Introduction to Investment Options, Risk
Introduction to Investment Options, Return, Risk and Allocations Facilitators Manual
Introduction We already learned that financial planning is nothing but defining your goals and identify the steps you must take to help make them a reality. What you first need to figure out... What are the steps you need to take to reach your goals? Is your wish to retire with a sound lump sum amount or do you want a steady monthly income. Is your son's education or daughters' marriage worrying you? The key is to figure out your goals and what will be needed financially to accomplish them. Why investing and not just save? You should invest so that your money grows and shields you against rising inflation. If prices rise by four per cent annually it would not be sufficient if your savings only give you a return of three per cent. It leaves you with a deficit of one per cent. The idea is that your rate of return on investments should be greater than the rate of inflation, leaving you with a nice surplus over a period of time. Whether your money is invested in stocks, bonds, mutual funds or certificates of deposit (CD), the end result is to create wealth for retirement, marriage, college fees, vacations, better standard of living or to just pass on the money to the next generation. Also, it's exciting to review your investment returns and to see how they are accumulating at a faster rate than your salary. This module will help you determine some of the first steps for reaching your financial goals through investing.
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Module Objectives After completing this module you should be able to: Recognize different investment options Understand the concept of yield Recognize what are investment risks Understand how to reduce risks Understand what is risk tolerance Recognize the different investment styles Understand the concepts of asset allocation, diversification and rebalancing Recognize different allocation strategies Understand the importance of time on the market Recognize the meaning of social responsible investments
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Recommended Time on Task by Lesson Lesson No.
M2.1 M2.2 M2.3 M2.4 M2.5 M2.6
Lesson Subject Introduction and Ice Breaker Investment Options Return What is Risk? Your Investing Style Asset Allocation, Diversification, and Rebalancing Buy and Hold
Suggested Module Instructional Duration:
Time Required 20 minutes 20 minutes 30 minutes 40 minutes 40 minutes 60 minutes 20minutes
3.5 hours
About This Manual This manual contains the same information provided in the instructional manual that the participants will have during the workshop. For each section we provide specific suggestions and resources selected to help you deliver the classroom instruction. These include teaching tips, questions to generate classroom discussion, and a module PowerPoint presentation. In addition every section or subject has additional reference materials which provide supplementary online instructional materials and resources. These were selected to provide the facilitator more information about the subject or materials which could be used to enhance the delivery of instruction.
Before the workshop session: Before conducting the workshop, take time to familiarize yourself with the participant manual, exercises, additional learning resources, teaching tips and questions to generate discussion and PowerPoint presentation. For classroom use it is highly recommended to secure a flip chart, color markers, projector, and laptop. Familiarize with setting up the equipment and with its operation.
At the workshop: Welcome the participants Ask participants to introduce themselves, and share what their expectations are for this program, and what they hope to get out of the seminar. Write these down on a flip chart as they share. (This activity will help participants get to know each other and feel more comfortable and give you an idea of what they are expecting from the session.)
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Review the objectives of the session and the agenda. If applicable, hand out materials to participants. Using the module PowerPoint presentation, review the module objetives:
Use this time to listen as well as to manage expectations as to what will be accomplished during the lesson. Let participants know that their specific personal situations may not be able to be addressed directly in the lesson but that the information should be valuable to them. Make sure to schedule breaks after 1.5 hours of instruction. Encourage participants to ask questions; try to create an interactive-participatory learning environment. If you do not have the answer to a question, be honest and say: ―I don’t know the answer but I will research it for you”. Bring the answer next day and explain where and how you found the answer. Do not ask personal questions to participants which could potentially disclose personal or confidential financial information. It is strongly recommended to always use hypothetical scenarios. Always use a flip chart to write down key concepts, at the end of the day review the key learning concepts.
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Table of Contents Introduction........................................................................................................................ 1 Module Objectives............................................................................................................. 2 Recommended Time on Task by Lesson ......................................................................... 3 About This Manual ............................................................................................................ 3 Key Terms ......................................................................................................................... 7 Investment Choices......................................................................................................... 10 Lesson No. M2.1 ......................................................................................................... 10 Return and Rate of Return .............................................................................................. 14 Lesson No. M2. 2 ........................................................................................................ 14 Return .......................................................................................................................... 16 Rate of Return.......................................................................................................... 17 Using Return ............................................................................................................ 17 Yield ............................................................................................................................. 18 What Is Risk? ................................................................................................................. 20 Lesson No. M2.3 ......................................................................................................... 20 Market Risk................................................................................................................. 23 Inflation Risk .............................................................................................................. 23 Liquidity Risk ............................................................................................................. 23 What Is the Best to Reduce Risks? ......................................................................... 24 Risk Tolerance ........................................................................................................... 24 Risk versus Reward..................................................................................................... 24 Exercise: “Assessing Your Risk Tolerance” – New York Institute of Finance Questionnaire ............................................................................................................ 25 Your Investing Style ...................................................................................................... 26 Lesson No. M2.4 ......................................................................................................... 26 Conservative Investing Style ....................................................................................... 29 The Risks of a No-Risk Portfolio ................................................................................. 29 When a Conservative Approach Makes Sense .......................................................... 29 Moderate Investing Style ............................................................................................. 30 Aggressive Investing Style .......................................................................................... 30 Contrarian Investing Style ........................................................................................... 31
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Guide to Asset Allocation, Diversification, and Rebalancing .......................................... 32 Lesson No. M2.5 ......................................................................................................... 32 Asset Allocation 101 .................................................................................................... 36 Why Asset Allocation Is So Important ......................................................................... 37 How to Get Started ...................................................................................................... 38 The Connection between Asset Allocation and Diversification ................................... 39 Diversification 101 ....................................................................................................... 39 Asset Allocation Strategies .................................................................................. 40 Changing Your Asset Allocation .................................................................................. 43 Rebalancing 101.......................................................................................................... 43 When to Consider Rebalancing................................................................................... 44 Where to Find More Information.................................................................................. 44 The Long Term Perspective: Benefits of “Buy and Hold”........................................ 46 Lesson No. M2.6 ......................................................................................................... 46 Additional Learning Resources ................................................................................... 49
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Key Terms 401(k):
The 401(k) plan is a type of retirement plan available in the United States. Named after a section of the 1978 Internal Revenue Code, a 401(k) is an employer-sponsored qualified retirement savings plan. It allows you to save for your retirement while deferring any immediate income taxes on the money you save or their respective earnings until withdrawn.
APY:
Stands for annual percentage yield or compound interest.
Asset:
Items of value owned by an individual. Assets that can be quickly converted into cash are considered "liquid assets." These include bank accounts, stocks, bonds, mutual funds, and so on. Other assets include real estate, personal property, and debts owed to an individual by others.
Asset Allocation: Apportioning of investment funds in categories of assets, such as Cash Equivalents, Stock, Fixed-Income Investments, and such tangible assets as real estate and precious metals. Also applies to subcategories such as government, municipal, and corporate bonds. Asset allocation affects both risk and return and is a central concept in personal financial planning and investment management. Bonds:
A certificate that is evidence of a debt on which the issuer promises to pay the holder a specified amount of interest for a specified length of time, and to repay the loan on its maturity. Strictly speaking, assets are pledged as security for the loan, except in the case of government bonds, but the term is often loosely used to describe any debt issue. Bonds are issued by corporations and by federal, provincial, and municipal governments.
Diversification:
An investment strategy that can reduce market risk by combining a variety of investments, such as stocks and bonds, which are unlikely to all move in the same direction at the same time.
Dividends:
Dividends are generally payments made to owners of a company. These payments can be in the form of cash or the issuance of additional stock. Dividends are generally used
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as a way to allow the owners to participate in the profits generated by the company. Fixed Investments: A security or investment account that pays a fixed rate of return. Interest:
Is the amount that is agreed to be paid in return for the use of a certain amount of money (principal). Interest is usually expressed as a percentage of the principal. For example, the bank may give you 2% interest on your principal of $100. Over the course of a year, you will earn $2 in interest on your $100 deposit (that is, if you leave the $100 in the savings account all year).
Market:
Refers to people coming together to buy and sell investments such as stocks and bonds, which we will discuss later.
Mutual Funds:
Typically consist of a group of stocks, bonds, or moneymarket securities from more than one source. There are three types—income funds (for people who need money to live on); growth funds (pay low dividends or none—works best for investors who can leave money in the fund so it can grow over a long period of time); and balanced funds (combination of stocks and bonds).
Principal:
Is the amount of money you invest to make money. For example, if you deposit $100 in a savings account in the bank, that deposit is your principal.
Rebalancing:
Returning a portfolio to its asset allocation targets by buying and/or selling securities. Rebalancing forces an investor to "buy low and sell high," and is contrarian in nature.
Return:
The profit earned on an investment. The $2 you earned in interest on your $100 deposit is known as your return. Returns come from many investments—like stocks and mutual funds. But be aware that returns are not guaranteed. Returns can be negative if there is a loss.
Securities Exchange Commission: A government regulatory agency that oversees and enforces the securities laws of the United States, publishes rules and guidance for the securities industry, and provides investor education.
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Stock Market:
The set of institutions that facilitate the exchange of stocks between buyers and sellers. A stock market can be an actual place, but with the growth of electronic transactions a large fraction of stock market transactions are not centrally located in a particular location.
Term:
Refers to a period of time. You might take out a home mortgage on a 15-year term or on a 30-year term. (Note that this differs from ―terms,‖ which usually refers to the conditions set in a loan agreement.)
Time Horizon:
Time Horizon is the time span of your investment objectives. Your time horizon dictates the types of investments that are suitable for your portfolio. The shorter the time horizon, the less appropriate are equities or any other asset class with high return variations. Conversely, the longer the time horizon, the more an investor can afford a higher return variation and thus a higher allocation to equities.
Volatility:
Accepted by academics and financial planning practitioners as a representation of risk, expressed statistically as the standard deviation, which analyzes the fluctuation of returns of an investment around an average. Also volatility is defined as the tendency of a security or market to fluctuate in price.
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Investment Choices Lesson No. M2.1 Lesson Objectives: After completing this lesson participants should be able to: Recognize different investment options Recognize that each investment option carries different risk levels
Time Required: 30 Minutes
Lesson Teaching Tips This module is about investment options and diversification; from the very beginning always relate to the analogy of not putting all the eggs in one basket.
Questions to Generate Discussion What do we need to do in order to reach our financial goals? Which investment options do you know? Which are three major asset categories? What are the differences between them?
PowerPoint Slides Thumbnails
Slide Notes Remind participants of their financial goals, these investment options will help them define a strategy to reach their goals.
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| The ASPIRA Association Define what stocks are. What are the risks and rewards of investing in stocks?
Define what are bonds. What are the risks and rewards of investing in bonds? Define “volatility”to participants.
Ask participants if in order to reach their financial goals they will put all of their assets on “Cash” investments and why?
Closure: Review lesson objectives with participants. Each of the investment options carries a risk level. Please let participants know that the concept of risk will be discussed following this lesson.
Learning Assessment: Ask participants to list the various investment options.
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Reference Materials Investment Choices – SEC http://www.sec.gov/investor/pubs/investop.htm
While we cannot recommend any particular investment product, you should know that a vast array of investment products exists - including stocks and stock mutual funds, corporate and municipal bonds, bond mutual funds, lifecycle funds, exchange-traded funds, money market funds, and U.S. Treasury securities. For many financial goals, investing in a mix of stocks, bonds, and cash can be a good strategy. Let's take a closer look at the characteristics of the three major asset categories. Stocks – are a financial instrument that signifies an ownership position in a corporation. Stocks have historically had the greatest risk and highest returns among the three major asset categories. As an asset category, stocks are a portfolio's "heavy hitter," offering the greatest potential for growth. Stocks hit home runs, but also strike out. The volatility of stocks makes them a very risky investment in the short term. Large company stocks as a group, for example, have lost money on average about one out of every three years. And sometimes the losses have been quite dramatic. But investors that have been willing to ride out the volatile returns of stocks over long periods of time generally have been rewarded with strong positive returns. Bonds - are long-term promissory note in which the issuer agrees to pay the owner the amount of the face value on a future date and to pay interest at a specified rate at regular intervals. Bonds are generally less volatile than stocks but offer more modest returns. As a result, an investor approaching a financial goal might increase his or her bond holdings relative to his or her stock holdings because the reduced risk of holding more bonds would be attractive to the investor despite their lower potential for growth. You should keep in mind that certain categories of bonds offer high returns similar to stocks. But these bonds, known as high-yield or junk bonds, also carry higher risk. Cash - Cash and cash equivalents - such as savings deposits, certificates of deposit (CD), treasury bills, money market deposit accounts, and money market funds - are the safest investments, but offer the lowest
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return of the three major asset categories. The chances of losing money on an investment in this asset category are generally extremely low. The federal government guarantees many investments in cash equivalents. Investment losses in nonguaranteed cash equivalents do occur, but infrequently. The principal concern for investors investing in cash equivalents is inflation risk. This is the risk that inflation will outpace and erode investment returns over time. Stocks, bonds, and cash are the most common asset categories. These are the asset categories you would likely choose from when investing in a retirement savings program or a college savings plan. But other asset categories - including real estate, precious metals and other commodities, and private equity - also exist, and some investors may include these asset categories within a portfolio. Investments in these asset categories typically have category-specific risks. Before you make any investment, you should understand the risks of the investment and make sure the risks are appropriate for you.
