CHAPTER 11

Fundamentals of Investing

“If a little money does not go out, great money will not come in.”

-- Confucius

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The Answer is…

“A Voluntary Tax on Stupid People”

What is the Question?

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Silly, the Question is…

“What is the

A Voluntary Tax on Stupid People

Lottery?”

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What are the Odds of Winning?

• The odds of winning the California Mega Millions Jackpot are 176 million to 1
• “But somebody has to win, right?”
• Yes, but that somebody will not be you!
• If a person purchases 50 lottery tickets each week, he or she will win the Mega Millions Jackpot about once every 50,000 years
• “Let’s see. $50 per week at 10% for 50,000 years…”

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Speaking of Odds…

• Astronomers have located an asteroid that is possibly on a collision course with Earth
• The asteroid could hit the Earth in 2036
• Triggering untold destruction and the end of tens of thousands of species, including the human race
• The odds of the asteroid hitting the Earth are currently set at 300 to 1
• But those odds will probably lessen as more is learned about the asteroid’s orbit

So Why Aren’t the Nations Preparing for This!?

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Because It Ain’t Gonna’ Happen!

And You Ain’t Gonna’ Win Da’ Lottery!

So Start Saving Now

But, of course, if the asteroid does hit, we will have plenty of warning for you to go out and spend all your savings on a really great time!

Now, let’s get serious…

Note: Subsequent calculations show it won’t hit the Earth for at least 100 years.

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Establishing Investment Goals

• You already know the #1 Financial Goal:
• “Spend Less Than You Earn”
• “Live Beneath Your Means”
• “Make Love, Not Loans”
• “Pay Yourself First”
• “Frugal, Frugal, Frugal!”
• If Goal #1 is followed, everything else is easy!
• For each investment goal, assess the time frame
• Is it short-term, intermediate-term, or long-term
• Choose an appropriate investment for the time frame
• This chapter gives you a thumb-nail view of each type
• With an emphasis on the risks and returns of each
• We will look at all of them in detail later on

Which one is your favorite?

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Essentials Before Investing

• Work to balance your budget
• Pay off high interest credit card debt first
• Start an emergency fund you can access quickly
• Three to nine months of living expenses

I simply do not agree with the concept of an “emergency fund” of three to nine months of living expenses. As long as you have access to cash via a home equity line of credit, for example, there is no good reason to keep $20,000 to $30,000 or more in a savings account earning 0.01%. Instead, use the money to pay down high interest debt, especially credit card debt.

P.S. The Wealthy Barber agrees with me.

P.P.S. You are adequately insured, right?

Exceptions: Salespeople and the self-employed

They are important but not essential

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First: Some Investment Terms

• Safety – Guarantee of return of principal
• Risk – Uncertainty about an outcome
• Inflation risk, Interest rate risk, Business failure risk, Market risk, Global investment risk
• Investing versus Speculating/Trading
• Liquidity
• Ability to buy or sell an investment quickly without substantially affecting the investment’s value

“I am not so much concerned with the return on my money as I am with the return of my money.” ‒ Will Rogers

What is your tolerance for risk? (Forbes Quiz - Rutgers Quiz) Unfortunately, you can’t know until you have some skin in the game … and then lose some skin!

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“Where Do I Get the Money to Invest?”

Pay Yourself First

• Take advantage of employer-sponsored retirement programs [401(k), 403(b), etc.]
• These come right out of your paycheck
• Take advantage of automatic contributions from your checking or savings account [Roth IRA]
• Schedule them to occur right after you normally receive your paycheck
• They work like a pay raise, only in reverse

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“How Much Do I Need?”

