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Investing your Money
Students may begin to consider ways to earn interest on their money once they begin to bring in a regular income. You might be saying, “yeah, right” but now is the time for you to begin to think about your options. You might not have the funds directly out of school, but knowing what possibilities exist for investing might help you down the road as you become more settled in your career.
Popular options to earn some interest on your money can vary widely. You can earn money on savings accounts, CDs (Certificates of Deposit), money market funds, stocks, bonds and mutual funds. Along with investment comes risk, so do your homework.
Savings accounts
Savings Accounts earn only 1 to 2 percent, if you are interested in more long-term investment investigate your other options. However, longer-term investments assume that you have some money squirreled away. What savings accounts can do is help instill fiscal discipline. Employers can often directly deposit money into both your checking account and savings account. You don’t have as ready access to your money – it protects you from that spontaneous purchase or evening out, and it can help you create a nest egg for future investment.
Certificates of Deposit (CD’s)
CD’s have a set life span from 3 months to 10 years with a set interest rate. Unlike a savings account, your money must remain in the CD for the appointed amount of time or you suffer a penalty. The minimum deposit for a CD is typically around $1,000. All banks have some options to invest money into a CD, consult your bank for more information. Remember, if you need ready access to your money a CD will not be the option for you.
Money Market funds always pay higher interest rates than savings accounts, and in many cases may higher rates than CDs, although this has not been the recent trend. Most money market funds allow you to have access to your money, some even work like checking accounts. Check the internet for more information - the four biggest money market sites are Vanguard Group, Putman Investments, Fidelity and American Funds, note that banks do not offer money market accounts. Be mindful of fees related to managing the account, you don’t want the fees to exceed interest earned.
Stocks
The stock market can be a confusing and intimidating endeavor. Investing in stocks is riskier, requiring more careful planning, but historically stocks gain the most profit for investors. Investors must use caution, online trading options and the hope for getting rich quick cause many to take undue risks with the potential to lose their entire investment.
Below is unit four of eleven from a home study course developed by the Cooperative Extension at Rutgers for beginning investors with small dollar amounts. The course is geared toward first time investors. More information can be found at: www.investing.rutgers.edu.
Common Stocks
When a company wants to raise money, it offers investors a share of ownership in the company in the form of stock in exchange for that money. As a partial owner of the company, each investor shares in the success or failure of the business. There is no guarantee of return on the investment. Investors become part owners of a business and have no guarantee that they will receive any income for the use of their money or that they will get back any or all of their money in the future.
However, historically, common stocks have outperformed all other investments. According to the Chicago investment research firm Ibbotson Associates, the average annual return on U.S. large company stocks from 1926 to through 2001 was 10.7% versus 12.5% for small company stocks, 5.3% for long-term government bonds, and 3.8% for U.S. Treasury bills.
If the company makes money in a given time period, its board of directors may decide to reward its owners by distributing dividends or may choose to reinvest the money in the company. If you own a stock that pays dividends, you may have the option of reinvesting them in more stock instead of receiving a cash dividend. The dividends are still taxable but dividend reinvestment plans (also known as DRIPs) are an easy way to increase your investment holdings.
As owners of the business, stockholders elect directors who select the people who manage the company on a day-to-day basis. Depending upon the business and the way in which it is set up to operate, stockholders may have the opportunity to influence other decisions as well. Typically, this happens at an annual business meeting and stockholders can cast proxy votes if they are unable to attend the meeting in person.
There are many companies that offer stock investments. If you are interested in purchasing stock you should learn about the industry and the particular business in which you are considering investing. There are many ways to learn. Magazines such as Kiplinger’s and Money are one. Newspapers, especially those that focus on economic topics, like the Wall Street Journal, and those in large cities, such as the New York Times are good sources. Companies such as Value Line produce materials to specifically rate stocks. These are typically carried in the reference section of larger libraries.
The Internet is full of Web sites that offer information. Scrutinize each site to determine the source and note whether a person or business that may gain profit from the information provided produces written material. One place to look for such Web sites is in the money section of the site at http://www.consumerworld.org/. There, you will find a link to the American Association of Independent Investors at http://www.aaii.org/, as well as a link to a stock market simulation for learning about how the market works (http://library.advanced.org/103361).
By law, a company must provide a prospectus, which describes information such as its management and financial situation when it first issues stock. If you are interested in purchasing new stock in a company, you can request a prospectus. You may also find prospectuses on line at the Securities and Exchange Commission Web site (http://www.sec.gov). Some annual reports are available online from the Public Registers Annual Report Service at http://www.prars.com.
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Generally stocks are classified by category.
- Growth stocks are those of companies that are expected to increase in value. They may have high P/E (price to earnings) ratios. This means that the price of the stock is high compared to the forecasted earnings. A high ratio tends to indicate a more speculative situation. A low ratio tends to indicate a more conservative investment.
- Income stocks are expected to pay regular, relatively high (compared to other companies) dividends.
- Speculative stocks are those that have potential for the future. They generally do not pay much in dividends and their prices may be relatively volatile.
- Value stocks currently have relatively low prices compared to their historical earnings and the value of the company’s assets.