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Return and Rate of Return Lesson No. M2.2 Lesson Objectives: After completing this lesson participants should be able to: Understand the concept of return of investment. Understand how to calculate return and yield.
Time Required: 30 Minutes
Lesson Teaching Tips Have available calculators or computers t perform examples.
Questions to Generate Discussion How do you know how much money you are making out of an investment; How do you know the yield of an investment?
PowerPoint Slides Thumbnails
Slide Notes Discuss with participants the concept of return.
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| The ASPIRA Association Make participants aware that total return is a measure of your profit or capital appreciation before taxes and commissions or fees.
The other factor that participants have to take into account in evaluating their return is the number of years they own the investment. There’s a big difference in realizing a return of 16.67% on an investment you own for just one year, or what’s called an annual return, and realizing the same return on an investment you own for five years. Define the concept; Discuss the example. Present the meaning of: coupon yield, current yield and yield to maturity.
Closure: Review lesson objectives with participants. Make sure participants will understand how to compare returns of different types of investments and the relationship with the investment time frame or maturity.
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Learning Assessment: Ask participants to define return of investment and yield.
Reference Materials Rate of Return: http://en.wikipedia.org/wiki/Return_on_investment
Return Investment return is what you get back on an investment you make1. Ideally, the return will be positive, your initial investment or principal will remain in intact, and you will end up with more than you invested. But because investing typically involves risk—especially if you invest in securities such as stocks, bonds, or mutual funds that invest in stocks and bonds—your returns can be negative, and you can wind up with less money than you initially invested. For example, let’s say you buy a stock for $30 a share and sell it for $35 a share. Your return is $5 a share minus any commission or other fees you paid when you bought and sold the stock. If the stock had paid a dividend of $1 per share while you owned it, your total return would be a gain of $6 a share before expenses. However, if you bought at $35 and sold at $30, you would have lost $5 on your investment, not counting expenses. If you earned a dividend of $1 per share, your actual loss would be reduced to $4 a share. Total return = Gain or loss in value + investment earnings Be aware that total return is a measure of your profit or capital appreciation before taxes and commissions or fees. When you evaluate your return on an investment, you should separately assess the impact of those costs. In the example above, if the commissions you paid both to buy and to sell the stock— plus any taxes you must pay on net capital gains—totaled more than $5, then you would have lost money. If you are investing in mutual funds, you will find both total annual returns and after-tax annual returns in the fee table in the
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Prepared for the FINRA Foundation by Lightbulb Press, Inc.; December 2007
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prospectus. Rate of Return Having determined the return on an investment, you will want to be able to compare that return to returns on other investments. The dollar amount by itself doesn’t tell you the whole story. To see why, compare a return of $5 per share on a $30 investment with a return of $5 per share on a $60 investment. In both cases, your dollar return is the same. But your rate of return, which you figure by dividing the gain by the amount you invest, is different. In this comparison, the rate of return, also called the percent return, on the $30 investment is 16.67% ($5 ÷ $30 = 16.666) while the rate of return on the $60 investment is 8.33% ($5 ÷ $60 = 8.333)—just half. Rate of return = Total return ÷ investment amount You can evaluate the return on savings accounts, bonds, mutual funds, and the entire range of investment alternatives in much the same way. The more you invest to get the same dollar return, the smaller your rate of return will actually be. The other factor that you have to take into account in evaluating your return is the number of years you own the investment. There’s a big difference in realizing a return of 16.67% on an investment you own for just one year, or what’s called an annual return, and realizing the same return on an investment you own for five years. In this case, after dividing the percent return by the number of years, the annualized return would be only 3.33%, which you figure by dividing the percent return by the number of years you held the investment. Annualized return = Percent return ÷ number of years Using Return Return can be a useful tool in evaluating whether the investments you own are performing in the way you expect, especially when you compare their return to that of similar investments or an appropriate benchmark, such as a market index that tracks the return of a group of similar investments2. Specifically, you might compare the annual percent return on a large company stock or the return on a large-company stock fund to the annual return of the Standard & Poor’s 500 Index (S&P 500). You can also use historical returns to compare the average annual return over 2
Prepared for the FINRA Foundation by Lightbulb Press, Inc.; December 2007
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time of different categories of investments, known as asset classes. In the context of investing, the most common asset classes include stocks (equities), bonds (fixed-income securities), and cash or cash equivalents. The research firms that track historical returns have found that, both over the past century and during shorter 10-year cycles, stock has had the strongest return among the major asset classes, bonds the next strongest, and cash equivalents the most stable but the lowest. While the annual return for any asset class, or mutual fund investing in that asset class, may surpass its historical average in a given year or series of years, the return may underperform the average as well. There’s always a risk in assuming that your return on an investment will be substantially higher than the average return on that investment over time. In fact, there’s no guarantee that it won’t be lower. Yield The yield on an investment is the amount of money you collect in interest or dividends, calculated as a percentage of either the current price of the investment or the price you paid to buy it. For example, if a stock pays annual dividends of $1 per share when the price is $35, the current yield is 2.9% ($1 ÷ $35 = 0.02857). However, if you bought the stock for $25, and used that number as the basis of your yield, that same $1 dividend would be 4% ($1 ÷ $25 = 0.04). While yield is just one of the factors you typically use to evaluate stock performance, it figures much more prominently in evaluating bonds and other interest-paying investments where current income is often of primary importance. In fact, with fixed-income investments yield is measured in different ways depending on what you want to know about the income you’re receiving: Coupon yield, for example, is the income a bond is paying as a percentage of the bond’s par value, usually $1,000. It’s always the same as the bond’s interest rate. So a bond that pays 4.5%, or $45 annually, has a coupon yield of 4.5%. Current yield, however, is the income a bond pays as a percentage of its current price, which may be more or less than $1,000. For example, if a bond’s coupon yield is 4.5% but the bond’s market value is $1,050, its current yield is 4.29% ($45 ÷ $1050). In contrast, if its market price is $950, its current yield is 4.74% ($45 ÷ $950). Yield to maturity is calculated using a more complex formula. It accounts for the bond’s future earnings until its maturity date, the amount you’ll gain or lose when par value is repaid, and what you would earn by reinvesting the interest you’re paid at the same rate during the bond’s remaining term.
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What Is Risk? Lesson No. M2.3 Lesson Objectives: After completing this lesson participants should be able to: Understand the financial concept of “risk” Recognize three types of risks Recognize the best strategy to reduce risk Understand what level of risk tolerance is
Time Required: 40 Minutes
Lesson Teaching Tips Use the analogy of reaching our financial goals as a journey: in order to reach our destination, we have several ways to travel, some faster and some slower with different chances of reaching the desired location.
Questions to Generate Discussion Who can define “risk”? What types of risks do we take in our lifetime? What is the relationship between reaching your financial goals and investment risks?
PowerPoint Slides Thumbnails
Slide Notes Follow the slide bullets and promote discussion. After this slide, you can ask students to complete the New York Institute of Finance questionnaire on risk tolerance.
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| The ASPIRA Association Use this slide to introduce three types risks.
Define market risks and provide examples. Examples include actual or anticipated developments within a particular company or industry; changes in the outlook for the economy as a whole; or shifts in investor attitude toward the stock market in general. Define market risks and provide examples. Historically, inflation in the United States has averaged 3.1%, offsetting most of the returns from investment in cash reserves and bonds, but less than half of that of stocks. Because stocks' real returns are often generally higher than inflation, stocks offer a way to help protect your money against inflation risk. Define market risks and provide examples. Currency risk is the risk associated with the price fluctuations in the dollar value of international stocks due to changing currency exchange rates.
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| The ASPIRA Association Use the analogy of the egg basket to explain this concept.
Along with this concept you must ask participants to consider how much time they have in order to reach their goal and how much risk they are willing to take.
Discuss the definition of “time horizon.”
Closure: Review lesson objectives with participants. Summarize by presenting again two adages: “don’t put all the eggs on one basket” and “no pain, no gain.” The answers are to start investing as early and as much as you can, to diversify, and to take calculated risks.
Learning Assessment: Ask participants to briefly define risk.
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Reference Materials Investments Risks – Florida State University http://learningforlife.fsu.edu/course/fp101/InvestmentsRisk.htm
Throughout our life’s almost everything we do has some risk attached to it. Risk can be defined as the chance or possibility of loss. In financial terms, it is defined as the degree of uncertainty regarding the rate of return on and/or the principal value of an investment. Part of becoming a good investor is understanding the types of risks you will face. On the other hand, you will need to know how much financial risk you can afford in order to reach your goals. There are three types of risks you need to become aware of: Market Risk Market risk is the risk that the value of your investment will decrease due to moves in market factors. The four standard market risk factors include: 1) Equity risk or the risk that stock prices will change. 2) Interest rate risk or the risk that interest rates will change. 3) Currency risk or the risk that foreign exchange rates will change. 4) Commodity risk or the risk that commodity prices (i.e. grains, metals, etc.) will change. Inflation Risk Inflation risk is the risk that the interest you're earning may fall below the inflation rate. When this happens, you are actually losing purchasing power. Say you are earning 4% interest but inflation is at 5% per year. Even though you have more dollars each year, you are actually losing value since you won't be able to purchase as much in the future. This is the effect of inflation. Liquidity Risk Liquidity risk is defined as the ease with which an investor can convert an investment to cash without negative impact on either capital or return. For example, you might have an asset (investment) that nobody wants to purchase, or you might have $4,000 invested on a 48-month CD (Certificate of Deposit) and you need the money immediately, but you can’t take the money out before its due date or you might face a penalty and lose money.
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What Is the Best to Reduce Risks? The best way to reduce risks is by diversifying your investments. Simply stated, don’t put all of your eggs into one basket. Diversification can be defined as: an investment strategy that can reduce market risk by combining a variety of investments, such as stocks and bonds, which are unlikely to all move in the same direction at the same time. We will discuss diversification and asset allocations in detail in the following section.
Risk Tolerance When dealing with investments and risk there is a simple rule of thumb: higher risk investments potentially produce higher returns. Your goal should always be to improve your returns (earnings) without taking on too much risk. This requires understanding your ―risk tolerance.‖ This could be defined as an investor's ability to withstand losses caused by one or more of the different types of risk. This ability can be limited by your temperament as well as your time frame and financial circumstances. For example, someone who is investing for a goal 10 to 20 years or more in the future generally has a higher risk tolerance and may feel more comfortable with riskier investments than a person whose investment goal is only 5 years away or less. Risk versus Reward When it comes to investing, risk and reward are inextricably entwined. You've probably heard the phrase "no pain, no gain" - those words come close to summing up the relationship between risk and reward. Don't let anyone tell you otherwise; all investments involve some degree of risk. If you intend to purchases securities - such as stocks, bonds, or mutual funds - it's important that you understand before you invest that you could lose some or all of your money.
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The reward for taking on risk is the potential for a greater investment return. If you have a financial goal with a long time horizon, you are likely to make more money by carefully investing in asset categories with greater risk, like stocks or bonds, rather than restricting your investments to assets with less risk, like cash equivalents. On the other hand, investing solely in cash investments may be appropriate for short-term financial goals. Exercise: “Assessing Your Risk Tolerance” – New York Institute of Finance Questionnaire
The New York Institute of Finance has developed a questionnaire to help you assess your risk tolerance. This questionnaire is available online at http://www.icief.org/risk/risk_quiz.html from the Investment Company Institute Education Foundation3. On this online questionnaire select what seems to be the most appropriate response for each question. In most cases, there are no right or wrong answers. To get an accurate score, you must answer each question. When you are finished, click on Calculate Score to see your total. You can then interpret your risk tolerance based on the information that follows.
