©2012, College for Financial Planning, all rights reserved.

Module 4Investment Principles & Mutual Funds

Foundations In Financial PlanningSM Professional Education Program

Learning Objectives

4–1: Identify types of investment risk and their characteristics.

4–2: Identify factors affecting an investor’s risk tolerance.4–3: Identify types and characteristics of investment

return and how they relate to investor risk tolerance. 4–4: Define the concepts of asset allocation,

diversification, and modern portfolio theory. 4–5: Describe methods of investment analysis and their

characteristics. 4–6: Describe various approaches to investing.4–7: Identify definitions or characteristics relating to

mutual funds. 4–8: Describe types or styles of mutual funds.

4-2

Questions To Get Us Warmed Up

4-3

Basic Investment Objectives & Concepts

• Objectiveso Incomeo Growtho Capital

preservation• Risk tolerance• Time horizon• Taxes

4-4

Systematic Risk

• Market risk• Interest rate risk• Reinvestment rate risk• Purchasing power risk (inflation)• Currency risk (exchange rate)

4-5

Unsystematic Risk

• Business risk• Financial risk• Credit risk• Default risk• Liquidity risk• Marketability risk• Event risk

4-6

Liquidity Risk & Marketability Risk

4-7

Investment Vehicle Liquidity Marketability Other Main Sources of Risk

Insured savings accounts High N/A1 P, R

Money market accounts/funds High N/A1 P, R

EE and I bonds High N/A1 P, R

Treasury bills High High P, R

Commercial paper High High P, R

Certificates of deposit High N/A1,2 P, R

Treasury notes and bonds Moderate3 High P, I, R

High-grade common stock Moderate High M, B

High-grade corporate bonds Moderate3 High/moderate P, I, R, CR, E

High-grade municipal bonds Moderate3 High/moderate P, I, R, CR, E

High-grade preferred stock Moderate High P, I, R, CR

Lower-grade common stock Moderate/low High B, M, F

High-yield corporate bonds Moderate/low3 High/moderate B, F, I, R, CR, D, E

Puts and calls Low High M, B

Real estate investments Low Low M, B, F

REITs Moderate High M, B, R

Tangible (hard) assets Low Low M

Futures contracts Low High M

Mortgage-backed securities Moderate High/moderate P, I, R

Limited partnerships Low Low4 M, B, F1 A secondary market does not exist. However, withdrawals or redemptions can be made.2 Some brokerage firms sell CDs, as well as maintain a secondary market in them, providing a moderate/high degree of marketability. Most CDs are redeemed, however.3 In general, the longer the period to maturity is, the lower the degree of liquidity is.4 A small number of firms provide a secondary market for some limited partnerships. Also, some partnerships permit a limited number of units to be sold back to the general partner.

Risk Tolerance Factors

• Goals• Time frame• Experience • Personality• Market conditions• Financial conditions• Age • Investment Advice

4-8

Methods of Measuring Risk

• Standard deviation• Covariance• Correlation coefficient• Beta

4-9

Types of Return

• Growth• Income

o Dividendso Interesto Rent

• Balance: growth & income

4-10

Asset Allocation

Two main decisions• What assets?• What proportion?

Strategic• Passive

Tactical• Sector rotation• Market timing

Core/satellite

4-11

Diversification & MPT

• Asset classes• MPT defined

o Correlation coefficiento Efficient portfolios

4-12

Investment Analysis

• Technicalo Indicators & Indexes

• Fundamentalo Top-downo Bottom-up

4-13

Investment Approaches

• Buy-and-hold• Market timing• Dollar cost averaging• Value averaging

4-14

Features of Mutual FundsAdvantages• Pooling• Diversification• Professional

management

Costs and Expenses

• Transaction (loads)• Operating

expenses

Taxation• Four types of basis

4-15

The Prospectus

• Minimum investment• Investment objective• Risk• Investment policies• Management• Fees and sales charges• Performance

4-16

Summary Prospectus

• A condensed version of the full, statutory prospectus

• Contains, in order, investment objective, fees and expenses, investment strategies, risks, and performance, fund management, brief information on purchase and sale of fund shares, brief tax information, and financial intermediary compensation (if applicable)

4-17

Stock Funds

4-18

Bond Funds

4-19

Other Fund Types

• Money market funds• Index funds• Growth funds• Sector funds• International and global funds• Asset combination funds• Closed-end funds

4-20

Other Fund Types

• Exchange-traded funds• Exchange-traded notes• Hedge funds

4-21

Question 1

Which one of the following is a type of unsystematic risk?a. business riskb. interest rate riskc. purchasing power riskd. market risk

4-22

Question 2

Diversification reducesa. systematic risk.b. unsystematic risk.c. market risk.d. purchasing power risk.

4-23

Question 3

Which one of the following is a measure of how much an investment’s returns vary from its average return?a. betab. correlation coefficientc. standard deviationd. covariance

4-24

Question 4

With a core/satellite asset allocation approach, the core portion generally represents which percentage range of the portfolio?a. 50% to 60%b. 60% to 70%c. 70% to 80%d. 80% to 90%

4-25

Question 5

The broad category of expenses listed in a mutual fund’s prospectus area. management fees and 12b-1 expenses

only.b. management fees and other expenses

only.c. 12b-1 expenses and other expenses

only.d. management fees, 12b-1 expenses,

and other expenses.

4-26

Question 6

A type of fund with a net asset value that does not change is a a. bond fund.b. index fund.c. money market fund.d. stock fund.

4-27

Question 7

Correlations range froma. 0 to +1.0.b. –1.0 to 0.c. –1.0 to +1.0.

4-28

©2012, College for Financial Planning, all rights reserved.

Module 4End of Slides

Foundations In Financial PlanningSM Professional Education Program