benefit
•Life Insurance Companies
•Banks
•Endowment Funds
Fin 2802, Spring 08 - Tang
Chapter 26: Personal Finance
19
Common Constraints
• Liquidity
• Investment Horizon
• Tax Considerations
• Regulations (mutual funds)
• Unique Needs (e.g., employment)
Fin 2802, Spring 08 - Tang
Chapter 26: Personal Finance
20
Specific Investor Objectives
Type Investor
Liquidity
Individual and
personal trusts
Variable
Life cycle
Prudent
man laws
(for trusts)
Variable
Mutual funds
Low
Short
Little
None
Pension funds
Young, low;
Mature, high
Long
ERISA
None
Endowment
funds
Little
Long
Little
None
Life insurance
companies
Low
Long
Complex
Non-life
insurance comp.
High
Short
Little
Banks
Low
Short
Changing
Fin 2802, Spring 08 - Tang
Horizon
Regulatory
Chapter 26: Personal Finance
Taxes
Yes
Yes
Yes
21
Investment Policy
Considerations:
• Asset Allocation
• Diversification
• Risk Positioning
• Income generation
• Tax positioning
Fin 2802, Spring 08 - Tang
Chapter 26: Personal Finance
22
Asset Allocation and Security
Selection for Palatial Investments
Fin 2802, Spring 08 - Tang
Chapter 26: Personal Finance
23
Monitoring Performance
• Changing market values
• Rebalancing portfolio
• Dynamic process
Fin 2802, Spring 08 - Tang
Chapter 26: Personal Finance
24
Investments for the Long Run
• Advice from the mutual fund industry
• Investment horizon determines which risk-free rate
to choose
• Make simple investment choices such as TDRFs
(target date retirement funds)
• Using options to frame the term structure of
interest rates
25
Do’s and Don’ts
Do:
1. Start early
2. Make a serious business plan
3. Buy index funds to save costs
4. Read “Rich Dad, Poor Dad” etc.
5. Commit, be sincere, and work hard
Don’t:
1. Take money out of special purpose funds
2. Believe in quick-profit with little effort
3. Be over-confident
4. Make impulsive purchases
5. Forget FIN 2802
Fin 2802, Spring 08 - Tang
Chapter 26: Personal Finance
26
Summary
•Savings plan with inflation and taxes
•The investment process Objectives
Constraints
Policies
•Risk-return tradeoff
•Impact of the life-cycle and investment decisions
•Professional and institutional investors
•Asset allocation and security selection
•Active versus passive management
•Tax considerations
•Evaluating and monitoring portfolio performance
•Presentations: April 21-24
Fin 2802, Spring 08 - Tang
Chapter 26: Personal Finance
27