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Chapter Twenty
Understanding Personal
Finances and Investments
Learning Objectives
1. Explain why you should manage your personal
finances and develop a personal investment
program.
2. Describe how the factors of safety, risk, income,
growth, and liquidity affect your investment
decisions.
3. Understand how securities are bought and sold.
4. Identify the advantages and disadvantages of
savings accounts, bonds, stocks, mutual funds, and
real estate.
5. Describe high-risk investment techniques.
6. Use financial information to evaluate investment
alternatives.
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Chapter 20 Outline
– Preparing for an Investment Program
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Managing Your Personal Finances
Investment Goals
A Personal Investment Program
Important Factors in Personal Investment
– How Securities Are Bought and Sold
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The Primary Market
The Secondary Market
The Role of an Account Executive
Regulation of Securities Trading
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Chapter 20 Outline (cont’d)
– Traditional Investment Alternatives
• Portfolio Management
• Asset Allocation, the Time Factor, and Your
Age
• Bank Accounts
• Corporate and Government Bonds
• Common Stock
• Preferred Stock
• Mutual Funds
• Real Estate
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Chapter 20 Outline (cont’d)
– High-Risk Investment Techniques
• Selling Short
• Buying Stock on Margin
• Other High-Risk Investments
– Sources of Financial Information
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The Internet
Financial Coverage of Securities Transactions
Other Sources of Financial Information
Security Averages
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Preparing for an Investment Program
• Managing Your Personal Finances
– The use of your personal funds to earn a financial
return
– Personal budget is a specific plan for spending
income
• Investment goals
– Personal investment goals must be
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Specific and measurable
Tailored to individual needs
Focused on the future
Realistic in terms of economic conditions and
opportunities
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Preparing for an Investment Program (cont’d)
• Questions to consider when establishing goals
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What financial goals do you want to achieve?
How much money will you need, and when?
What will you use the money for?
Is it reasonable to assume that you can obtain the amount of
money you will need to meet your investment goals?
Do you expect your personal situation to change in a way that
will affect your investment goals?
What economic conditions could alter your investment goals?
Are you willing to make the necessary sacrifices to ensure that
your investment goals are met?
What are the consequences of not obtaining your investment
goals?
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Preparing for an Investment Program (cont’d)
• A personal investment program
– Involves a careful evaluation of different
investment opportunities
– Financial planner
– Begin by accumulating an emergency fund
– Invest funds according to your plan
– Monitor the plan
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Preparing for an Investment Program (cont’d)
• Suggestions to help you accumulate the money
needed to fund an investment plan
– Learn to balance your budget
– Make savings a higher priority
– Take advantage of employer-sponsored retirement
programs
– Participate in an elective savings program
– Make a special savings effort one or two months
each year
– Take advantage of gifts, inheritances, and windfalls
Source: Jack R. Kapoor, Les R. Dlabay, and Robert J. Hughes, Personal Finance, 9th ed. Copyright © 2009 by The McGraw Hill Companies, Inc.
.
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Important Factors in Personal
Investment
• Match potential investments with your goals in terms
of several factors
– Safety and risk
– Investment income
– Investment growth
– Investment liquidity
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Surviving a Financial Crisis
• To survive a financial crisis, many experts
recommend that you take action before the crisis to
make sure your financial affairs are in order
• Seven steps you can take
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Establish a larger than usual emergency fund
Know what you owe
Reduce spending
Pay off credit cards
Apply for a line of credit at your bank, credit union, or
financial institution
– Notify credit card companies and lenders if you are unable to
make payments
– Monitor the value of your investment accounts
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How Securities Are Bought and Sold
• Securities are usually exchanged with the help of an
account executive or stockbroker
• The primary market
– A market in which an investor purchases financial
securities (via an investment bank) directly from the
issuer of those securities
• Investment banking firm
• High-risk investment
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How Securities Are Bought and Sold (cont’d)
• The secondary market
– A market for existing financial securities that
are traded between investors
– Securities exchange
– Over-the-counter (OTC) market
• Nasdaq
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How Securities Are Bought and Sold (cont’d)
• The role of an account executive
– An individual, sometimes called a stockbroker or
registered representative, who buys and sells
securities for clients
• Full-service broker
• Discount broker
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How Securities Are
Bought and Sold (cont’d)
• The mechanics of a transaction
– Market order
– Limit order
– Discretionary order
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How Securities Are
Bought and Sold (cont’d)
• Online security transactions
– Software can help investors evaluate potential
investments, manage investments, monitor value,
and place buy and sell orders online
– Investors must still analyze the information and
make decisions
– Online trading generally has lower costs
– Program trading—a computer-driven program that
monitors the market value of particular stocks and
enters buy or sell orders when those stocks reach
specified prices
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How Securities Are
Bought and Sold (cont’d)
• Commissions
– Most brokerage firms have a minimum
commission
– Additional commission charges are based on the
number of shares and the value of stock bought
and sold
– Generally, online transactions are less expensive
when compared to trading through a full-service
brokerage firm
– Full-service brokerages charge a percentage of
the transaction amount (as much as 1.5 to 2.0%)
– Commissions for bonds, commodities, and options
are lower than for stocks
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Regulation of Securities Trading
• A regulatory pyramid of four different levels
exists to make sure investors are protected
– 1st level: Federal regulation by the U.S.