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Investment Company Institute Education Foundation: From How Mutual Funds Work, Second Edition, by Albert J. Fredman and Russ Wiley. Copyright © 1998.Published by the New York Institute of Finance. Reprinted with permission of Prentice Hall Direct.
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Your Investing Style Lesson No. M2.4 Lesson Objectives: After completing this lesson participants should be able to: Understand the different types of investment styles Recognize the relationship between risk tolerance and financial goals with the various types of investment styles Recognize the implications of the different investment styles related to reaching financial goals.
Time Required: 40 Minutes
Lesson Teaching Tips Review the concepts of financial goals and risk tolerance.
Questions to Generate Discussion What are your financial goals? What is your risk tolerance? How these two elements will shape your investment strategies?
PowerPoint Slides Thumbnails
Slide Notes Follow the slide bullets and promote discussion. Ask participants about their financial goals and risk tolerance and how these two elements could shape their investment style.
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| The ASPIRA Association Discuss with participants the profile of this type of investor. List the types of investments typical of this style.
Discuss the risks associated with the conservative investment style. Review the definition of inflation.
Discuss with participants the profile of this type of investor. List the types of investments typical of this style.
Discuss with participants the profile of this type of investor. List the types of investments typical of this style. Discuss the risks associated with this investment style.
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| The ASPIRA Association Discuss with participants the profile of this type of investor. List the types of investments typical of this style. Discuss the skills needed to engage in this investment style.
Closure: Review lesson objectives with participants. Summarize by the topic by indicating that their (participants) investment style will be related to their personal financial goals and risk tolerance.
Learning Assessment: As potential first time investors, and taking into consideration participants financial goals and risk tolerance ask participants: what type of investing style they initially plan to adopt?
Reference Materials Finding Your Investment Style http://www.metlife.com/Applications/Corporate/WPS/CDA/Page Generator/0,4132,P2013,00.html
How you decide to allocate your assets—whether you choose a conservative, moderate, or aggressive allocation mix based on your tolerance for risk—is sometimes called your investing style, or profile.4 Your investing style reflects your personality, but it is also influenced by other factors like your age, financial circumstances, investment goals, and experience. For example, if you are approaching retirement or have lived through a period of major economic upheaval, such as a recession, you may be inclined to invest 4
Prepared for the FINRA Foundation by Lightbulb Press, Inc.; December 2007
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more conservatively. That might also be the case if you run a small business or are the sole provider for your family. On the other hand if you’re still early in your career, have few financial responsibilities, or own substantial assets, you may be willing to take more risk in your portfolio because you don’t need all of your current assets to meet your financial obligations.
Conservative Investing Style Conservative investors make capital preservation, or safeguarding the assets they already have, their priority. Because they normally aren’t willing to put any of their principal at risk, conservative investors usually have to settle for modest returns. The portfolios of conservative investors are typically heavily allocated in bonds, such as U.S. Treasury bills, notes, and bonds, highly rated municipal bonds, and insured investments, such as certificates of deposit (CDs) and money market accounts. While conservative investors tend to avoid stock because of its volatility, they may allocate a small portion of their portfolios to large-company stocks, which sometimes pay dividends and tend to be more stable in price than other types of stock.
The Risks of a No-Risk Portfolio As counterintuitive as it may sound, avoiding risk altogether can make conservative investors vulnerable to other types of risk—notably inflation risk. If you invest so conservatively that your invested assets barely keep pace with the rate of inflation (which has averaged 3% annually since 1926 but can sometimes spike higher), then your invested assets may barely be growing at all in terms of real buying power. If you’re also paying taxes on those assets, then they may in fact be shrinking compared to inflation. That’s why a conservative investment strategy can make it difficult to meet long-term investment goals, such as a comfortable retirement.
When a Conservative Approach Makes Sense There are some circumstances, however, when a conservative approach to investing may be appropriate. If you’re investing to meet shorter-term goals—for instance, you plan to make a down payment on a house in the next two or three years—then you may not want to put those assets at risk by investing in volatile securities, since your portfolio may not have time to recover if there’s a market
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downturn. Similarly, if you have substantial amounts of money invested in your own business or have other major financial responsibilities, you may be more comfortable taking a more conservative approach with your investment portfolio.
Moderate Investing Style Moderate investors seek a middle course between protecting the assets they already have and achieving long-term growth. They strive to offset the volatility of growth investments, like stocks and stock funds, by allocating a portion of their portfolios to stable, income-producing investments, such as highly rated bonds. While moderate investors may favor large-company domestic and international stocks, they may also diversify their portfolios by investing in some more volatile small-company or emerging-market stocks, to take advantage of the potential for higher returns. There is no hard and fast rule about exactly what mix of assets is appropriate for someone striving to achieve a moderate asset mix, since that mix depends to some extent on individual circumstances and tolerance for risk. For instance, a portfolio that is invested 35% in large cap domestic stocks, 15% in smallcompany and international securities, and 50% in bonds, might be considered very moderate—even conservative—for someone with 30 or 40 years until retirement. However, this same asset mix would carry more risk for someone with only a few years until he or she retires. If you’re not a risk taker by nature, a moderate investing approach may make sense in almost all circumstances. In broadest terms, a moderate approach means finding the mix of assets that gives you both the potential for long-term growth yet adequate protection for your assets given your age and financial circumstances.
Aggressive Investing Style Aggressive investors focus on investments that have the potential to offer significant growth, even if it means putting some of their principal at risk. That means they may allocate 75% to 95% of their portfolios in stock and stock mutual funds, including substantial holdings in more speculative investments, such as emerging market and small-company stock and stock funds. Aggressive investors with large portfolios may also allocate some of their assets to private equity funds, derivatives, direct investments, and other alternative investment products. Aggressive investors tend to keep only a percentage of their assets in cash and cash equivalents so they maximize their potential returns but have cash available when new investing opportunities arise.
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An aggressive approach is best suited to people with 15 years or more to invest to meet a financial goal, and who have adequate resources, so that they can absorb potential losses without jeopardizing their financial security. While past performance is no guarantee of future results, history demonstrates that an aggressive investing style coupled with a well-diversified portfolio, combined with the patience to follow through on a long-term strategy, can be very rewarding in the long run. Contrarian Investing Style A contrarian investor’s approach is to flout conventional wisdom. Contrarians buy investments that are currently out of favor with the market and avoid investments that are currently popular. But contrarians aren’t just trying to be different—there is a method to their being contrary. Specifically, they believe that stocks that are undervalued by the market may be poised for a rebound, while stocks that are currently popular may be overvalued, have already peaked, or may not be able to meet investor expectations. A contrarian strategy isn’t for everyone. You need experience and the willingness to do lots of research to be able to discriminate between companies that may be undervalued and those that are simply performing poorly. You also need patience, since it can take time before a stock makes a turnaround. Consistent with having a well-diversified portfolio, you may want to use this approach with only a portion of your portfolio—perhaps by choosing a mutual fund with a contrarian style.
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Guide to Asset Allocation, Diversification, and Rebalancing5 Lesson No. M2.5 Lesson Objectives After completing this lesson participants should be able to: Understand the concepts of asset allocation, diversification, and rebalancing Recognize the different allocations strategies Understand the relationship between different allocation strategies, financial goals, risk tolerance, and time horizon. Understand why and when to rebalance.
Time Required: 60 Minutes
Lesson Teaching Tips When teaching the concept of asset allocation, use the analogy of not putting all eggs into a single basket. Make sure the participants understand the concepts of time horizon and risk tolerance. Use the online asset allocation calculator available from the Iowa Public Employees Retirement System to illustrate the concepts (http://www.ipers.org/calcs/AssetAllocator.html ).
Questions to Generate Discussion Let’s assume that you have already defined your financial goals, can you describe your investment strategy and asset allocation?
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Beginners Guide to Asset Allocation, Diversification, and Rebalancing: U.S. Securities and Exchange Commission, http://www.sec.gov/investor/pubs/assetallocation.htm
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PowerPoint Slides Thumbnails
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Slide Notes Define what is asset allocation. Define time horizon and risk tolerance and their relationship with your asset allocation strategy.
Discuss the definition. Provide examples: time horizon for retirement (when you plan on retiring and when have you started to invest).
Define what risk tolerance is. Make sure participants understand that as your tie to reach your financial goal gets closer your risk tolerance goes lower; i.e retirement.
This slide presents the relationship between allocations and market risk (fluctuation).
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| The ASPIRA Association To better illustrate the concept of asset allocation, use the analogy of the egg basket.
Make sure participants understand which are the major asset categories: stocks, bonds, and cash; and what are subcategories such as midcap, U.S. Bonds, Municipal Bonds, etc.
At this point, briefly introduce the buy-andhold strategy, which will be discussed in the following lesson.
The following three slides present three different allocation strategies based on the investor’s risk tolerance. This strategy is suitable for somebody close to retirement that does not need to risk his/her funds.
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If your risk tolerance is high and have a long time horizon, this could be an appropriate investment allocation strategy.
Rebalancing takes your allocations to a “comfortable level of risk”; whatever is based on your financial goals and time horizon.
Rebalancing should be done periodically (i.e. annually) or when there is a major market event having a major impact on one of your assets.
Closure: Review lesson objectives with participants. Indicate to participants that determining their asset allocation might be the most important decision in regards to their investments.
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Learning Assessment: Ask participants to rewrite their definition of investing.
Reference Materials Asset Allocation – Wikipedia: http://en.wikipedia.org/wiki/Asset_allocation
Even if you are new to investing, you may already know some of the most fundamental principles of sound investing. How did you learn them? Through ordinary, real-life experiences that have nothing to do with the stock market. For example, have you ever noticed that street vendors often sell seemingly unrelated products - such as umbrellas and sunglasses? Initially, that may seem odd. After all, when would a person buy both items at the same time? Probably never - and that's the point. Street vendors know that when it's raining, it's easier to sell umbrellas but harder to sell sunglasses. And when it's sunny, the reverse is true. By selling both items - in other words, by diversifying the product line - the vendor can reduce the risk of losing money on any given day. If that makes sense, you've got a great start on understanding asset allocation and diversification. This section will cover those topics more fully and will also discuss the importance of rebalancing from time to time. Let's begin by looking at asset allocation. Asset Allocation 101 Asset allocation involves dividing an investment portfolio among different asset categories, such as stocks, bonds, and cash. The process of determining which mix of assets to hold in your portfolio is a very personal one. The asset allocation that works best for you at any given point in your life will depend largely on your time horizon and your ability to tolerate risk. Time Horizon - Your time horizon is the expected number of months, years, or decades you will be investing to achieve a particular financial
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goal. An investor with a longer time horizon may feel more comfortable taking on a riskier, or more volatile, investment because he or she can wait out slow economic cycles and the inevitable ups and downs of our markets. By contrast, an investor saving up for a teenager's college education would likely take on less risk because he or she has a shorter time horizon. Risk Tolerance - Risk tolerance is your ability and willingness to lose some or all of your original investment in exchange for greater potential returns. An aggressive investor, or one with a high-risk tolerance, is more likely to risk losing money in order to get better results. A conservative investor, or one with a low-risk tolerance, tends to favor investments that will preserve his or her original investment. In the words of the famous saying, conservative investors keep a "bird in the hand," while aggressive investors seek "two in the bush."
Why Asset Allocation Is So Important By including asset categories with investment returns that move up and down under different market conditions within a portfolio, an investor can protect against significant losses. Historically, the returns of the three major asset categories have not moved up and down at the same time. Market conditions that cause one asset category to do well often cause another asset category to have average or poor returns. By investing in more than one asset category, you'll reduce the risk that you'll lose money and your portfolio's overall investment returns will have a smoother ride. If one asset category's investment return falls, you'll be in a position to counteract your losses in that asset category with better investment returns in another asset category.
The Magic of Diversification. The practice of spreading money among different investments to reduce risk is known as diversification. By picking the right group of investments, you may be able to limit your losses and reduce the fluctuations of investment returns without sacrificing too much potential gain.
