Investing and Estate Planning

Chapter Objectives

• Explain the role of investments in overall financial planning.

• Identify the various types of investment choices.

• Read and understand market quotations.

• Explain the role of real estate in an investment plan.

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Chapter Objectives

• Describe factors to consider when choosing investments.

• Identify retirement investment options.

• Explore the basics of estate planning including wills and trusts.

Deciding to Invest

• Investing is purchasing a financial product or valuable item with the goal of increasing wealth over time

• Investments offer greater returns than savings

• You risk losing some or all of your investment, but gains usually exceed losses over time

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Deciding to Invest

• Reasons people invest:– To increase

wealth through appreciation

– To earn a steady income

– To beat inflation

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Deciding to Invest

• Other reasons people invest:– To take advantage of tax benefits;

capital gain is income earned when the selling price is greater than purchase price

– To preserve wealth in unstable economic times

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Deciding to Invest

• Investment characteristics:– Degree of volatility– Potential rate of return– Level of risk– Liquidity

• Risk tolerance is the amount of uncertainty you can handle

Types of Investments

• Security—a type of investment issued by a corporation, government, or other organization

• Securities include– stocks– bonds– mutual funds

Stocks

• Corporations sell stock to pay costs of start-up, continuing operations, and expansion

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Stocks

• Stockholders – have equity in a company – share in profits after debts, taxes,

and operating expenses are paid– aren’t responsible for company debt

if company fails, but can lose their investment

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Stocks

• Stockholders make money in several ways:– Dividend income– Increased stock value– Stock splits

Stock Classifications

• Common stock– Stockholders can vote in election of

company directors and other matters– Increases in value more than

preferred

• Preferred stock– Less risk; stockholders have first claim

on assets if company fails – No voting privileges

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Stock Classifications

• Blue-chip • Income• Growth• Defensive• Cyclical• Penny

Stock Trading

• Stocks are bought and sold by stockbrokers in a securities exchange or stock market

• Stockbrokers charge commissions on “buy” and “sell” transactions

• Major exchanges:– New York Stock Exchange Euronext– NASDAQ

Over-the-Counter Markets

• Stocks not listed on securities exchanges can be bought and sold at over-the-counter (OTC) markets

• An electronic network– allows dealers and brokers to conduct

business– lacks regulations of securities

exchanges– presents more risk for investors

Initial Public Offering

• An initial public offering (IPO) is a company’s first sale of stock to the public to– raise capital for expansion– become publicly traded

• Investment banks charge a commission to sell securities to investors; rest of money goes to the company

• Can be risky investments

Stock Quotations

• Stock quotations appear in major newspapers and financial Web sites

• To find a particular stock, you need the ticker symbol, or company abbreviation

• Current yield and price/earnings (PE) ratio help investors determine health or weakness of a company

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Stock Quotations

Bonds

• When you buy bonds, you lend money to the issuer—a corporation or government

• Issuer owes you the amount of the loan plus interest on the bond’s face value

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Bonds

• Information stated on bonds includes– maturity date– face value– yield– coupon rate– market value– current yield

Types of Bonds

• Corporate bonds are issued when businesses need money to operate and expand

• Municipal bonds are issued by state, county, and city governments

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Types of Bonds

• U.S. Government bonds are issued by the U.S. Treasury

• Safest bonds you can buy– Treasury bills (T-bills)– Treasury notes and Treasury bonds– U.S. savings bonds

Mutual Funds

• Inexperienced investors often start with mutual funds made up of securities chosen by professional managers at investment firms

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Mutual Funds

• Advantages:– Professional management– Diversification– Liquidity

• Disadvantages:– Management fees– Lack of control– Minimum investment required

In Your Opinion

• Do you think the advantages of mutual funds outweigh the disadvantages?

Types of Mutual Funds

• Closed-end funds – Offer a fixed number of shares– Shares are traded like stocks on

securities exchanges– Shares are bought and sold through

investment brokers, not through an investment company

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Types of Mutual Funds

• Most mutual funds are open-end funds – Unlimited number of shares– Shares are sold and redeemed at

their net asset value (NAV)– Value per share is the NAV of the

fund divided by number of shares outstanding

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Types of Mutual Funds

– Load funds charge a commission on amount invested when shares are bought

– No-load funds don’t charge fees when shares are bought, but may charge fees when shares are sold or redeemed

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Types of Mutual Funds

• Income funds• Balanced funds• Growth funds• Specialized funds• Money market funds

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Types of Mutual Funds

Factors Affecting Returns

• Laws of supply and demand determine the price of stocks and other investments

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Factors Affecting Returns

• Factors affecting returns include– business cycle fluctuations– interest rate fluctuations– stock market fluctuations (bull

market or bear market)– product innovation– government actions– exchange-rate risk

Real Estate

• Buying real estate (land or buildings) is another way to invest for future profit

