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Investing

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Investing

Investing is taking a long term perspective and is a process of purchasing securities wherein stability and value and level of return are somewhat predictable.

Getting started

Have ample insurance and liquidity. After this you need about $500 to start investing. The authors suggest you begin to track stocks now while you accumulate savings - plan ahead.

Why invest? Why not, you can get

1) current income - work hard, save a lot, retire at 35 and live off your investments. More likely, when you retire you can still have your investments earn.

2) save enough for a major purchase like a down payment on a home, kids college, or to start a business.

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3) retirement - remember you may have a retirement plan at your place of employment and there is social security, but plan ahead.

4) tax shelter - your tax burden can be reduced with investments when the rules apply.

Ways to invest

A) common stock - buy ownership in a corporation - buy shares of stock. You can get dividends, periodic payment of the profits of the firm, and appreciation of share price. Over the long haul stocks perform pretty well, but some better than others.

B) Bonds - corporations and governments ask you to lend them money - they pay back with interest. Corporate bonds pay less than stocks but more than government bonds.

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C) preferred securities - issued like stock - owner of a company - but have a stated dividend rate - common stock may or may not give a dividend.

D) convertible security - starts as a bond (or maybe a preferred security) and can later be converted to common stock. Why take this security? You like the dividends they provide, but want the capital gain if the common stock rises.

E) Mutual Funds - professional managers let you buy into their org and you become part owner of what they own.

F) Real Estate - earn rent, capital gains, tax benefits, but beware you have to collect the rent and stuff like that.

G) Futures markets - you get involved in contacts to buy/sell at a future date - commodities markets include cotton, corn and frozen orange juice concentrate - financial markets include stock and foreign currencies.

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H) options - get right to buy or sell at a set price over a specified time period.

Securities markets - the place where trades occur.

Primary market

-a corporation or the government issue new securities directly to the public

-an investment banking firm might be hired to sell the new securities, they may advise on price, bring in a syndicate to help in the sale.

-a prospectus is a document describing the firm and the new issue.

Analogy: The primary market for baseball cards is when you buy them at the store. The secondary market, what we talk about next, is where people trade what has already been issued.

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Secondary market (our focus from here on out)

-investors trade with each other

Organized securities markets

1) New York Stock Exchange

-worlds major exchange

-only certain companies are listed to be traded

-you and me have to trade through brokerage firms that have a seat on the exchange.

2) American stock exchange and regional exchanges

-not as prominent as NY, similar function

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3) Over the counter market

-dealers buy from and sell to the public

-NASDAQ is major player because of the companies it lists - tech stocks.

4) Foreign exchanges

-Japan and other countries have exchanges as well.

Regulation

The point of regulation is so that adequate and accurate information is disclosed to potential and existing investors.

Bull or bear

Day to day stocks can fluctuate in price. A general trend of stocks going up is called a bull market. A trend downward is called a bear market.

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Stockbrokers

-really financial consultants

-execute trades for you

-should you pick a creep? Of course not, get someone who listens to you and doesn’t churn (Have you trade a lot so they can get commissions).

Odd lots - trade in fewer than 100 shares of stock.

Round lot - 100 shares

Odd lot transactions result in additional fees for the brokers.

Brokers fees

You pay when you buy and when you sell. Typically you pay a fixed amount plus a % of the value of the transaction.

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Types of orders

Market order - an order to buy or sell now.

Limit order

-an order to buy when the price is a SPECIFIED AMOUNT OR LOWER

-an order to sell when the price is a specified amount or higher.

You can specify an order is open until a certain date or until the order is cancelled.

Stop loss order

-order to sell a stock when the market price reaches or drops below a certain level - if the point is reached it becomes a market order.

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Margin Trades (buying on margin)

-you can borrow some of the money to buy securities (brokerages or banks will lend and you pay interest on the funds borrowed)

The most recent maximum amount you can borrow is 50%. So 50% of each dollar invested must be your own. Say you want $K worth of stock. You have to have $.5K. The authors say using margin magnifies gains and losses. Let’s do a numerical example to see this (9% interest charge + principal).

Buy $5000 worth of stock without margin with margin

your money you pay out 5000 2500

you sell later for in 1 year 7000 7000

gain minus interest 2000 4500 - 2500- .09(2500)

=1775

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Remember from early on we had

F = P(1 + i). So, over one year i = (F/P) -1 = (F - P)/P

Without margin the rate of return is 2000/5000 = .4 or 40%

With margin the rate of return is 1775/2500 = .71 or 71%

A similar result holds if there is a loss.

Short Selling

This is a process where you first sell shares that you have borrowed and then you buy back later to repay what you borrowed. You hope the stock prices will fall.

Note that you are borrowing shares, not money like buying on margin. When you first sell the shares you don’t get the money. You only get funds when you buy shares and settle up. Plus, you have to put up some money up front, even though you sell shares first.

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Being an informed investor

Goal - knowing how to achieve decent rates of return without taking unnecessary risks.

Rule of thumb - never start an investment program (or buy an investment vehicle) unless you are thoroughly familiar with what you are getting into!

Where to look

1) Annual stockholders’ reports

-look at the income statement and balance sheet

-find the earnings per share and dividend amounts

-see what the ceo’s letter says - anything unusual?

-read auditor’s report - conditional statements like except for and subject to means you should proceed with caution.

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2) Financial Press

-look for info about general economic conditions

-market data - look to stock market indexes and see how they re changing over time.

dow jones industrial average - 30 stocks - called blue chips - this is the most watched index in the world and is printed in most daily newspapers

Standard & Poors 500 - broader index looking at 500 stocks

NASDAQ composite - high tech stocks index

Wilshire 5000 - represents total market value of 98 to 99% of all publicly traded stocks.

Note that market cap stands for market capitalization or market value and equals market price times shares outstanding.

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-the press will often have stories about industries and companies

-stock quotes in the press usually have the following info

company name and/or stock symbol (an abbreviation)

YTD% - the % change in the stock since Jan 1

52 week hi and lo - the highest share price and the lowest share price in the last 52 weeks.

DIV - per share dividend for the last 12 months

YLD% - DIV divided by the closing share price on the most recently traded day

P/E ratio - market price/earnings per share

vol 100’s - the volume of shares traded

last - closing price net change = last - last from day before

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3) Other sources of information are brokerage reports, advisory services, investment newsletters and investment advisors.

The internet has become an important source of information for investing and many tools are available.

watch out for scams - don’t give social security number or credit card number unless you are really sure you are in a secure environment

day trading - this is when you watch stock prices all day on the internet and you try to “time” trades to make money. This may work, but is a short term view. You should invest for the long term.

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Managing Investment holdings

big word - Portfolio - the “mix” of your investments.

The pros say your portfolio should be a reflection of your philosophy. One philosophy is diversification.

Diversification

-combining securities with dissimilar risk-return characteristics

-hold more than 1 company stock

-hold more than 1 industry stock

-have stock and bonds, cash and maybe other stuff.

Your philosophy may change over time

young - growth

older - stability of principal.