In addition, asset allocation is important because it has major impact on whether you will meet your financial goal. If you don't include enough risk in your portfolio, your investments may not earn a large enough return to meet your goal. For example, if you are saving for a long-term goal, such as retirement or college, most financial experts agree that you will likely need to include at least some stock or stock mutual funds in your portfolio. On the other hand, if you include too much risk in your portfolio, the money for your goal may not be there when you need it. A portfolio heavily weighted in stock or stock mutual funds, for instance,
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would be inappropriate for a short-term goal, such as saving for a family's summer vacation. How to Get Started Determining the appropriate asset allocation model for a financial goal is a complicated task. Basically, you're trying to pick a mix of assets that has the highest probability of meeting your goal at a level of risk which with you can live. As you get closer to meeting your goal, you'll need to be able to adjust the mix of assets. If you understand your time horizon and risk tolerance - and have some investing experience - you may feel comfortable creating your own asset allocation model. "How to" books on investing often discuss general "rules of thumb," and various online resources can help you with your decision. For example, although we cannot endorse any particular formula or methodology, the Iowa Public Employees Retirement System offers an online asset allocation calculator. In the end, you'll be making a very personal choice. There is no single asset allocation model that is right for every financial goal. You'll need to use the one that is right for you.
Some financial experts believe that determining your asset allocation is the most important decision that you'll make with respect to your investments - which it's even more important than the individual investments you buy. With that in mind, you may want to consider asking a financial professional to help you determine
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your initial asset allocation and suggest adjustments for the future. But before you hire anyone to help you with these enormously important decisions, be sure to do a thorough check of his or her credentials and disciplinary history. The Connection between Asset Allocation and Diversification Diversification is a strategy that can be neatly summed up by the timeless adage "Don't put all your eggs in one basket." The strategy involves spreading your money among various investments in the hope that if one investment loses money, the other investments will more than make up for those losses. Many investors use asset allocation as a way to diversify their investments among asset categories. But other investors deliberately do not. For example, investing entirely in stock, in the case of a twenty-five year-old investing for retirement, or investing entirely in cash equivalents, in the case of a family saving for the down payment on a house, might be reasonable asset allocation strategies under certain circumstances. But neither strategy attempts to reduce risk by holding different types of asset categories. So choosing an asset allocation model won't necessarily diversify your portfolio. Whether your portfolio is diversified will depend on how you spread the money in your portfolio among different types of investments. Diversification 101 A diversified portfolio should be diversified at two levels: between asset categories and within asset categories. So in addition to allocating your investments among stocks, bonds, cash equivalents, and possibly other asset categories, you'll also need to spread out your investments within each asset category. The key is to identify investments in segments of each asset category that may perform differently under different market conditions. One way of diversifying your investments within an asset category is to identify and invest in a wide range of companies and industry sectors. But the stock portion of your investment portfolio won't be diversified, for example, if you only invest in only four or five individual stocks. You'll need at least a dozen carefully selected individual stocks to be truly diversified. Because achieving diversification can be so challenging, some investors may find it easier to diversify within each asset category through the ownership of mutual funds rather than through individual investments from each asset category. A mutual fund is a company that pools money from many investors and invests the money in stocks, bonds, and other financial instruments. Mutual funds make it easy for investors to own a small portion of many investments. A total stock market index fund, for example, owns stock in thousands of companies. That's a lot of diversification for one investment!
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Be aware, however, that a mutual fund investment doesn't necessarily provide instant diversification, especially if the fund focuses on only one particular industry sector. If you invest in narrowly focused mutual funds, you may need to invest in more than one mutual fund to get the diversification you seek. Within asset categories, that may mean considering, for instance, large company stock funds as well as some small company and international stock funds. Between asset categories, that may mean considering stock funds, bond funds, and money market funds. Of course, as you add more investments to your portfolio, you'll likely pay additional fees and expenses, which will, in turn, lower your investment returns. So you'll need to consider these costs when deciding the best way to diversify your portfolio. Options for One-Stop Shopping - Lifecycle Funds To accommodate investors who prefer to use one investment to save for a particular investment goal, such as retirement, some mutual fund companies have begun offering a product known as a "lifecycle fund." A lifecycle fund is a diversified mutual fund that automatically shifts toward a more conservative mix of investments as it approaches a particular year in the future, known as its "target date." A lifecycle-fund investor picks a fund with the right target date based on his or her particular investment goal. The managers of the fund then make all decisions about asset allocation, diversification, and rebalancing. It's easy to identify a lifecycle fund because its name will likely refer to its target date. For example, you might see lifecycle funds with names like "Portfolio 2015," "Retirement Fund 2030," or "Target 2045."
Asset Allocation Strategies The beauty of balanced mutual funds is that they offer diversity across investment types. Asset allocation is the term used to describe diversification of investments among different types of ―asset classes.‖ This means dividing investments between such asset classes as stocks, bonds, and cash or ―cashequivalents,‖ meaning money market funds or bank accounts. This way, the portfolio contains some investments that are likely to earn interest with little risk (like bonds), and some investments that are more aggressive (like stocks). Many investors make sure that their asset allocation includes some cash or ―cashequivalents‖ such as bank accounts or money market funds so that they can have immediate access to them (in other words, they have high liquidity). And some investors further diversify into industry groups or into securities from foreign countries, for example. Asset allocation is an important part of your investment strategy, and you (and your advisor or broker) should think long and
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hard about how to allocate your assets to make sure they are aligned with your overall investment strategy and your life goals.
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Asset Allocation Examples As presented above, asset allocation means the diversification of investments. Remember don’t put all your eggs on the same basket. By diversifying your assets you minimize your risk, can provide for immediate access to cash (liquidity), and determine your growth rate (the fastest growth rate the higher the risk). The following graphics presents some examples of assets allocation strategies. Stocks, 25%
Capital Preservation
Conservative Investment
Asset Allocation
Cash, 50%
Stocks 25% Bonds 25% Bonds, 25%
Cash, 10%
Cash 50%
Income Growth Stocks, 50%
Asset Allocation Stocks 50% Bonds 40%
Bonds, 40%
Bonds, 10%
Cash 10%
Cash, 10%
Aggressive Growth Asset Allocation Stocks 50% Stocks, 80%
Bonds 40% Cash 10%
Aggressive investment
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Changing Your Asset Allocation The most common reason for changing your asset allocation is a change in your time horizon. In other words, as you get closer to your investment goal, you'll likely need to change your asset allocation. For example, most people investing for retirement hold less stock and more bonds and cash equivalents as they get closer to retirement age. You may also need to change your asset allocation if there is a change in your risk tolerance, financial situation, or the financial goal itself. But savvy investors typically do not change their asset allocation based on the relative performance of asset categories - for example, increasing the proportion of stocks in one's portfolio when the stock market is hot. Instead, that's when they "rebalance" their portfolios. Rebalancing 101 Rebalancing is bringing your portfolio back to your original asset allocation mix. This is necessary because over time some of your investments may become out of alignment with your investment goals. You'll find that some of your investments will grow faster than others. By rebalancing, you'll ensure that your portfolio does not overemphasize one or more asset categories, and you'll return your portfolio to a comfortable level of risk. For example, let's say you determined that stock investments should represent 60% of your portfolio. But after a recent stock market increase, stock investments represent 80% of your portfolio. You'll need to either sell some of your stock investments or purchase investments from an under-weighted asset category in order to reestablish your original asset allocation mix. When you rebalance, you'll also need to review the investments within each asset allocation category. If any of these investments are out of alignment with your investment goals, you'll need to make changes to bring them back to their original allocation within the asset category. There are basically three different ways you can rebalance your portfolio: 1. You can sell off investments from over-weighted asset categories and use the proceeds to purchase investments for under-weighted asset categories. 2. You can purchase new investments for under-weighted asset categories. 3. If you are making continuous contributions to the portfolio, you can alter your contributions so that more investments go to under-weighted asset categories until your portfolio is back into balance.
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Before you rebalance your portfolio, you should consider whether the method of rebalancing you decide to use will trigger transaction fees or tax consequences. Your financial professional or tax adviser can help you identify ways that you can minimize these potential costs. Stick with Your Plan: Buy Low, Sell High - Shifting money away from an asset category when it is doing well in favor of an asset category that is doing poorly may not be easy, but it can be a wise move. By cutting back on the current "winners" and adding more of the current so-called "losers," rebalancing forces you to buy low and sell high.
When to Consider Rebalancing You can rebalance your portfolio based either on the calendar or on your investments. Many financial experts recommend that investors rebalance their portfolios on a regular time interval, such as every six or twelve months. The advantage of this method is that the calendar is a reminder of when you should consider rebalancing. Others recommend rebalancing only when the relative weight of an asset class increases or decreases more than a certain percentage that you've identified in advance. The advantage of this method is that your investments tell you when to rebalance. In either case, rebalancing tends to work best when done on a relatively infrequent basis. Where to Find More Information For more information on investing wisely and avoiding costly mistakes, please visit the Investor Information section of the SEC's Web site. You also can learn more about several investment topics, including asset allocation, diversification and rebalancing in the context of saving for retirement by visiting FINRA's Smart 401(k) Investing Web site as well as the Department of Labor's Employee Benefits Security Administration Web site. You can find out more about your risk tolerance by completing free online questionnaires available on numerous Web sites maintained by investment publications, mutual fund companies, and other financial professionals. Some of the Web sites will even estimate asset allocations based on responses to the questionnaires. While the suggested asset allocations may be a useful starting point for determining an appropriate allocation for a particular goal, investors should keep in mind that the results may be biased toward financial products or services sold by companies or individuals maintaining the Web sites.
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Once you've started investing, you'll typically have access to online resources that can help you manage your portfolio. The Web sites of many mutual fund companies, for example, give customers the ability to run a "portfolio analysis" of their investments. The results of a portfolio analysis can help you analyze your asset allocation, determine whether your investments are diversified, and decide whether you need to rebalance your portfolio.
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The Long Term Perspective: Benefits of “Buy and Hold” Lesson No. M2.6 Lesson Objectives: After completing this lesson participants should be able to: Recognize the importance of time-on-market Understand the concept of time horizon
Time Required: 15 Minutes
Lesson Teaching Tips Make sure participants understand the concept of compound interest. Point out to the participants the time required to reach their financial goals.
Questions to Generate Discussion How long will it take you to reach your financial goals; What are the differences between day trading and a buy-andhold strategy? What are the pros and cons of buy-and-hold strategy vs. day trading?
PowerPoint Slides Thumbnails
Slide Notes Follow the bullets presented on the slide and promote discussion. Define what is day trading and market volatility.
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Closure: Review lesson objectives with participants.
Learning Assessment: Ask participants to summarize the advantages of a buy-andhold strategy vs. day trading.
Reference Materials Buy and Hold: Definition http://www.investorwords.com/637/buy_and_hold.html
Buy and hold is a long term investment strategy based on the concept that in the long run financial markets give a good rate of return despite periods of volatility or decline. This viewpoint also holds that market timing, i.e. the concept that one can enter the market on the lows and sell on the highs, does not work or does not work for small investors so it is better to simply buy and hold. The antithesis of buy and hold is the concept of day trading in which money can be made in the short term if an individual tries to short on the peaks, and buy on the lows with greater money coming with greater volatility. One of the strongest arguments for the buy and hold strategy is the efficient market hypothesis (EMH6): If every security is fairly valued at all times, then there is really no point to trade. Some take the buy and hold strategy to an extreme, advocating that you should never sell a security unless you need the money. Others have advocated buy and hold on purely cost-based grounds, without resort to the EMH. Costs such as brokerage and bid/offer spread are incurred on all transactions, and buy-and-hold involves the fewest transactions for a given amount invested in the market, all other things being equal. Warren Buffett is an example of a buy and hold advocate who has rejected the EMH in his writings. 6
In finance, the efficient market hypothesis (EMH) asserts that financial markets are "informationally efficient", or that prices on traded assets, e.g., stocks, bonds, or property, already reflect all known information and therefore are unbiased in the sense that they reflect the collective beliefs of all investors about future prospects.
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In unstable market environments, it is important to stick to a well-considered investment plan. There are substantial long-term benefits in buying securities and holding a diversified investment portfolio instead of trading stocks or mutual funds frequently. In fact, frequent trading can reduce your returns for many reasons, among them: First, you will be charge transaction fees each time you buy and sell. Second, the more you trade in an account, the sooner you will pay taxes on your gains and the higher your taxes will be. Third, it is virtually impossible to time the market. You don’t want to jump into a hot investment just in time to see it cool off.