Congress
– 2nd level: Securities and Exchange
Commission (SEC)
– 3rd level: State regulation
– 4th level: Self-regulation by securities
exchanges and brokerage firms
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Traditional Investment Alternatives
• Portfolio management
• Asset allocation, the time factor, and your age
– Asset allocation
– The time factor
– Age
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Traditional Investment Alternatives (cont’d)
• Bank accounts
– Advantages
– Disadvantage
• Corporate bonds
• Convertible bonds
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Traditional Investment Alternatives (cont’d)
• Government bonds
– Considered risk free; pay low interest
– Treasury bills
– Treasury notes
– Treasury bonds
– Savings bonds
– Municipal bonds
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Traditional Investment Alternatives (cont’d)
• Common stock
– Dividend income
• Stock dividend
• Dividend payments
– Increase in dollar value
• Capital gain
• Market value
– Stock splits
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Traditional Investment Alternatives (cont’d)
• Preferred stock
– Stock in a corporation that has a claim on the
dividends that supersedes common stock
– Cumulative preferred stock
– Convertible preferred stock
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Traditional Investment Alternatives (cont’d)
• Mutual funds
– A professionally managed investment vehicle that combines and
invests the funds of many individual investors
– Closed-end funds
– Open-end funds
– Net asset value (NAV)
Net asset value = Value of the fund’s portfolio – Liabilities
Number of shares outstanding
• Current market value of a mutual fund’s portfolio
minus the mutual fund’s liabilities and divided by
the number of outstanding shares
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Traditional Investment Alternatives (cont’d)
• Mutual funds (cont.)
– Load funds
– No-load funds
– Yearly management fee
– Managed funds
– Index funds
– Family of funds
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Traditional Investment Alternatives (cont’d)
• Types of mutual fund investments
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Aggressive growth stock funds
Global stock funds
Growth stock funds
High-yield (junk) bond funds
Income stock funds
Index funds
Long-term U.S. bond funds
Sector stock funds
Small-cap stock funds
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Traditional Investment Alternatives (cont’d)
• Real estate
– Advantages
– Disadvantages
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High-Risk Investment Techniques
• Buying long
– Buying stocks expected to increase in value,
which can then can be sold at a profit
• Selling short
– The process of selling stock that an investor does
not actually own but has borrowed from a
brokerage firm and will repay at a later date
• Buying stock on margin
– Buying stock by borrowing part of the purchase
price, usually from a stock brokerage firm
• Margin requirement
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High-Risk Investment Techniques (cont’d)
• Other high-risk investments
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Stock options
Commodities
Precious metals
Gemstones
Coins
Antiques and collectibles
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Sources of Financial Information
• The Internet
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www.bloomberg.com
http://money.cnn.com
www.fool.com
www.quicken.com
www.sec.gov
http://finance.yahoo.com
• Newspaper coverage of securities transactions
– Common and preferred stocks
– Bonds
– Mutual funds
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Sources of Financial Information
• Other sources of financial information
– Investors’ services
• Moody’s, Standard & Poor’s, Mergent, Value Line, Morningstar,
Lipper Analytical Services, Wiesenberger Investment Companies
– Brokerage firm analysts’ reports
• UBS PaineWebber, Smith Barney, Merrill Lynch
– Business periodicals
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Business Week, Fortune, Forbes
Advertising Age, Business Insurance
U.S. News & World Report, Time, Newsweek
Money, Kiplinger’s Personal Finance Magazine, Consumer Reports
– Corporate reports
• A security average (security index) is an average of the current
market prices of selected securities
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Sources of Financial Information (cont’d)
• Security averages
– An average of the current market prices of
selected securities
– Dow Jones Industrial Average
– Standard & Poor’s 500 Stock Index
– New York Stock Exchange Composite Index
– American Stock Exchange Index
– Nasdaq Composite Index
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