• Usually requires a down payment and a long-term loan

• Property usually increases in value over time

Home Ownership

• For many people, a home is– a place to live– the first

experience in buying property

• Owning a home can increase net worth and protect against inflation

REITs and Real Estate Mutual Funds

• Indirect investments in real estate include – Real Estate Investment Trust (REIT) – Real estate mutual funds

• They avoid the complications and financial commitment of owning individual properties

Valuable Goods

• Collectibles—rare coins, books, stamps, art, antiques, sports memorabilia, vintage automobiles

• Precious metals—gold, silver, platinum

• Precious gemstones and jewelry—diamonds, emeralds, sapphires

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Valuable Goods

• Advantages– Value is not

eroded by inflation – Objects can bring

pleasure and can be used or displayed

– Objects can increase in value

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Valuable Goods

• Disadvantages– Less liquidity; can be difficult to sell

quickly– Requires knowledge to judge value– Difficult to store and protect from

damage and theft– Prices are often volatile– No guaranteed return on

investment

Choosing Investments

• Investment portfolio—a collection of securities and other assets a person owns

• Diversification is a strategy of successful investors

Sources of Information

• Professionals and financial experts can help

• Online resources:– Investment-related Web sites– Web sites of individual companies– U.S. Securities and Exchange

Commission (SEC) EDGAR database

Annual Reports

• Are included in most corporate Web sites

• Show current and predicted market performance

• Report earnings per share (EPS)

Prospectuses

• When an investor buys a security, the issuer must provide a prospectus

• Additional copies are– posted on company Web sites– found on SEC’s EDGAR database– mailed to prospective investors on

request

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Prospectuses

• Contents include– company officers– business’s history and operations– future plans – financial risks– performance summary– fees and expenses– management

Market Quotations

• Stock, bond, and mutual fund quotations appear in the financial section of major newspapers and financial Internet sites

• Quotations, or listings, contain financial information including records of past and current performance

Investment Strategies

• Smart investing requires balancing risks against returns

Buy and Hold

• Strategy of buying securities and holding them for long-term gains as opposed to frequent trading

• Investors who sell stocks when they drop in value lose money; investors who hold onto stocks during market fluctuations usually gain in the long run

Dollar-Cost Averaging

• With dollar-cost averaging, you invest without regard to the price of the investment at the time you buy it

• You end up buying more shares when the price is low and fewer when it is high

• You can set up automatic payments with as little as $25 monthly

Buying Securities

• You can use a brokerage or securities firm to buy and sell securities

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Buying Securities

• Open an account with a brokerage or securities firm

• These firms charge a fee for their services

• Brokerage firms keep records of investors’ transactions and periodically send out statements

Brokerage Firms

• Full-service brokerage firms– maintain research departments– provide investment advice, portfolio

management, and other services– are good for both experienced and

beginning investors

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Brokerage Firms

• Discount Brokerage Firms– execute orders to buy and sell

securities– charge lower commissions than full-

service– are good for some experienced

investors

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Brokerage Firms

• Online brokerage firms have hundreds of brokers available to help consumers buy and sell securities

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Brokerage Firms

• When using online brokerage firms,– check if it’s reputable and legitimate– print information on any investment

you are considering– obtain and keep written confirmation

of your buy-and-sell orders and their completion

– follow your investments’ performance

Investment Clubs

• A group of people who work together to learn about securities and invest their pooled funds

• Good for beginning investors

DRIPs

• Many companies offer Dividend Reinvestment Plans (DRIPs)

• Advantages – Small amounts can be invested – Stock purchases can be made

automatically, weekly, or monthly – Investors save on brokers’

commissions– Investors may get a discount

Investing for Retirement

• Retirement planning is key element of financial security

• Some retirees need income for up to 30 years

• Starting a retirement investment plan early is the most effective way to provide enough money on which to live after retiring

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Investing for Retirement

• Social security should not be your sole source of retirement income

Employer-Sponsored Retirement Plans

• Employee Retirement Income Security Act (ERISA) set standards for pension and retirement plans to guarantee that workers receive entitled benefits

• Vesting requirements are an important part of this act

401k

• An employer-sponsored retirement plan

• Funded with employees’ before-tax salary contributions; portion often matched by employer contributions of cash, stock, profit sharing, or deferred-compensation

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401k

• Advantages:– Most plans offer different

investment options, including stocks, bonds, or mutual funds

– Employers match contributions– Tax-deferred growth of savings– Automatic payroll deductions

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401k

• Disadvantage:– Investors may lack knowledge,

which can cause them to make poor choices

Personal Retirement Plans

• You can start a personal retirement plan at most financial institutions

• Usually consists of investments in stocks, bonds, and mutual funds

IRAs

• Individual Retirement Account (IRA) is a personal retirement account with tax benefits– Traditional: contributions and

earnings are not taxed until funds are withdrawn at retirement

– Roth: contributions are taxed, but withdrawals are usually not

Self-Employed Plans

• Simplified Employee Pension (SEP) plan or Keogh plan– Tax-deductible contributions– Contributions limited to percentage

of earned income– Earnings grow tax deferred until

money withdrawn at retirement

In Your Opinion

• Why is retirement planning more important for self-employed people than for those who work for someone else?

