Investment Basics
CHAPTER PLAYLIST SONG:
“For the Love of Money” by The O'Jays
McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Learning Objectives
LO 11-1 Distinguish between savings and
LO 11-2
LO 11-3
LO 11-4
LO 11-5
investments.
Analyze the risk and return on varying
investment products.
Interpret the hierarchies of the investment
pyramid.
Examine the importance of varying your
investments.
Compare portfolio asset allocations for the
different personal finance life stages.
11-2
Savings vs. Investments
Who is rich? He that is content. Who is that? Nobody.”
~ Benjamin Franklin
How much money should you have in savings vs.
investments?
What is the difference?
“Savings is not to make you rich, but it is to keep you
from being poor.” ~ J.B. Quinn
Savings – No or low-risk investments with low returns.
11-3
Should You Save or Invest?
Figure 11.1
11-4
Impact of Inflation on Savings
Inflation is
Savings - retain your purchasing power by
Investing - beat the inflation rate
Bureau of Labor Statistics Consumer Price Index page
Consumer Price Index from 1913 – present
11-5
Insured Savings
FDIC –
NCUA –
United States Treasury Bills, Notes, and Bonds
Risk Premium – The difference between the risk-free
rate of return and the expected yield of an
investment with risk.
11-6
Risk of Investing
Investing has risk – the chance of losing some or all
of your investment
To compensate for risk and entice an investor,
investments with risk must pay a premium
Risk premium –
“Zero” risk – FDIC, NCUA, U.S. Treasury bills, notes,
and bonds – risk-free rate
11-7
Types of Risk
Default Risk or Credit Risk – Risk that the
company invested in may declare bankruptcy
2009 Chrysler bankruptcy: bondholders received $0.26 for
every dollar they invested
Bondholders could lose their entire investment
FDIC and NCUA will insure deposits up to $250,000 until
December 31, 2013, when the cap will revert back to $100,000
11-8
Types of Risk
Interest Rate Risk – Risk taken on when you lock into
a fixed-rate investment for a specific length of time
11-9
Types of Risk
Interest Rate Risk – Risk taken on when you lock into
a fixed-rate investment for a specific length of time
11-10
Types of Risk
Market Risk – The risk that the value of your
investment will decrease due to changes in the
market
11-11
Types of Risk
Liquidity Risk – The
risk that you will not be
able to
11-12
Analyzing Your Risk Tolerance
How much can you afford to lose?
Rule of thumb: The higher the risk, the higher the
potential return and the less likely you are to achieve
the higher return
Risk tolerance quizzes
Rutgers University’s Investment Risk Tolerance Quiz
money.msn.com
11-13
Investment Pyramid
11-14
Diversification of Assets
Diversification –
Why is diversifying your investments important?
Portfolio – Holding more than one investment
Asset Allocation –
Diversified Balanced Funds – Both equities and
bonds
Targeted and automatic asset allocation mutual
funds
11-15
Asset Allocation for Target Date Funds
T. Rowe Price Balance Fund (RPBAX)
Vanguard Target Retirement Fund
Asset Allocation Tool
11-16
Portfolio Evaluation
Re-evaluate your investment goals, risk tolerance,
portfolio returns, and asset allocation
Pick an easy date to remember to rebalance your
portfolio
January 1st
11-17
Life Stages and Accounts How Should the Assets Be
Allocated?
Independent (16-24)
529 College Savings Account
Retirement Savings
Early Family (25-44)
529 College Savings Account
Auto Down Payment
11-18
Life Stages and Accounts How Should the Assets Be
Allocated?
Empty Nest (41-65)
Funds used within the next 10 years
Retirement (66+)
Retirement funds
Investment funds
11-19
Continuing Case
Blake bought into a stock mutual fund as a
retirement investment 6 months ago. Ever since
then, he has watched the prices slowly drop each
month. He is afraid that it will soon be worthless. He
is tempted to cash in the stock and move what funds
are left to another instrument. What advice would
you give him?
11-20
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