• Start small!
• “Can you afford $50 per month?”
• Small amounts invested regularly become large amounts over time
• Obviously, the more the better
• But it is better to get started with a small amount now than to lazily dream of a day when you’ll be able to put away far more – Get Started Now!
• You can always increase the amount
• Try to increase the amount each year
• Especially when you get a pay raise

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Regular Taxable Accounts versus Tax-Qualified Accounts

Taxable Account

Tax-Qualified Account

Stocks

Bonds

Mutual Funds

“Cash”

Stocks

Bonds

Mutual Funds

“Cash”

Although there are many subtle and not-so-subtle differences, the major differences are how they are taxed by the IRS, how much money you can contribute, and what you can have in the account.

aka Retirement Accounts, Education Accounts, MSA 🡪 HSA

aka Regular account

No limit on contributions

Strict limits on contributions

Options

Futures

Strict limits on investment types

No limits on investment types

Margining

Shorting

Pay taxes every year on gains

Tax-deferred (pre-tax) or

Tax-free (post-tax)

All contributions are post-tax dollars

Most are pre-tax. Some are post-tax

Real Estate

Hard Assets

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Major Investment Alternatives

• Stocks Dividends & Capital Gains – 8%-10% – long-term
• Bonds Interest & Principal – 3%-6% – long/intermediate
• “Cash” Interest & Principal – 1%-4% – short-term
• aka Short-term investments, guaranteed, safety of principal
• Annuities Fixed <1%-3%, Variable <1%-6% – BOHICA!
• Real Estate Rent & Capital Gains – 7%-8% – long-term
• Other Investment Alternatives…
• …That I hope you will avoid …
• Unless you know exactly what you are doing or are willing to lose a good chunk of your money or, preferably, both
• Derivatives (options, futures, etc.), hard assets, precious metals, art & collectibles, starting a business, etc.

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“So What Is Your Choice?”

• If the goal is long-term (example: retirement), then my choice is high-quality stocks
• Although some people prefer bonds because they are less risky than stocks (or a combination of both)
• If the goal is intermediate-term, then bonds or REITs (Real Estate Investment Trusts) make sense
• If the goal is short-term, you have no choice but to use a guaranteed short-term “cash” investment such as a money market account
• Although bonds close to maturity could also work
• The “Others” never make sense except for a small percentage of the population

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“So I am buying stocks and bonds. Great! How do I get started?”

• Well, actually, you don’t…
• Buy the stocks and bonds, that is…
• For the vast majority of people, the best investments are mutual funds that buy the stocks and bonds for them
• Professional money management
• Diversification

“But you got me all excited about buying stocks and bonds all by myself! Besides, in their commercials on TV, E*trade and Robinhood show everyday, hard-working Americans just like me happily and profitably buying and selling stocks all the time.”

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Let me ask you a few questions…

• Do you have the discipline, courage and brains to buy when everyone else is selling and sell when everyone else is buying?
• Do you have a strong background in finance, business, marketing, economics, politics, and history?
• Are you a part of a global research team stationed all around the world?
• Do you have the time and resources to visit in person the companies you intend to invest in?
• Plus their customers, competitors, and suppliers?
• Do you have enough money to buy at least 20 or more stocks representing various sectors of the economy?
• Most importantly, do you have a knack or intuition for recognizing unrecognized value?

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Your results?

• If the answer to two or more of the previous questions is, “No” (especially the last two: money for 20 or more stocks & an intuitive eye for value)
• Stay away from individual stocks!
• Bonds are also difficult since bond traders usually deal in tens of thousands of dollars per trade
• (The exceptions are government bonds bought directly from www.treasurydirect.gov)
• Mutual Funds are your Best Bet
• And if it means anything to you, virtually all of my family’s financial investments (and my clients’) are in mutual funds (>99%)
• I certainly can’t answer “Yes” to all those questions

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Mutual Funds �(The legal term is Investment Company)

STOCKS BONDS “CASH”

Professional Money Management

Diversification

Stock mutual funds

Bond mutual funds

Money market mutual funds

Balanced mutual funds

a “mutual” fund

(investment company)

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“So, How Do I Pick a Mutual Fund?”