- Blue chip stocks are those of established companies with relatively stable stock prices and relatively predictable earnings. Since the end of World War II, dividends have accounted for about 40% of the stock market’s total return; price increases for the remaining 60%.
- Penny stocks are sold for $5 per share or less. They may be initial offerings with prices set intentionally low or stocks of companies that are experiencing difficult financial times. In either case, they are speculative stocks; if you invest in them, you should be prepared to lose all of your money.
It is important to consider your goals and your needs when you invest in stocks and to select ones that are most likely to match your situation.
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Investors use indexes to assess the general activity of the stock market. They are widely reported in newspapers, on television and radio, and via the Internet. The Dow Jones Industrial Average is the most widely followed gauge of daily market activity. It includes 30 stocks in well-established companies. Other indexes include the Standard & Poor’s 500 (which includes 400 industrial companies, 40 financial institutions, 40 public utilities, and 20 transportation firms), the New York Stock Exchange Composite (all stocks traded on the New York Stock Exchange), the American Stock Exchange Composite (stocks traded on the American Stock Exchange), and the NASDAQ Composite (newer stocks traded over-the-counter in the quotations system of the National Association of Securities Dealers).
Indexes also help show trends in market behavior. Investors use Beta as a measure of a stock’s price volatility–how much it changes. The average Beta for all stocks is +1. However, the Beta for an individual stock can be either positive or negative. The larger the Beta figure (e.g. +2 versus .50), the more speculative–and thus risky–a stock.
A "must read" for all equity investors is a company’s annual report. Along with other investor resources, such as Value Line and professional advisors, annual reports provide important clues to company performance. To obtain a company’s annual report, call its "shareholder relations" department or request a copy online from the company Web site.
The first part of a company’s annual report is the letter to shareholders. Here, company management explains significant changes in company operations (e.g., new products, decreased earnings) and in the report’s financial statements (balance sheet and income statement).
Like a personal net worth statement, the balance sheet in an annual report lists a company’s assets and liabilities (debts) at a particular time (usually the end of a company’s fiscal year). Assets are things owned by a company, such as product inventory and accounts receivable (money owed by customers). Liabilities are company obligations to pay for goods and services or to repay borrowed funds (e.g., interest and principal on company bonds). The name balance sheet reflects the fact that figures must "balance;" the value of a company’s assets must equal the sum of its liabilities and shareholder equity (the total value of all shareholders’ investments in a company).
Various financial ratios can be used to determine the financial health of a company. A common one is the current ratio, which is current (less than a year) assets divided by current liabilities. A 2:1 ratio ($2 of assets for every $1 of debt) is considered adequate. Another helpful ratio is the debt-to-equity ratio, a company’s total liabilities divided by shareholder equity. It should be less than 1:1.
Income statements in an annual report describe a company’s net income (or loss) per share. A common ratio used to analyze income statements is earnings per share: net income divided by the number of outstanding shares. Another is the price/earnings (P/E) ratio, which is calculated by dividing the share price by earnings per share (e.g., $24 per share and $2 earnings per share = P/E of 12).
Stocks can be bought and sold on one of the nine major exchanges. Newspapers typically report on the New York Stock Exchange and the American Stock Exchange. Newer or less frequently traded stocks are sold by telephone or computer hookup rather than at an exchange and are called Over the Counter.
Current information about stock prices and sales is available in most newspapers. An example of a newspaper report of the New York Stock Exchange is shown in Figure 2. As of April 2001, all stock prices are reported in decimals instead of fractions.
Figure 2 - NYSE
| 52-week |
|
Sales |
|
| High |
Low |
|
(000s) |
Last |
Chg |
| 96.13 |
48.38 |
AT&T |
12728 |
85.56 |
-2.44 |
| 51.25 |
22.94 |
Compaq |
21938 |
32.75 |
-1.63 |
| 8.50 |
3.44 |
Ethyl |
66 |
4.69 |
- .13 |
| 68.00 |
47.44 |
Litton |
53 |
56.94 |
+ .07 |
Terms used in Figure 2:
52-week High-Low–These numbers tell the highest and lowest prices at which the stock has sold in the last year. Prices are in dollars and decimals of dollars. For example, highest price the AT&T stock sold for in the last year was $96.13 and the lowest price was $48.38.
Abbreviation–Standard abbreviation of the stock’s name. For example, AT&T.
Sales (000s)–The number of shares traded yesterday. It is multiplied by 1,000. Thus, AT&T sold 12,728,000 shares the previous selling day.
Last–Price at closing yesterday. For AT&T it was $85.56 per share.
Chg–The difference in the closing price yesterday and the day before. The price today was $2.44 lower than yesterday’s.
Note: The nation's stock exchanges converted stock prices from fractions to decimals in 2001.
When stock is purchased or sold, a fee is generally charged. The cost will vary, depending on where the stock is purchased (e.g. discount broker, direct purchase, online). Comparison shop to determine available costs and services and to get the best deal.
Many investors use a specific strategy, dollar cost averaging, to invest in stocks. They regularly invest the same amount (e.g. $50) at regular intervals (e.g. monthly)–regardless of the price of the stock.