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Additional Learning Resources Please visit the following online resources to learn more about the subjects presented on this module:
TIAA-CREF Investments Learning Center: Forms, planning tools, publications and educational information about investing. U.S. Securities Exchange Commission en español U.S. Securities Exchange Commission Beginners Guide to Asset Allocation, Diversification, and Rebalancing U.S. Securities Exchange Commission form for taking notes Building Native Communities: Investing for the Future. First Nations Development Institute
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Introduction We already learned that financial planning is nothing but defining your goals and identify the steps you must take to help make them a reality. What you first need to figure out... What are the steps you need to take to reach your goals? Is your wish to retire with a sound lump sum amount or do you want a steady monthly income. Is your son's education or daughters' marriage worrying you? The key is to figure out your goals and what will be needed financially to accomplish them. Why investing and not just save? You should invest so that your money grows and shields you against rising inflation. If prices rise by four per cent annually it would not be sufficient if your savings only give you a return of three per cent. It leaves you with a deficit of one per cent. The idea is that your rate of return on investments should be greater than the rate of inflation, leaving you with a nice surplus over a period of time. Whether your money is invested in stocks, bonds, mutual funds or certificates of deposit (CD), the end result is to create wealth for retirement, marriage, college fees, vacations, better standard of living or to just pass on the money to the next generation. Also, it's exciting to review your investment returns and to see how they are accumulating at a faster rate than your salary. This module will help you determine some of the first steps for reaching your financial goals through investing.
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Module Objectives After completing this module you should be able to: Recognize different investment options Understand the concept of yield Recognize what are investment risks Understand how to reduce risks Understand what is risk tolerance Recognize the different investment styles Understand the concepts of asset allocation, diversification and rebalancing Recognize different allocation strategies Understand the importance of time on the market Recognize the meaning of social responsible investments
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Recommended Time on Task by Lesson Lesson No.
M2.1 M2.2 M2.3 M2.4 M2.5 M2.6
Lesson Subject Introduction and Ice Breaker Investment Options Return What is Risk? Your Investing Style Asset Allocation, Diversification, and Rebalancing Buy and Hold
Suggested Module Instructional Duration:
Time Required 20 minutes 20 minutes 30 minutes 40 minutes 40 minutes 60 minutes 20minutes
3.5 hours
About This Manual This manual contains the same information provided in the instructional manual that the participants will have during the workshop. For each section we provide specific suggestions and resources selected to help you deliver the classroom instruction. These include teaching tips, questions to generate classroom discussion, and a module PowerPoint presentation. In addition every section or subject has additional reference materials which provide supplementary online instructional materials and resources. These were selected to provide the facilitator more information about the subject or materials which could be used to enhance the delivery of instruction.
Before the workshop session: Before conducting the workshop, take time to familiarize yourself with the participant manual, exercises, additional learning resources, teaching tips and questions to generate discussion and PowerPoint presentation. For classroom use it is highly recommended to secure a flip chart, color markers, projector, and laptop. Familiarize with setting up the equipment and with its operation.
At the workshop: Welcome the participants Ask participants to introduce themselves, and share what their expectations are for this program, and what they hope to get out of the seminar. Write these down on a flip chart as they share. (This activity will help participants get to know each other and feel more comfortable and give you an idea of what they are expecting from the session.)
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Review the objectives of the session and the agenda. If applicable, hand out materials to participants. Using the module PowerPoint presentation, review the module objetives:
Use this time to listen as well as to manage expectations as to what will be accomplished during the lesson. Let participants know that their specific personal situations may not be able to be addressed directly in the lesson but that the information should be valuable to them. Make sure to schedule breaks after 1.5 hours of instruction. Encourage participants to ask questions; try to create an interactive-participatory learning environment. If you do not have the answer to a question, be honest and say: ―I don’t know the answer but I will research it for you”. Bring the answer next day and explain where and how you found the answer. Do not ask personal questions to participants which could potentially disclose personal or confidential financial information. It is strongly recommended to always use hypothetical scenarios. Always use a flip chart to write down key concepts, at the end of the day review the key learning concepts.
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Table of Contents Introduction........................................................................................................................ 1 Module Objectives............................................................................................................. 2 Recommended Time on Task by Lesson ......................................................................... 3 About This Manual ............................................................................................................ 3 Key Terms ......................................................................................................................... 7 Investment Choices......................................................................................................... 10 Lesson No. M2.1 ......................................................................................................... 10 Return and Rate of Return .............................................................................................. 14 Lesson No. M2. 2 ........................................................................................................ 14 Return .......................................................................................................................... 16 Rate of Return.......................................................................................................... 17 Using Return ............................................................................................................ 17 Yield ............................................................................................................................. 18 What Is Risk? ................................................................................................................. 20 Lesson No. M2.3 ......................................................................................................... 20 Market Risk................................................................................................................. 23 Inflation Risk .............................................................................................................. 23 Liquidity Risk ............................................................................................................. 23 What Is the Best to Reduce Risks? ......................................................................... 24 Risk Tolerance ........................................................................................................... 24 Risk versus Reward..................................................................................................... 24 Exercise: “Assessing Your Risk Tolerance” – New York Institute of Finance Questionnaire ............................................................................................................ 25 Your Investing Style ...................................................................................................... 26 Lesson No. M2.4 ......................................................................................................... 26 Conservative Investing Style ....................................................................................... 29 The Risks of a No-Risk Portfolio ................................................................................. 29 When a Conservative Approach Makes Sense .......................................................... 29 Moderate Investing Style ............................................................................................. 30 Aggressive Investing Style .......................................................................................... 30 Contrarian Investing Style ........................................................................................... 31
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Guide to Asset Allocation, Diversification, and Rebalancing .......................................... 32 Lesson No. M2.5 ......................................................................................................... 32 Asset Allocation 101 .................................................................................................... 36 Why Asset Allocation Is So Important ......................................................................... 37 How to Get Started ...................................................................................................... 38 The Connection between Asset Allocation and Diversification ................................... 39 Diversification 101 ....................................................................................................... 39 Asset Allocation Strategies .................................................................................. 40 Changing Your Asset Allocation .................................................................................. 43 Rebalancing 101.......................................................................................................... 43 When to Consider Rebalancing................................................................................... 44 Where to Find More Information.................................................................................. 44 The Long Term Perspective: Benefits of “Buy and Hold”........................................ 46 Lesson No. M2.6 ......................................................................................................... 46 Additional Learning Resources ................................................................................... 49
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Key Terms 401(k):
The 401(k) plan is a type of retirement plan available in the United States. Named after a section of the 1978 Internal Revenue Code, a 401(k) is an employer-sponsored qualified retirement savings plan. It allows you to save for your retirement while deferring any immediate income taxes on the money you save or their respective earnings until withdrawn.
APY:
Stands for annual percentage yield or compound interest.
Asset:
Items of value owned by an individual. Assets that can be quickly converted into cash are considered "liquid assets." These include bank accounts, stocks, bonds, mutual funds, and so on. Other assets include real estate, personal property, and debts owed to an individual by others.
Asset Allocation: Apportioning of investment funds in categories of assets, such as Cash Equivalents, Stock, Fixed-Income Investments, and such tangible assets as real estate and precious metals. Also applies to subcategories such as government, municipal, and corporate bonds. Asset allocation affects both risk and return and is a central concept in personal financial planning and investment management. Bonds:
A certificate that is evidence of a debt on which the issuer promises to pay the holder a specified amount of interest for a specified length of time, and to repay the loan on its maturity. Strictly speaking, assets are pledged as security for the loan, except in the case of government bonds, but the term is often loosely used to describe any debt issue. Bonds are issued by corporations and by federal, provincial, and municipal governments.
Diversification:
An investment strategy that can reduce market risk by combining a variety of investments, such as stocks and bonds, which are unlikely to all move in the same direction at the same time.
Dividends:
Dividends are generally payments made to owners of a company. These payments can be in the form of cash or the issuance of additional stock. Dividends are generally used
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as a way to allow the owners to participate in the profits generated by the company. Fixed Investments: A security or investment account that pays a fixed rate of return. Interest:
Is the amount that is agreed to be paid in return for the use of a certain amount of money (principal). Interest is usually expressed as a percentage of the principal. For example, the bank may give you 2% interest on your principal of $100. Over the course of a year, you will earn $2 in interest on your $100 deposit (that is, if you leave the $100 in the savings account all year).
Market:
Refers to people coming together to buy and sell investments such as stocks and bonds, which we will discuss later.
Mutual Funds:
Typically consist of a group of stocks, bonds, or moneymarket securities from more than one source. There are three types—income funds (for people who need money to live on); growth funds (pay low dividends or none—works best for investors who can leave money in the fund so it can grow over a long period of time); and balanced funds (combination of stocks and bonds).
Principal:
Is the amount of money you invest to make money. For example, if you deposit $100 in a savings account in the bank, that deposit is your principal.
Rebalancing:
Returning a portfolio to its asset allocation targets by buying and/or selling securities. Rebalancing forces an investor to "buy low and sell high," and is contrarian in nature.
Return:
The profit earned on an investment. The $2 you earned in interest on your $100 deposit is known as your return. Returns come from many investments—like stocks and mutual funds. But be aware that returns are not guaranteed. Returns can be negative if there is a loss.
Securities Exchange Commission: A government regulatory agency that oversees and enforces the securities laws of the United States, publishes rules and guidance for the securities industry, and provides investor education.
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Stock Market:
The set of institutions that facilitate the exchange of stocks between buyers and sellers. A stock market can be an actual place, but with the growth of electronic transactions a large fraction of stock market transactions are not centrally located in a particular location.
Term:
Refers to a period of time. You might take out a home mortgage on a 15-year term or on a 30-year term. (Note that this differs from ―terms,‖ which usually refers to the conditions set in a loan agreement.)
Time Horizon:
Time Horizon is the time span of your investment objectives. Your time horizon dictates the types of investments that are suitable for your portfolio. The shorter the time horizon, the less appropriate are equities or any other asset class with high return variations. Conversely, the longer the time horizon, the more an investor can afford a higher return variation and thus a higher allocation to equities.
Volatility:
Accepted by academics and financial planning practitioners as a representation of risk, expressed statistically as the standard deviation, which analyzes the fluctuation of returns of an investment around an average. Also volatility is defined as the tendency of a security or market to fluctuate in price.
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Investment Choices Lesson No. M2.1 Lesson Objectives: After completing this lesson participants should be able to: Recognize different investment options Recognize that each investment option carries different risk levels
Time Required: 30 Minutes
Lesson Teaching Tips This module is about investment options and diversification; from the very beginning always relate to the analogy of not putting all the eggs in one basket.
Questions to Generate Discussion What do we need to do in order to reach our financial goals? Which investment options do you know? Which are three major asset categories? What are the differences between them?
PowerPoint Slides Thumbnails
Slide Notes Remind participants of their financial goals, these investment options will help them define a strategy to reach their goals.
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Investments: Resources for Reaching the American Dream
| The ASPIRA Association Define what stocks are. What are the risks and rewards of investing in stocks?
Define what are bonds. What are the risks and rewards of investing in bonds? Define “volatility”to participants.
Ask participants if in order to reach their financial goals they will put all of their assets on “Cash” investments and why?
Closure: Review lesson objectives with participants. Each of the investment options carries a risk level. Please let participants know that the concept of risk will be discussed following this lesson.
Learning Assessment: Ask participants to list the various investment options.
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Reference Materials Investment Choices – SEC http://www.sec.gov/investor/pubs/investop.htm
While we cannot recommend any particular investment product, you should know that a vast array of investment products exists - including stocks and stock mutual funds, corporate and municipal bonds, bond mutual funds, lifecycle funds, exchange-traded funds, money market funds, and U.S. Treasury securities. For many financial goals, investing in a mix of stocks, bonds, and cash can be a good strategy. Let's take a closer look at the characteristics of the three major asset categories. Stocks – are a financial instrument that signifies an ownership position in a corporation. Stocks have historically had the greatest risk and highest returns among the three major asset categories. As an asset category, stocks are a portfolio's "heavy hitter," offering the greatest potential for growth. Stocks hit home runs, but also strike out. The volatility of stocks makes them a very risky investment in the short term. Large company stocks as a group, for example, have lost money on average about one out of every three years. And sometimes the losses have been quite dramatic. But investors that have been willing to ride out the volatile returns of stocks over long periods of time generally have been rewarded with strong positive returns. Bonds - are long-term promissory note in which the issuer agrees to pay the owner the amount of the face value on a future date and to pay interest at a specified rate at regular intervals. Bonds are generally less volatile than stocks but offer more modest returns. As a result, an investor approaching a financial goal might increase his or her bond holdings relative to his or her stock holdings because the reduced risk of holding more bonds would be attractive to the investor despite their lower potential for growth. You should keep in mind that certain categories of bonds offer high returns similar to stocks. But these bonds, known as high-yield or junk bonds, also carry higher risk. Cash - Cash and cash equivalents - such as savings deposits, certificates of deposit (CD), treasury bills, money market deposit accounts, and money market funds - are the safest investments, but offer the lowest
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return of the three major asset categories. The chances of losing money on an investment in this asset category are generally extremely low. The federal government guarantees many investments in cash equivalents. Investment losses in nonguaranteed cash equivalents do occur, but infrequently. The principal concern for investors investing in cash equivalents is inflation risk. This is the risk that inflation will outpace and erode investment returns over time. Stocks, bonds, and cash are the most common asset categories. These are the asset categories you would likely choose from when investing in a retirement savings program or a college savings plan. But other asset categories - including real estate, precious metals and other commodities, and private equity - also exist, and some investors may include these asset categories within a portfolio. Investments in these asset categories typically have category-specific risks. Before you make any investment, you should understand the risks of the investment and make sure the risks are appropriate for you.
