selecting and monitoring your investments
TRANSCRIPT
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Selecting and Monitoring Your Investments
Dr. Barbara O’Neill, CFP® Rutgers Cooperative Extension [email protected]
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Your Questions?
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Types of Investments All investments fall into two major categories: Loanership (Fixed-Income) Lend money to a debt issuer (e.g., a city) Receive a pre-set interest rate Receive original principal back (assuming no default)
Ownership (Equity) Full or partial owner of investment Values fluctuate Potential higher return
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Asset Allocation Models
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What are Bonds? Why Own Them? IOUs issued by corporations or government entities “Cushions” a stock portfolio (adds diversification)
Addresses short- and intermediate-term goals
Provides predictable income stream in retirement
Affordable: face values as low as $100 (e.g., U.S. Treasury securities)
Some pay interest semi-annually (corporate and government bonds)
Others pay interest at maturity (e.g., EE and zero-coupon bonds)
Some offer tax advantages (municipal bonds)
Capital gains potential (if interest rates go down after purchase and you sell)
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Bond Investment Risks
Credit risk
Interest rate risk
Inflation risk
Call risk
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Bond Investor Decisions Decide on risk level
Investment grade bonds: top 4 grades (BBB, A, AA, AAA)
Junk bonds (a.k.a., high yield bonds): lower rated and higher risk
Decide on maturity Match to financial goals
Determine the after-tax return Taxable versus tax-exempt
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Bond Ratings Measure Default Risk
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U.S. Treasury Securities Considered safest fixed-income investment
Sold at periodic auctions; secondary market
Earnings exempt from state and local tax (principle of “reciprocal immunity”)
$100 minimum with $100 increments
Resource: http://www.treasurydirect.gov
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U.S. Treasury Securities Types of Treasury Securities: Bills: Maturities up to 12 months; buy at discount Notes: 2-, 3-, 5-, 7-, and 10-year maturities Bonds: 30-year maturities (“long bonds”)
Can purchase through Treasury Direct Guided Tour: http://www.treasurydirect.gov/indiv/TDTour/default.htm
Interest is credited electronically
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TIPS: Treasury Inflation Protected Securities
5-, 10-, and 30-year maturities
Interest rate fixed for term of bond
Principal adjusted twice a year for CPI
Protection against deflation (will get principal back)
Lower interest than regular Treasuries
Resource: https://www.treasurydirect.gov/indiv/products/prod_tips_glance.htm
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U.S. Savings Bonds Two types: EE bonds and I bonds
EE Bonds: Buy at 50% of face value I Bonds: Partly indexed for inflation; buy at full face value
Denominations from $50 to $5,000 Maximum of $10,000 of each type per year (electronic) Interest compounds semi-annually; no state taxes Can cash in after 12 months; lose 3 months interest if cash in
within 5 years; mature in 30 years Resources: https://www.treasurydirect.gov/indiv/products/prod_eebonds_glance.htm
and https://www.treasurydirect.gov/indiv/products/prod_ibonds_glance.htm
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Corporate Bonds A corporation’s pledge to repay principal and periodic interest
Considered safer than company stocks
Face Value Dollar amount bondholder receives at bond’s maturity date Usually $1,000
Coupon rate Stated interest rate Interest payments made every six months Example: $1,000 x 5.8% = $58 (in two $29 payments)
Maturity Date = Date that face value is repaid; generally 1 to 30 years
Resource: https://www.sec.gov/investor/alerts/ib_corporatebonds.pdf
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Zero-Coupon Bonds Pay no (zero) periodic interest
Sold at a deep discount from face value
Eventually grows to face value at maturity
Very volatile as interest rates change (if sold prior to maturity)
Advantages: Low up-front cost Predictable return
Disadvantage: Annual increase in value is taxable (“phantom income”)
Can put in an IRA or buy tax-exempt “zeros” to avoid this problem
Resource: http://www.sec.gov/answers/zero.htm
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Classifications of Stock Common and preferred stock
Preferred Stock- a cross between a stock and a bond (income oriented); no voting rights
Market capitalization (“cap”) Share price x number of outstanding shares
Defensive and cyclical
Cyclical Stocks – stock from a company whose profits are greatly influenced by changes in the economic business cycle.
Countercyclical (or Defensive) Stocks – stock from a company that performs well even in an environment characterized by weak economic activity
Growth and value Value Stock- Stock that is selling for < the true worth of company assets.
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Common Stock Share of ownership in a company
Elect directors
Voting rights on other matters
Proxy – written authorization given by shareholder to someone else to represent him or her and vote his or her shares at a stockholder’s meeting.
Two ways to earn money value of stock increases (capital gain)
stock pays dividends
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Historically, common stocks have out-performed all other types of investments, over longtime periods BUT…it has not been a smooth ride!