When investors use the buy and hold strategy, they purchase stocks and keep them for a number of years, not worrying about the changes in the market. Investors refer to times when prices are very low as a bear market and times when they are high as a bull market. The goal of successful equity investing is to buy when prices are low and sell when prices are high. You can learn more about strategies in Unit 2, Investment Basics.
Leech, Irene. “Investing for you Future: Unit 4: Ownership Investments.” Investing for your Future: a cooperative extension system basic investing home study course. 2005. http://www.investing.rutgers.edu/ (11 Jan. 2006)
Bond Market
Bonds can be a less risky investment for investors than stocks, and might interest new investors as they begin to make decisions about their risk tolerance. The following is excerpted from www.investinginbonds.com.
A bond is a debt security, similar to an I.O.U. When you purchase a bond, you are lending money to a government, municipality, corporation, federal agency or other entity known as the issuer. In return for the loan, the issuer promises to pay you a specified rate of interest during the life of the bond and to repay the face value of the bond (the principal) when it "matures," or comes due.
Among the types of bonds you can choose from are: U.S. government securities, municipal bonds, corporate bonds, mortgage and asset—backed securities, federal agency securities and foreign government bonds.
There are several ways to invest in bonds. You can buy individual bonds, bond funds or unit investment trusts. Make sure to consult with a financial planner as you consider this investment option. More information can be found at www.investinginbonds.com.
Bond Market Association. "Overview." www.investinginbonds.com. (11 Jan. 2006)
Mutual funds
Mutual funds are a popular option for investors interested in a diversified portfolio, but don’t have the time or knowledge to follow the market. Below is unit six of eleven from a home study course developed by the Cooperative Extension at Rutgers for beginning investors with small dollar amounts. The course is geared toward first time investors. More information can be found at: www.investing.rutgers.edu.
A mutual fund is a portfolio of stocks, bonds, or other securities that is collectively owned by hundreds or thousands of investors and managed by a professional investment company. The shareholders are people who have similar investment goals. Each fund has specific investment criteria, which are spelled out in its prospectus, the official booklet that describes the mutual fund. Investors then know what they are getting and can match their objective to that of a fund. The pooled money has more buying power than one investor alone, so that a fund can own hundreds of different securities. Thus, its success is not dependent on how just one or two companies perform.
A mutual fund makes money in several ways: by earning dividends or interest on the investments it owns and by selling securities that have appreciated in value. You, in turn, make money in the form of dividends and interest that are passed on to you and the increase (or decrease) in the fund's value. The mutual fund manager keeps constant watch on financial markets and adjusts the portfolio to achieve the strongest returns. By owning part of a fund, the hard work of selecting and monitoring stocks and bonds is done for you.
Investment Options for Growth objective include:
- Growth funds invest for the long term, and share prices can fluctuate considerably. They buy profitable, well-established companies that expect above-average earnings growth. Income is secondary, paying very small dividends, if any.
- Aggressive growth (also called maximum capital appreciation) funds use riskier investment techniques (e.g., options, short selling) and/or invest in stocks of smaller, less-proven companies. They can be very volatile, but the trade-off is a high potential for capital appreciation.
- Small capitalization funds invest in stocks of small companies with assets under $1 billion and are riskier than larger capitalization stock funds (over $5 billion in assets). (Capitalization means number of shares outstanding multiplied by the price per share.)
- Specialty or Sector funds limit investments to a specific industry (e.g., health care, biotechnology, financial services).
- International funds invest in securities of countries outside the United States.
- Global funds invest in securities worldwide including the U.S.
- Index funds invest in stocks of one of the major broadly based market indexes such as the S&P 500 (large companies), Russell 2000 (small companies) or Europe, Australia, Far East or EAFE (international). Generally, these are passively managed funds with low expenses (meaning there is no manager deciding when to buy or sell securities).
Mutual Fund with an income objective:
- Income funds usually include a combination of bonds and utility stocks to produce steady income and lower investment risk.
- Corporate bond funds are available in short-term, intermediate, or long-term maturities. They invest in investment-grade bonds (debt) of seasoned companies. Investment grade bonds have ratings of AAA, AA, A, or BBB by Moody's or Standard and Poor's.
- Municipal bond funds (short-, intermediate-, and long-term) invest in tax-exempt municipal issues of state and local governments. Investors generally seek them in the 28% and higher brackets.
- High-yield (junk) bond funds buy bonds with less than a BBB rating, thereby increasing risk to seek a higher return (not suitable for the risk-averse). See Unit 5.
- Government bond funds invest in safe government-backed securities (e.g., Treasury notes).
- Ginnie Mae (GNMA) funds hold securities backed by a pool of government-insured mortgages.
- Global bond funds invest in bonds of overseas companies.
Brennan, Patricia. "Investing for you Future: Unit 6: Mutual Fund Investing." Investing for your Future: a cooperative extension system basic investing home study course. 2005. http://www.investing.rutgers.edu/ (11 Jan. 2006)
To learn more about investing options you can consult with the following websites:
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