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Return and Rate of Return Lesson No. M2.2 Lesson Objectives: After completing this lesson participants should be able to: Understand the concept of return of investment. Understand how to calculate return and yield.
Time Required: 30 Minutes
Lesson Teaching Tips Have available calculators or computers t perform examples.
Questions to Generate Discussion How do you know how much money you are making out of an investment; How do you know the yield of an investment?
PowerPoint Slides Thumbnails
Slide Notes Discuss with participants the concept of return.
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| The ASPIRA Association Make participants aware that total return is a measure of your profit or capital appreciation before taxes and commissions or fees.
The other factor that participants have to take into account in evaluating their return is the number of years they own the investment. There’s a big difference in realizing a return of 16.67% on an investment you own for just one year, or what’s called an annual return, and realizing the same return on an investment you own for five years. Define the concept; Discuss the example. Present the meaning of: coupon yield, current yield and yield to maturity.
Closure: Review lesson objectives with participants. Make sure participants will understand how to compare returns of different types of investments and the relationship with the investment time frame or maturity.
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Learning Assessment: Ask participants to define return of investment and yield.
Reference Materials Rate of Return: http://en.wikipedia.org/wiki/Return_on_investment
Return Investment return is what you get back on an investment you make1. Ideally, the return will be positive, your initial investment or principal will remain in intact, and you will end up with more than you invested. But because investing typically involves risk—especially if you invest in securities such as stocks, bonds, or mutual funds that invest in stocks and bonds—your returns can be negative, and you can wind up with less money than you initially invested. For example, let’s say you buy a stock for $30 a share and sell it for $35 a share. Your return is $5 a share minus any commission or other fees you paid when you bought and sold the stock. If the stock had paid a dividend of $1 per share while you owned it, your total return would be a gain of $6 a share before expenses. However, if you bought at $35 and sold at $30, you would have lost $5 on your investment, not counting expenses. If you earned a dividend of $1 per share, your actual loss would be reduced to $4 a share. Total return = Gain or loss in value + investment earnings Be aware that total return is a measure of your profit or capital appreciation before taxes and commissions or fees. When you evaluate your return on an investment, you should separately assess the impact of those costs. In the example above, if the commissions you paid both to buy and to sell the stock— plus any taxes you must pay on net capital gains—totaled more than $5, then you would have lost money. If you are investing in mutual funds, you will find both total annual returns and after-tax annual returns in the fee table in the
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Prepared for the FINRA Foundation by Lightbulb Press, Inc.; December 2007
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prospectus. Rate of Return Having determined the return on an investment, you will want to be able to compare that return to returns on other investments. The dollar amount by itself doesn’t tell you the whole story. To see why, compare a return of $5 per share on a $30 investment with a return of $5 per share on a $60 investment. In both cases, your dollar return is the same. But your rate of return, which you figure by dividing the gain by the amount you invest, is different. In this comparison, the rate of return, also called the percent return, on the $30 investment is 16.67% ($5 ÷ $30 = 16.666) while the rate of return on the $60 investment is 8.33% ($5 ÷ $60 = 8.333)—just half. Rate of return = Total return ÷ investment amount You can evaluate the return on savings accounts, bonds, mutual funds, and the entire range of investment alternatives in much the same way. The more you invest to get the same dollar return, the smaller your rate of return will actually be. The other factor that you have to take into account in evaluating your return is the number of years you own the investment. There’s a big difference in realizing a return of 16.67% on an investment you own for just one year, or what’s called an annual return, and realizing the same return on an investment you own for five years. In this case, after dividing the percent return by the number of years, the annualized return would be only 3.33%, which you figure by dividing the percent return by the number of years you held the investment. Annualized return = Percent return ÷ number of years Using Return Return can be a useful tool in evaluating whether the investments you own are performing in the way you expect, especially when you compare their return to that of similar investments or an appropriate benchmark, such as a market index that tracks the return of a group of similar investments2. Specifically, you might compare the annual percent return on a large company stock or the return on a large-company stock fund to the annual return of the Standard & Poor’s 500 Index (S&P 500). You can also use historical returns to compare the average annual return over 2
Prepared for the FINRA Foundation by Lightbulb Press, Inc.; December 2007
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time of different categories of investments, known as asset classes. In the context of investing, the most common asset classes include stocks (equities), bonds (fixed-income securities), and cash or cash equivalents. The research firms that track historical returns have found that, both over the past century and during shorter 10-year cycles, stock has had the strongest return among the major asset classes, bonds the next strongest, and cash equivalents the most stable but the lowest. While the annual return for any asset class, or mutual fund investing in that asset class, may surpass its historical average in a given year or series of years, the return may underperform the average as well. There’s always a risk in assuming that your return on an investment will be substantially higher than the average return on that investment over time. In fact, there’s no guarantee that it won’t be lower. Yield The yield on an investment is the amount of money you collect in interest or dividends, calculated as a percentage of either the current price of the investment or the price you paid to buy it. For example, if a stock pays annual dividends of $1 per share when the price is $35, the current yield is 2.9% ($1 ÷ $35 = 0.02857). However, if you bought the stock for $25, and used that number as the basis of your yield, that same $1 dividend would be 4% ($1 ÷ $25 = 0.04). While yield is just one of the factors you typically use to evaluate stock performance, it figures much more prominently in evaluating bonds and other interest-paying investments where current income is often of primary importance. In fact, with fixed-income investments yield is measured in different ways depending on what you want to know about the income you’re receiving: Coupon yield, for example, is the income a bond is paying as a percentage of the bond’s par value, usually $1,000. It’s always the same as the bond’s interest rate. So a bond that pays 4.5%, or $45 annually, has a coupon yield of 4.5%. Current yield, however, is the income a bond pays as a percentage of its current price, which may be more or less than $1,000. For example, if a bond’s coupon yield is 4.5% but the bond’s market value is $1,050, its current yield is 4.29% ($45 ÷ $1050). In contrast, if its market price is $950, its current yield is 4.74% ($45 ÷ $950). Yield to maturity is calculated using a more complex formula. It accounts for the bond’s future earnings until its maturity date, the amount you’ll gain or lose when par value is repaid, and what you would earn by reinvesting the interest you’re paid at the same rate during the bond’s remaining term.
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Investments: Resources for Reaching the American Dream
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What Is Risk? Lesson No. M2.3 Lesson Objectives: After completing this lesson participants should be able to: Understand the financial concept of “risk” Recognize three types of risks Recognize the best strategy to reduce risk Understand what level of risk tolerance is
Time Required: 40 Minutes
Lesson Teaching Tips Use the analogy of reaching our financial goals as a journey: in order to reach our destination, we have several ways to travel, some faster and some slower with different chances of reaching the desired location.
Questions to Generate Discussion Who can define “risk”? What types of risks do we take in our lifetime? What is the relationship between reaching your financial goals and investment risks?
PowerPoint Slides Thumbnails
Slide Notes Follow the slide bullets and promote discussion. After this slide, you can ask students to complete the New York Institute of Finance questionnaire on risk tolerance.
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| The ASPIRA Association Use this slide to introduce three types risks.
Define market risks and provide examples. Examples include actual or anticipated developments within a particular company or industry; changes in the outlook for the economy as a whole; or shifts in investor attitude toward the stock market in general. Define market risks and provide examples. Historically, inflation in the United States has averaged 3.1%, offsetting most of the returns from investment in cash reserves and bonds, but less than half of that of stocks. Because stocks' real returns are often generally higher than inflation, stocks offer a way to help protect your money against inflation risk. Define market risks and provide examples. Currency risk is the risk associated with the price fluctuations in the dollar value of international stocks due to changing currency exchange rates.
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| The ASPIRA Association Use the analogy of the egg basket to explain this concept.
Along with this concept you must ask participants to consider how much time they have in order to reach their goal and how much risk they are willing to take.
Discuss the definition of “time horizon.”
Closure: Review lesson objectives with participants. Summarize by presenting again two adages: “don’t put all the eggs on one basket” and “no pain, no gain.” The answers are to start investing as early and as much as you can, to diversify, and to take calculated risks.
Learning Assessment: Ask participants to briefly define risk.
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Reference Materials Investments Risks – Florida State University http://learningforlife.fsu.edu/course/fp101/InvestmentsRisk.htm
Throughout our life’s almost everything we do has some risk attached to it. Risk can be defined as the chance or possibility of loss. In financial terms, it is defined as the degree of uncertainty regarding the rate of return on and/or the principal value of an investment. Part of becoming a good investor is understanding the types of risks you will face. On the other hand, you will need to know how much financial risk you can afford in order to reach your goals. There are three types of risks you need to become aware of: Market Risk Market risk is the risk that the value of your investment will decrease due to moves in market factors. The four standard market risk factors include: 1) Equity risk or the risk that stock prices will change. 2) Interest rate risk or the risk that interest rates will change. 3) Currency risk or the risk that foreign exchange rates will change. 4) Commodity risk or the risk that commodity prices (i.e. grains, metals, etc.) will change. Inflation Risk Inflation risk is the risk that the interest you're earning may fall below the inflation rate. When this happens, you are actually losing purchasing power. Say you are earning 4% interest but inflation is at 5% per year. Even though you have more dollars each year, you are actually losing value since you won't be able to purchase as much in the future. This is the effect of inflation. Liquidity Risk Liquidity risk is defined as the ease with which an investor can convert an investment to cash without negative impact on either capital or return. For example, you might have an asset (investment) that nobody wants to purchase, or you might have $4,000 invested on a 48-month CD (Certificate of Deposit) and you need the money immediately, but you can’t take the money out before its due date or you might face a penalty and lose money.
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What Is the Best to Reduce Risks? The best way to reduce risks is by diversifying your investments. Simply stated, don’t put all of your eggs into one basket. Diversification can be defined as: an investment strategy that can reduce market risk by combining a variety of investments, such as stocks and bonds, which are unlikely to all move in the same direction at the same time. We will discuss diversification and asset allocations in detail in the following section.
Risk Tolerance When dealing with investments and risk there is a simple rule of thumb: higher risk investments potentially produce higher returns. Your goal should always be to improve your returns (earnings) without taking on too much risk. This requires understanding your ―risk tolerance.‖ This could be defined as an investor's ability to withstand losses caused by one or more of the different types of risk. This ability can be limited by your temperament as well as your time frame and financial circumstances. For example, someone who is investing for a goal 10 to 20 years or more in the future generally has a higher risk tolerance and may feel more comfortable with riskier investments than a person whose investment goal is only 5 years away or less. Risk versus Reward When it comes to investing, risk and reward are inextricably entwined. You've probably heard the phrase "no pain, no gain" - those words come close to summing up the relationship between risk and reward. Don't let anyone tell you otherwise; all investments involve some degree of risk. If you intend to purchases securities - such as stocks, bonds, or mutual funds - it's important that you understand before you invest that you could lose some or all of your money.
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The reward for taking on risk is the potential for a greater investment return. If you have a financial goal with a long time horizon, you are likely to make more money by carefully investing in asset categories with greater risk, like stocks or bonds, rather than restricting your investments to assets with less risk, like cash equivalents. On the other hand, investing solely in cash investments may be appropriate for short-term financial goals. Exercise: “Assessing Your Risk Tolerance” – New York Institute of Finance Questionnaire
The New York Institute of Finance has developed a questionnaire to help you assess your risk tolerance. This questionnaire is available online at http://www.icief.org/risk/risk_quiz.html from the Investment Company Institute Education Foundation3. On this online questionnaire select what seems to be the most appropriate response for each question. In most cases, there are no right or wrong answers. To get an accurate score, you must answer each question. When you are finished, click on Calculate Score to see your total. You can then interpret your risk tolerance based on the information that follows.