• Pick a Mutual Fund that…
• Invests in high-quality stocks or bonds
• Is well-diversified across several industries and sectors of the economy and countries of the world
• Has a long-term perspective and a manager or (better yet) a management team with many years of experience
• Avoid companies that “shuffle” their managers every few years (which used to be virtually all of them!)
• Has been around for decades and performed consistently well in both good and bad markets

More about choosing a good mutual fund when we get to Chapter 14.

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“How Do I Purchase a Mutual Fund?”

• Normally, a little bit at a time
• Virtually all mutual funds will allow you to start an automatic investment plan with as little as $25 to $50 per month
• Either through your employer (401k, 403b, etc.)
• Or from your checking or savings accounts (Traditional IRA, Roth IRA)
• The ones that won’t are specialized funds that you normally don’t want to deal with anyway
• Minimum purchases of $1,000 to $25,000 or more

Investing a fixed amount ($50, $100, etc.) periodically is called “dollar cost averaging.”

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Dollar Cost Averaging

• A system of buying an investment at regular intervals with a fixed dollar amount
• $50 per month, $100 per month, etc.
• With Dollar Cost Averaging, there is always “Good News”
• “The market is up! Good News!”
• Your account is worth more
• “The market is down! Good News!”
• Next month, you will get more shares at a lower price when the $50 or $100 comes out of your paycheck or checking account

Yippee!

Huh?!

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“But Now It All Sounds So Boring…”

• In the investment world, Boring is Good!
• After you have built a solid foundation of high-quality stock or bond investments through mutual funds, then you can “play the market”
• I used to call it my “Vega$ Fund”
• Take no more than 5% to 10% of your financial assets and choose your own stocks
• Be prepared for “volatility”
• “Volatility” is the investment world’s euphemism for large losses – Buy a stock for $11.88, sell it for 30¢
• I kept my “Vega$ Fund” to no more than 1% of our total portfolio, by the way

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Investments: What are ___?

Investment companies that pool investors' money and invest in a diversified portfolio of securities. Investors get diversification and professional money management.

1. short-term securities (aka “cash”)
2. stocks
3. bonds
4. mutual funds

The correct answer is (D). Investment company is the legal term. Mutual fund is the popular term.

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Investments: What are ___?

Represent ownership in a corporation. Investors optionally receive dividends and capital gains (or capital losses).

​

1. real estate
2. stocks
3. bonds
4. short-term securities (aka “cash”)

The correct answer is (B). Stock investors are part-owners of corporations.

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Investments: What are ___?

Fixed-income securities that represent loans to corporations, municipalities (state & local governments & agencies), and the Federal government. Investors receive interest and a promise to repay the loan.

​

1. real estate
2. stocks
3. bonds
4. short-term securities (aka “cash”)

The correct answer is (C). Bonds are “fixed-income” investments.

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Investments: What are ___?

Investments with very little risk, and correspondingly, very little return. They are usually guaranteed or pretty darned close. There is a huge opportunity cost if you leave your money here for the long term.

​

1. real estate
2. stocks
3. bonds
4. short-term securities (aka “cash”)

The correct answer is (D). Low risk, low return.

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What are Reasonable Expectations?

What are reasonable expectations of returns from the following investments?

​

1. stocks
2. bonds
3. short-term securities
4. real estate
5. mutual funds
6. the “others”

8% - 10%

3% - 6%

1% - 4%

?

-?

7% - 8%

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Coming Attractions

• Chapter 12 ‒ Investing in Stocks
• Exciting! Sexy! Risky!
• Chapter 13 ‒ Investing in Bonds
• Stodgy. Boring. Reliable.
• Chapter 14 ‒ Investing in Mutual Funds
• Investments for the Masses
• Chapter 15 ‒ Investing in Real Estate and Other Investment Alternatives
• Because everyone isn’t the same

If this material piques your interest, please consider taking BUS-123, Introduction to Investments. There is a future for you in the financial and investment services industry!

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