Annuities

• An annuity with an insurance company provides income for a set period of time, and sometimes death benefits

• Investors pay into an annuity over many years or in one large payment

• Principal and interest accumulate tax free until money is either withdrawn or paid out

Estate Planning

• Estate planning is part of an overall financial plan

• Active management of assets with directives for managing and distributing them when the owner dies

• Assets include property, savings, investments, and insurance benefits

Goals of an Estate Plan

• Let people decide how they want their assets managed after their death

• Provide for dependents• Minimize tax liabilities• Name an executor to oversee the

management of a deceased person’s affairs

• Prepare a will

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Goals of an Estate Plan

• Assign a power of attorney—a document giving someone the power to act on the financial and legal matters of another person

Wills

• A will guarantees disposal of an estate according to the wishes of the deceased person and makes settling an estate simpler for beneficiaries

• Beneficiaries may be family members, friends, a favorite charity, a college, or other organization

What Wills Should Include

• Name beneficiaries, people or groups who will receive assets

• Name an executor• Name a guardian to care for

young children • Name a guardian or trustee to

manage assets on behalf of beneficiaries

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What Wills Should Include

• Wills must be signed before witnesses

• If will is changed, either a new will is drawn up or a codicil is added

• Cost of wills vary• People with complex estates

should consult experts

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What Wills Should Include

• Dying without a will is called dying intestate

• Property is divided according to state laws

The Living Will

• The purpose of the living will is to make known what medical treatments you do or do not wish to receive in case of a terminal injury or illness

Trusts

• A trust agreement may be needed if an estate is complex or needs special arrangements for its settlement

• Grantor—person who creates a trust and transfers assets to the trust; names a trustee and beneficiaries

• Requires a lawyer familiar with estate planning

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Trusts

• Living trust:– Set up during your lifetime– Can provide for the management of

your assets before your death – Provides for the distribution of

assets as directed after your death

• Testamentary trust:– Becomes effective upon death

Purposes of Trusts

• People set up trusts to provide for minor children and dependents with disabilities

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Purposes of Trusts

• Provide income and asset management for beneficiaries

• Devise a plan to manage financial affairs if grantor becomes incapacitated

• Minimize estate and gift taxes• Protect privacy and avoid probate

court

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Purposes of Trusts

• Probate requirements:– Proof that a person’s will is valid– Inventory and identification of

deceased person’s assets and property

– Property appraisals– Settlement of debts and taxes– Distribution of property according to

terms of the will

Central Ideas of the Chapter

• Investments create wealth that meets long-term financial goals.

• Investing offers the opportunity to earn relatively high returns but it is not without risk.

Glossary of Key Terms

• annuity. A contract with an insurance company that provides income for a set period of time or for life.

• appreciation. An increase in the value of an investment.

• bear market. Term for the market when investors feel insecure and stock prices fall.

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Glossary of Key Terms

• bond. A certificate of debt issued by a corporation or government that entitles the bondholder to a set rate of interest on the face value of the bond until it matures.

• bull market. Term for the market when investors are confident in the economy and stock prices are rising.

• capital gain. Income earned from selling an asset for more than the purchase price.

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Glossary of Key Terms

• common stock. Stock that pays dividends declared by the company and gives stockholders certain voting rights.

• diversification. Spreading risk by putting money in a variety of investments.

• dividend. A portion of a company’s earnings paid to stockholders.

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Glossary of Key Terms

• dollar-cost averaging. An strategy of investing a fixed dollar amount at regular intervals.

• estate. The possessions, such as property, savings, investments, and insurance benefits, a person leaves when he or she dies.

• executor. A person appointed to carry out the terms outlined in a will.

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Glossary of Key Terms

• investment portfolio. The collection of securities and other assets a person owns.

• living will. A statement of instructions for specific medical treatment if a person becomes unable to make medical decisions. Also called a healthcare directive.

• money market fund. A type of mutual fund that deals only in high interest, short-term investments such as U.S. Treasury Bills, certificates of deposit, and commercial paper.

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Glossary of Key Terms

• mutual fund. An investment created by pooling the money of many people and investing it in a collection of several securities.

• net asset value. A mutual fund’s assets minus its liabilities. Also called current market value.

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Glossary of Key Terms

• preferred stock. Stock that pays regular dividends at a set rate. Preferred stockholders have priority in receiving dividends and assets, but do not have voting privileges.

• probate court. The government institution that processes a deceased individual’s will and estate.

• prospectus. A legal document that gives a detailed description of a security.

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Glossary of Key Terms

• securities exchange. A formal market where securities are bought and sold by stockbrokers.

• stock. A share in ownership of a corporation.

• stockbroker. An agent who buys and sells securities for clients.

• trust. A legal agreement where assets and property are managed by a trustee on behalf of the beneficiaries.

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Glossary of Key Terms

• trustee. A person or institution named to manage an estate on behalf of the beneficiaries.

• will. A legal document stating a person’s wishes for his or her estate after death.

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