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Investment Company Institute Education Foundation: From How Mutual Funds Work, Second Edition, by Albert J. Fredman and Russ Wiley. Copyright © 1998.Published by the New York Institute of Finance. Reprinted with permission of Prentice Hall Direct.
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Your Investing Style Lesson No. M2.4 Lesson Objectives: After completing this lesson participants should be able to: Understand the different types of investment styles Recognize the relationship between risk tolerance and financial goals with the various types of investment styles Recognize the implications of the different investment styles related to reaching financial goals.
Time Required: 40 Minutes
Lesson Teaching Tips Review the concepts of financial goals and risk tolerance.
Questions to Generate Discussion What are your financial goals? What is your risk tolerance? How these two elements will shape your investment strategies?
PowerPoint Slides Thumbnails
Slide Notes Follow the slide bullets and promote discussion. Ask participants about their financial goals and risk tolerance and how these two elements could shape their investment style.
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| The ASPIRA Association Discuss with participants the profile of this type of investor. List the types of investments typical of this style.
Discuss the risks associated with the conservative investment style. Review the definition of inflation.
Discuss with participants the profile of this type of investor. List the types of investments typical of this style.
Discuss with participants the profile of this type of investor. List the types of investments typical of this style. Discuss the risks associated with this investment style.
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Investments: Resources for Reaching the American Dream
| The ASPIRA Association Discuss with participants the profile of this type of investor. List the types of investments typical of this style. Discuss the skills needed to engage in this investment style.
Closure: Review lesson objectives with participants. Summarize by the topic by indicating that their (participants) investment style will be related to their personal financial goals and risk tolerance.
Learning Assessment: As potential first time investors, and taking into consideration participants financial goals and risk tolerance ask participants: what type of investing style they initially plan to adopt?
Reference Materials Finding Your Investment Style http://www.metlife.com/Applications/Corporate/WPS/CDA/Page Generator/0,4132,P2013,00.html
How you decide to allocate your assets—whether you choose a conservative, moderate, or aggressive allocation mix based on your tolerance for risk—is sometimes called your investing style, or profile.4 Your investing style reflects your personality, but it is also influenced by other factors like your age, financial circumstances, investment goals, and experience. For example, if you are approaching retirement or have lived through a period of major economic upheaval, such as a recession, you may be inclined to invest 4
Prepared for the FINRA Foundation by Lightbulb Press, Inc.; December 2007
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more conservatively. That might also be the case if you run a small business or are the sole provider for your family. On the other hand if you’re still early in your career, have few financial responsibilities, or own substantial assets, you may be willing to take more risk in your portfolio because you don’t need all of your current assets to meet your financial obligations.
Conservative Investing Style Conservative investors make capital preservation, or safeguarding the assets they already have, their priority. Because they normally aren’t willing to put any of their principal at risk, conservative investors usually have to settle for modest returns. The portfolios of conservative investors are typically heavily allocated in bonds, such as U.S. Treasury bills, notes, and bonds, highly rated municipal bonds, and insured investments, such as certificates of deposit (CDs) and money market accounts. While conservative investors tend to avoid stock because of its volatility, they may allocate a small portion of their portfolios to large-company stocks, which sometimes pay dividends and tend to be more stable in price than other types of stock.
The Risks of a No-Risk Portfolio As counterintuitive as it may sound, avoiding risk altogether can make conservative investors vulnerable to other types of risk—notably inflation risk. If you invest so conservatively that your invested assets barely keep pace with the rate of inflation (which has averaged 3% annually since 1926 but can sometimes spike higher), then your invested assets may barely be growing at all in terms of real buying power. If you’re also paying taxes on those assets, then they may in fact be shrinking compared to inflation. That’s why a conservative investment strategy can make it difficult to meet long-term investment goals, such as a comfortable retirement.
When a Conservative Approach Makes Sense There are some circumstances, however, when a conservative approach to investing may be appropriate. If you’re investing to meet shorter-term goals—for instance, you plan to make a down payment on a house in the next two or three years—then you may not want to put those assets at risk by investing in volatile securities, since your portfolio may not have time to recover if there’s a market
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downturn. Similarly, if you have substantial amounts of money invested in your own business or have other major financial responsibilities, you may be more comfortable taking a more conservative approach with your investment portfolio.
Moderate Investing Style Moderate investors seek a middle course between protecting the assets they already have and achieving long-term growth. They strive to offset the volatility of growth investments, like stocks and stock funds, by allocating a portion of their portfolios to stable, income-producing investments, such as highly rated bonds. While moderate investors may favor large-company domestic and international stocks, they may also diversify their portfolios by investing in some more volatile small-company or emerging-market stocks, to take advantage of the potential for higher returns. There is no hard and fast rule about exactly what mix of assets is appropriate for someone striving to achieve a moderate asset mix, since that mix depends to some extent on individual circumstances and tolerance for risk. For instance, a portfolio that is invested 35% in large cap domestic stocks, 15% in smallcompany and international securities, and 50% in bonds, might be considered very moderate—even conservative—for someone with 30 or 40 years until retirement. However, this same asset mix would carry more risk for someone with only a few years until he or she retires. If you’re not a risk taker by nature, a moderate investing approach may make sense in almost all circumstances. In broadest terms, a moderate approach means finding the mix of assets that gives you both the potential for long-term growth yet adequate protection for your assets given your age and financial circumstances.
Aggressive Investing Style Aggressive investors focus on investments that have the potential to offer significant growth, even if it means putting some of their principal at risk. That means they may allocate 75% to 95% of their portfolios in stock and stock mutual funds, including substantial holdings in more speculative investments, such as emerging market and small-company stock and stock funds. Aggressive investors with large portfolios may also allocate some of their assets to private equity funds, derivatives, direct investments, and other alternative investment products. Aggressive investors tend to keep only a percentage of their assets in cash and cash equivalents so they maximize their potential returns but have cash available when new investing opportunities arise.
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An aggressive approach is best suited to people with 15 years or more to invest to meet a financial goal, and who have adequate resources, so that they can absorb potential losses without jeopardizing their financial security. While past performance is no guarantee of future results, history demonstrates that an aggressive investing style coupled with a well-diversified portfolio, combined with the patience to follow through on a long-term strategy, can be very rewarding in the long run. Contrarian Investing Style A contrarian investor’s approach is to flout conventional wisdom. Contrarians buy investments that are currently out of favor with the market and avoid investments that are currently popular. But contrarians aren’t just trying to be different—there is a method to their being contrary. Specifically, they believe that stocks that are undervalued by the market may be poised for a rebound, while stocks that are currently popular may be overvalued, have already peaked, or may not be able to meet investor expectations. A contrarian strategy isn’t for everyone. You need experience and the willingness to do lots of research to be able to discriminate between companies that may be undervalued and those that are simply performing poorly. You also need patience, since it can take time before a stock makes a turnaround. Consistent with having a well-diversified portfolio, you may want to use this approach with only a portion of your portfolio—perhaps by choosing a mutual fund with a contrarian style.
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Guide to Asset Allocation, Diversification, and Rebalancing5 Lesson No. M2.5 Lesson Objectives After completing this lesson participants should be able to: Understand the concepts of asset allocation, diversification, and rebalancing Recognize the different allocations strategies Understand the relationship between different allocation strategies, financial goals, risk tolerance, and time horizon. Understand why and when to rebalance.
Time Required: 60 Minutes
Lesson Teaching Tips When teaching the concept of asset allocation, use the analogy of not putting all eggs into a single basket. Make sure the participants understand the concepts of time horizon and risk tolerance. Use the online asset allocation calculator available from the Iowa Public Employees Retirement System to illustrate the concepts (http://www.ipers.org/calcs/AssetAllocator.html ).
Questions to Generate Discussion Let’s assume that you have already defined your financial goals, can you describe your investment strategy and asset allocation?
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Beginners Guide to Asset Allocation, Diversification, and Rebalancing: U.S. Securities and Exchange Commission, http://www.sec.gov/investor/pubs/assetallocation.htm
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PowerPoint Slides Thumbnails
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Slide Notes Define what is asset allocation. Define time horizon and risk tolerance and their relationship with your asset allocation strategy.
Discuss the definition. Provide examples: time horizon for retirement (when you plan on retiring and when have you started to invest).
Define what risk tolerance is. Make sure participants understand that as your tie to reach your financial goal gets closer your risk tolerance goes lower; i.e retirement.
This slide presents the relationship between allocations and market risk (fluctuation).
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| The ASPIRA Association To better illustrate the concept of asset allocation, use the analogy of the egg basket.
Make sure participants understand which are the major asset categories: stocks, bonds, and cash; and what are subcategories such as midcap, U.S. Bonds, Municipal Bonds, etc.
At this point, briefly introduce the buy-andhold strategy, which will be discussed in the following lesson.
The following three slides present three different allocation strategies based on the investor’s risk tolerance. This strategy is suitable for somebody close to retirement that does not need to risk his/her funds.
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| The ASPIRA Association If you have an average risk tolerance and look forward to a long time horizon, this might be an adequate investment allocation strategy.
If your risk tolerance is high and have a long time horizon, this could be an appropriate investment allocation strategy.
Rebalancing takes your allocations to a “comfortable level of risk”; whatever is based on your financial goals and time horizon.
Rebalancing should be done periodically (i.e. annually) or when there is a major market event having a major impact on one of your assets.
Closure: Review lesson objectives with participants. Indicate to participants that determining their asset allocation might be the most important decision in regards to their investments.
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Learning Assessment: Ask participants to rewrite their definition of investing.
Reference Materials Asset Allocation – Wikipedia: http://en.wikipedia.org/wiki/Asset_allocation
Even if you are new to investing, you may already know some of the most fundamental principles of sound investing. How did you learn them? Through ordinary, real-life experiences that have nothing to do with the stock market. For example, have you ever noticed that street vendors often sell seemingly unrelated products - such as umbrellas and sunglasses? Initially, that may seem odd. After all, when would a person buy both items at the same time? Probably never - and that's the point. Street vendors know that when it's raining, it's easier to sell umbrellas but harder to sell sunglasses. And when it's sunny, the reverse is true. By selling both items - in other words, by diversifying the product line - the vendor can reduce the risk of losing money on any given day. If that makes sense, you've got a great start on understanding asset allocation and diversification. This section will cover those topics more fully and will also discuss the importance of rebalancing from time to time. Let's begin by looking at asset allocation. Asset Allocation 101 Asset allocation involves dividing an investment portfolio among different asset categories, such as stocks, bonds, and cash. The process of determining which mix of assets to hold in your portfolio is a very personal one. The asset allocation that works best for you at any given point in your life will depend largely on your time horizon and your ability to tolerate risk. Time Horizon - Your time horizon is the expected number of months, years, or decades you will be investing to achieve a particular financial
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goal. An investor with a longer time horizon may feel more comfortable taking on a riskier, or more volatile, investment because he or she can wait out slow economic cycles and the inevitable ups and downs of our markets. By contrast, an investor saving up for a teenager's college education would likely take on less risk because he or she has a shorter time horizon. Risk Tolerance - Risk tolerance is your ability and willingness to lose some or all of your original investment in exchange for greater potential returns. An aggressive investor, or one with a high-risk tolerance, is more likely to risk losing money in order to get better results. A conservative investor, or one with a low-risk tolerance, tends to favor investments that will preserve his or her original investment. In the words of the famous saying, conservative investors keep a "bird in the hand," while aggressive investors seek "two in the bush."
Why Asset Allocation Is So Important By including asset categories with investment returns that move up and down under different market conditions within a portfolio, an investor can protect against significant losses. Historically, the returns of the three major asset categories have not moved up and down at the same time. Market conditions that cause one asset category to do well often cause another asset category to have average or poor returns. By investing in more than one asset category, you'll reduce the risk that you'll lose money and your portfolio's overall investment returns will have a smoother ride. If one asset category's investment return falls, you'll be in a position to counteract your losses in that asset category with better investment returns in another asset category.
The Magic of Diversification. The practice of spreading money among different investments to reduce risk is known as diversification. By picking the right group of investments, you may be able to limit your losses and reduce the fluctuations of investment returns without sacrificing too much potential gain.