Historical Perspective
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Time-Tested Stock Strategies Buy what you know or get to know (research)
Buy and hold quality stocks
Diversify among industry sectors
Dollar-cost average
Reinvest dividends and capital gains
Don’t invest > 10% of total portfolio in your own employer’s stock
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Analyzing Stock Performance Earnings per share (EPS)
Formula: Corporation’s after-tax income divided by number of outstanding shares of common stock
Example: $5,000,000/10,000,000 = $0.50
EPS increase = generally a healthy sign
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Analyzing Stock Performance Price-Earnings Ratio (P/E Multiple)
Price per share of stock ÷ firm’s earnings per share (EPS) Example: $10 price/0.50 EPS = a PE ratio of 20 Tells how much investors are paying for a company’s
earning power P/E of 15 long-term average P/E Need to compare P/E of stock to firms in same industry
Projected Earnings EPS and P/E based on historical data Future expectations more relevant
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Common Stock Price Quotes
Last trade price = $44.37 Annual dividend = $1.68
P/E = 15.41 (44.37÷ 2.88) Earnings per share = $2.88
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Stock Splits Stock Split- when shares of stock owned by
existing shareholders are divided into a larger number of shares; done to change (lower) price
Example: 2:1- twice as many shares worth half as much
Reverse Stock Split- results in smaller number of shares; less common; often done to maintain listing on a stock exchange (to meet minimum share price)
Example: 1:2- half as many shares worth twice as much
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What is a Mutual Fund? n Portfolio of stocks, bonds, or other securities
n Collectively owned by many investors
n Managed by professional investment company
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Mutual Fund Advantages Full time professional money management
Reduced risk through diversification
Low minimum to get started and reinvest
Ready access to your money (liquidity) Shares issued and redeemed on demand
Automatic investment and withdrawal plans
Monitoring is easy
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Mutual Fund Disadvantages
If broad market drops, so goes a fund
No guaranteed rate of return
Unwanted taxable distributions
High fund expenses erode returns
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How Fund Investors Make Money Income Dividends
Earnings paid from dividend and interest income Taxed as ordinary income
Capital Gains Distributions Distributions when the fund buys and sells securities Taxed as long-term gains
Combination = Total Return
Capital Gains (or Losses) Capital gains (or losses) when fund investors sell shares at a price
different than price you originally paid Taxed as short- or long-term gains
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Net Asset Value The NAV is the price your fund pays you
per share when you sell. Value of fund
Number of shares = NAV
Example: $52,500,000 3,500,000 = $15 per share
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Mutual Funds Versus Individual Securities Individual securities (e.g., stocks and bonds)
Require time and expertise to analyze
Usually have higher transaction costs
Offer less probability of adequate diversification
OK if:
you have stock-picking expertise
you have $20-30K to buy 10-20 stocks to diversify
you are buying Treasury securities
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Bonds vs. Bond Mutual Funds Individual bonds: Semi-annual income stream Return of principal at maturity Ability to “ladder” maturities
Bond mutual funds: Diversification-owns 100+ bonds Dividends paid out monthly Low minimum to purchase Liquidity Subject to interest rate risk
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Actively Managed Funds Versus Index Funds Managed Fund fund manager makes
decisions regarding what securities are included in the fund’s portfolio
Index Fund securities held by the fund replicate those contained in a specific index like the Standard & Poor’s (S&P) 500
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Stock Funds Long-term
Funds
Stock Funds Bonds Funds Other Funds
Growth
Equity income
Price growth vs. Dividend Income
Aggressive Growth
Socially responsible Invest in socially responsible firms
Economic SectorsSector funds
Company Size
Regional
Index funds Match index holdings
% U.S. vs. International
Small-cap
Mid-cap
Global
International
Large-cap
Source: Kapoor, Dlabay, & Hughes. Focus on Personal Finance (2008)
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Bond Funds Long-term Funds
Stock Funds Bonds Funds Other Funds
High-yield
Intermediate Corporate bondsIntermediate U.S.
Gov't bondsLong-term
corporate bondsLong-term U.S.
gov't bonds
Municipal bonds
Short-term corporate bonds
Short-term U.S.gov't bonds
Source: Kapoor, Dlabay, & Hughes. Focus on Personal Finance (2008)
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Other Funds Long-term
Funds
Stock Funds Bonds Funds Other Funds
Money Market Funds
Asset Allocation Funds
Balanced Funds
Lifecycle Funds
Fund of Funds
Source: Kapoor, Dlabay, & Hughes. Focus on Personal Finance (2008)
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Balancing Risk and Return Source: Garman and Forgue. Personal Finance (2008)
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Mutual Fund Fees Sales Charges/Loads- Charged to buy and sell shares
Operating Expenses
Management fee- Charged yearly (.25%-1.5% of average NAV) to pay fund manager
12(b)1 Fee- Annual fee to defray advertising and marketing costs; cannot exceed 1% of assets
Operating Expenses- Charged for shareholder services
Expense Ratio Total expenses associated with management fees and operating costs of the fund
Avoid above-average fund expense ratios
Stock funds > 1.4%
Bond funds > 1.00%
Money market funds > 0.5%
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Typical Mutual Fund Fees Source: Kapoor, Dlabay, & Hughes. Focus on Personal Finance (2008)
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Steps to Buying a Mutual Fund Identify type of fund that matches goal
Research specific funds Family of Funds: One investment company
manages a group of mutual funds portfolios
Get and read the prospectus Prospectus: Required legal document that states a
mutual fund’s investment objectives and policies
Make your purchase
Establish a schedule to buy more shares
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Sources of Investment Information Stock and Mutual Fund Annual Reports Financial Publications
Business Week, Forbes, Kiplinger's Personal Finance, WSJ, and Money
Quality Ratings Bonds -- Standard & Poor’s, Moody’s
Annuities -- Standard & Poor’s, Moody’s, Duff & Phelps, Weiss Research,
A.M. Best Stocks -- Value Line Investment Survey, Standard & Poor’s Stock Guide
Mutual Funds -- Morningstar
Many of these are available at public libraries and/or online
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Action Steps Get started now
Know your risk tolerance
Match investments to your goals
Know that the biggest risk in investing is not investing -- inflation is the real enemy
Reinvest dividends and capital gains
Compare results to market benchmarks
Take a long view and hold on
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Questions and Comments? Barbara O'Neill, Ph.D., CFP®, CRPC
Extension Specialist in Financial Resource Management and Professor II Rutgers University Phone: 848-932-9126
E-mail: [email protected]
Internet: http://njaes.rutgers.edu/money/
Twitter: http://twitter.com/moneytalk1