In addition, asset allocation is important because it has major impact on whether you will meet your financial goal. If you don't include enough risk in your portfolio, your investments may not earn a large enough return to meet your goal. For example, if you are saving for a long-term goal, such as retirement or college, most financial experts agree that you will likely need to include at least some stock or stock mutual funds in your portfolio. On the other hand, if you include too much risk in your portfolio, the money for your goal may not be there when you need it. A portfolio heavily weighted in stock or stock mutual funds, for instance,
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would be inappropriate for a short-term goal, such as saving for a family's summer vacation. How to Get Started Determining the appropriate asset allocation model for a financial goal is a complicated task. Basically, you're trying to pick a mix of assets that has the highest probability of meeting your goal at a level of risk which with you can live. As you get closer to meeting your goal, you'll need to be able to adjust the mix of assets. If you understand your time horizon and risk tolerance - and have some investing experience - you may feel comfortable creating your own asset allocation model. "How to" books on investing often discuss general "rules of thumb," and various online resources can help you with your decision. For example, although we cannot endorse any particular formula or methodology, the Iowa Public Employees Retirement System offers an online asset allocation calculator. In the end, you'll be making a very personal choice. There is no single asset allocation model that is right for every financial goal. You'll need to use the one that is right for you.
Some financial experts believe that determining your asset allocation is the most important decision that you'll make with respect to your investments - which it's even more important than the individual investments you buy. With that in mind, you may want to consider asking a financial professional to help you determine
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your initial asset allocation and suggest adjustments for the future. But before you hire anyone to help you with these enormously important decisions, be sure to do a thorough check of his or her credentials and disciplinary history. The Connection between Asset Allocation and Diversification Diversification is a strategy that can be neatly summed up by the timeless adage "Don't put all your eggs in one basket." The strategy involves spreading your money among various investments in the hope that if one investment loses money, the other investments will more than make up for those losses. Many investors use asset allocation as a way to diversify their investments among asset categories. But other investors deliberately do not. For example, investing entirely in stock, in the case of a twenty-five year-old investing for retirement, or investing entirely in cash equivalents, in the case of a family saving for the down payment on a house, might be reasonable asset allocation strategies under certain circumstances. But neither strategy attempts to reduce risk by holding different types of asset categories. So choosing an asset allocation model won't necessarily diversify your portfolio. Whether your portfolio is diversified will depend on how you spread the money in your portfolio among different types of investments. Diversification 101 A diversified portfolio should be diversified at two levels: between asset categories and within asset categories. So in addition to allocating your investments among stocks, bonds, cash equivalents, and possibly other asset categories, you'll also need to spread out your investments within each asset category. The key is to identify investments in segments of each asset category that may perform differently under different market conditions. One way of diversifying your investments within an asset category is to identify and invest in a wide range of companies and industry sectors. But the stock portion of your investment portfolio won't be diversified, for example, if you only invest in only four or five individual stocks. You'll need at least a dozen carefully selected individual stocks to be truly diversified. Because achieving diversification can be so challenging, some investors may find it easier to diversify within each asset category through the ownership of mutual funds rather than through individual investments from each asset category. A mutual fund is a company that pools money from many investors and invests the money in stocks, bonds, and other financial instruments. Mutual funds make it easy for investors to own a small portion of many investments. A total stock market index fund, for example, owns stock in thousands of companies. That's a lot of diversification for one investment!
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Be aware, however, that a mutual fund investment doesn't necessarily provide instant diversification, especially if the fund focuses on only one particular industry sector. If you invest in narrowly focused mutual funds, you may need to invest in more than one mutual fund to get the diversification you seek. Within asset categories, that may mean considering, for instance, large company stock funds as well as some small company and international stock funds. Between asset categories, that may mean considering stock funds, bond funds, and money market funds. Of course, as you add more investments to your portfolio, you'll likely pay additional fees and expenses, which will, in turn, lower your investment returns. So you'll need to consider these costs when deciding the best way to diversify your portfolio. Options for One-Stop Shopping - Lifecycle Funds To accommodate investors who prefer to use one investment to save for a particular investment goal, such as retirement, some mutual fund companies have begun offering a product known as a "lifecycle fund." A lifecycle fund is a diversified mutual fund that automatically shifts toward a more conservative mix of investments as it approaches a particular year in the future, known as its "target date." A lifecycle-fund investor picks a fund with the right target date based on his or her particular investment goal. The managers of the fund then make all decisions about asset allocation, diversification, and rebalancing. It's easy to identify a lifecycle fund because its name will likely refer to its target date. For example, you might see lifecycle funds with names like "Portfolio 2015," "Retirement Fund 2030," or "Target 2045."
Asset Allocation Strategies The beauty of balanced mutual funds is that they offer diversity across investment types. Asset allocation is the term used to describe diversification of investments among different types of ―asset classes.‖ This means dividing investments between such asset classes as stocks, bonds, and cash or ―cashequivalents,‖ meaning money market funds or bank accounts. This way, the portfolio contains some investments that are likely to earn interest with little risk (like bonds), and some investments that are more aggressive (like stocks). Many investors make sure that their asset allocation includes some cash or ―cashequivalents‖ such as bank accounts or money market funds so that they can have immediate access to them (in other words, they have high liquidity). And some investors further diversify into industry groups or into securities from foreign countries, for example. Asset allocation is an important part of your investment strategy, and you (and your advisor or broker) should think long and
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hard about how to allocate your assets to make sure they are aligned with your overall investment strategy and your life goals.
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Asset Allocation Examples As presented above, asset allocation means the diversification of investments. Remember don’t put all your eggs on the same basket. By diversifying your assets you minimize your risk, can provide for immediate access to cash (liquidity), and determine your growth rate (the fastest growth rate the higher the risk). The following graphics presents some examples of assets allocation strategies. Stocks, 25%
Capital Preservation
Conservative Investment
Asset Allocation
Cash, 50%
Stocks 25% Bonds 25% Bonds, 25%
Cash, 10%
Cash 50%
Income Growth Stocks, 50%
Asset Allocation Stocks 50% Bonds 40%
Bonds, 40%
Bonds, 10%
Cash 10%
Cash, 10%
Aggressive Growth Asset Allocation Stocks 50% Stocks, 80%
Bonds 40% Cash 10%
Aggressive investment
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Changing Your Asset Allocation The most common reason for changing your asset allocation is a change in your time horizon. In other words, as you get closer to your investment goal, you'll likely need to change your asset allocation. For example, most people investing for retirement hold less stock and more bonds and cash equivalents as they get closer to retirement age. You may also need to change your asset allocation if there is a change in your risk tolerance, financial situation, or the financial goal itself. But savvy investors typically do not change their asset allocation based on the relative performance of asset categories - for example, increasing the proportion of stocks in one's portfolio when the stock market is hot. Instead, that's when they "rebalance" their portfolios. Rebalancing 101 Rebalancing is bringing your portfolio back to your original asset allocation mix. This is necessary because over time some of your investments may become out of alignment with your investment goals. You'll find that some of your investments will grow faster than others. By rebalancing, you'll ensure that your portfolio does not overemphasize one or more asset categories, and you'll return your portfolio to a comfortable level of risk. For example, let's say you determined that stock investments should represent 60% of your portfolio. But after a recent stock market increase, stock investments represent 80% of your portfolio. You'll need to either sell some of your stock investments or purchase investments from an under-weighted asset category in order to reestablish your original asset allocation mix. When you rebalance, you'll also need to review the investments within each asset allocation category. If any of these investments are out of alignment with your investment goals, you'll need to make changes to bring them back to their original allocation within the asset category. There are basically three different ways you can rebalance your portfolio: 1. You can sell off investments from over-weighted asset categories and use the proceeds to purchase investments for under-weighted asset categories. 2. You can purchase new investments for under-weighted asset categories. 3. If you are making continuous contributions to the portfolio, you can alter your contributions so that more investments go to under-weighted asset categories until your portfolio is back into balance.
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Before you rebalance your portfolio, you should consider whether the method of rebalancing you decide to use will trigger transaction fees or tax consequences. Your financial professional or tax adviser can help you identify ways that you can minimize these potential costs. Stick with Your Plan: Buy Low, Sell High - Shifting money away from an asset category when it is doing well in favor of an asset category that is doing poorly may not be easy, but it can be a wise move. By cutting back on the current "winners" and adding more of the current so-called "losers," rebalancing forces you to buy low and sell high.
When to Consider Rebalancing You can rebalance your portfolio based either on the calendar or on your investments. Many financial experts recommend that investors rebalance their portfolios on a regular time interval, such as every six or twelve months. The advantage of this method is that the calendar is a reminder of when you should consider rebalancing. Others recommend rebalancing only when the relative weight of an asset class increases or decreases more than a certain percentage that you've identified in advance. The advantage of this method is that your investments tell you when to rebalance. In either case, rebalancing tends to work best when done on a relatively infrequent basis. Where to Find More Information For more information on investing wisely and avoiding costly mistakes, please visit the Investor Information section of the SEC's Web site. You also can learn more about several investment topics, including asset allocation, diversification and rebalancing in the context of saving for retirement by visiting FINRA's Smart 401(k) Investing Web site as well as the Department of Labor's Employee Benefits Security Administration Web site. You can find out more about your risk tolerance by completing free online questionnaires available on numerous Web sites maintained by investment publications, mutual fund companies, and other financial professionals. Some of the Web sites will even estimate asset allocations based on responses to the questionnaires. While the suggested asset allocations may be a useful starting point for determining an appropriate allocation for a particular goal, investors should keep in mind that the results may be biased toward financial products or services sold by companies or individuals maintaining the Web sites.
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Once you've started investing, you'll typically have access to online resources that can help you manage your portfolio. The Web sites of many mutual fund companies, for example, give customers the ability to run a "portfolio analysis" of their investments. The results of a portfolio analysis can help you analyze your asset allocation, determine whether your investments are diversified, and decide whether you need to rebalance your portfolio.
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The Long Term Perspective: Benefits of “Buy and Hold” Lesson No. M2.6 Lesson Objectives: After completing this lesson participants should be able to: Recognize the importance of time-on-market Understand the concept of time horizon
Time Required: 15 Minutes
Lesson Teaching Tips Make sure participants understand the concept of compound interest. Point out to the participants the time required to reach their financial goals.
Questions to Generate Discussion How long will it take you to reach your financial goals; What are the differences between day trading and a buy-andhold strategy? What are the pros and cons of buy-and-hold strategy vs. day trading?
PowerPoint Slides Thumbnails
Slide Notes Follow the bullets presented on the slide and promote discussion. Define what is day trading and market volatility.
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Closure: Review lesson objectives with participants.
Learning Assessment: Ask participants to summarize the advantages of a buy-andhold strategy vs. day trading.
Reference Materials Buy and Hold: Definition http://www.investorwords.com/637/buy_and_hold.html
Buy and hold is a long term investment strategy based on the concept that in the long run financial markets give a good rate of return despite periods of volatility or decline. This viewpoint also holds that market timing, i.e. the concept that one can enter the market on the lows and sell on the highs, does not work or does not work for small investors so it is better to simply buy and hold. The antithesis of buy and hold is the concept of day trading in which money can be made in the short term if an individual tries to short on the peaks, and buy on the lows with greater money coming with greater volatility. One of the strongest arguments for the buy and hold strategy is the efficient market hypothesis (EMH6): If every security is fairly valued at all times, then there is really no point to trade. Some take the buy and hold strategy to an extreme, advocating that you should never sell a security unless you need the money. Others have advocated buy and hold on purely cost-based grounds, without resort to the EMH. Costs such as brokerage and bid/offer spread are incurred on all transactions, and buy-and-hold involves the fewest transactions for a given amount invested in the market, all other things being equal. Warren Buffett is an example of a buy and hold advocate who has rejected the EMH in his writings. 6
In finance, the efficient market hypothesis (EMH) asserts that financial markets are "informationally efficient", or that prices on traded assets, e.g., stocks, bonds, or property, already reflect all known information and therefore are unbiased in the sense that they reflect the collective beliefs of all investors about future prospects.
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In unstable market environments, it is important to stick to a well-considered investment plan. There are substantial long-term benefits in buying securities and holding a diversified investment portfolio instead of trading stocks or mutual funds frequently. In fact, frequent trading can reduce your returns for many reasons, among them: First, you will be charge transaction fees each time you buy and sell. Second, the more you trade in an account, the sooner you will pay taxes on your gains and the higher your taxes will be. Third, it is virtually impossible to time the market. You don’t want to jump into a hot investment just in time to see it cool off.
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Additional Learning Resources Please visit the following online resources to learn more about the subjects presented on this module:
TIAA-CREF Investments Learning Center: Forms, planning tools, publications and educational information about investing. U.S. Securities Exchange Commission en español U.S. Securities Exchange Commission Beginners Guide to Asset Allocation, Diversification, and Rebalancing U.S. Securities Exchange Commission form for taking notes Building Native Communities: Investing for the Future. First Nations Development Institute
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