Investment Environment Chapter 1

Investment Overview

• Investment refers to any vehicle for placing funds with the expectation of positive income or increased value.
• Return on investment includes current income and appreciation in value.

Types of Investments

• Securities: Include stocks, bonds, and options.
• Real Property: Comprises land and buildings.
• Tangible Personal Property: Examples are gold, artwork, and antiques.
• Investment Ownership: Can be direct (personal claim) or indirect (interest in managed collections).
• Asset Types:
  • Debt securities (e.g., bonds) involve lending for interest.
  • Equity securities (e.g., stocks) signify ownership in a business.
  • Derivative securities derive value from underlying assets (e.g., options).
• Investment Risk: Defined as the likelihood of actual returns differing from expected returns.
• Investment Duration:
  • Short-term: Matures within one year.
  • Long-term: Matures beyond one year.
• Geographic Focus:
  • Domestic investments target U.S.-based entities.
  • Foreign investments focus on international firms.

Participants in the Investment Market

• Suppliers: Individuals typically supply funds; businesses and governments are usually net demanders.
• Types of Investors:
  • Individual Investors: Pursue personal financial goals (e.g., retirement).
  • Institutional Investors: Manage larger sums of money for entities like banks and pension funds.

Investment Steps

• Prerequisites: Ensure basic life needs are met and protection against risks (death, illness).
• Goal Setting: Include accumulating retirement funds, enhancing income, and major expenditures planning.
• Investment Plan: Create a plan detailing target dates and risk tolerance.
• Evaluation: Assess potential returns and risks of various investment vehicles.
• Selection: Conduct research and finalize investment choices.
• Diversification: Build a portfolio with varied investments to mitigate risk.
• Management: Regularly compare performance against expectations and adjust as needed.

Tax Considerations

• Effective tax planning targets after-tax returns, income types, and timing of profits/losses.
• Income Types:
  • Active Income: Earnings from work.
  • Portfolio Income: Returns from investments (interest, dividends, capital gains).
  • Passive Income: Earnings from special investments (rent, royalties).
• Capital Gains Tax:
  • Less than one year: Taxed at ordinary income rates.
  • More than one year: Lower rates (usually 15%).
• Capital Losses: Can offset capital gains and a portion can affect ordinary income.

Retirement Accounts

• Popular tax-advantaged retirement plans must be considered:
  • Employer-sponsored (401(k), profit-sharing)
  • Self-employed plans (Keogh, SEP-IRA)
  • Individual arrangements (traditional and Roth IRAs).

Investor Life Cycle

• Youth Stage (20s-30s): Focus on growth-oriented investments, favor capital gains over immediate income (e.g., stocks).
• Consolidation Stage (45-60): Shift towards lower-risk investments due to family obligations (e.g., high-grade bonds).
• Retirement Stage (60+): Emphasis on capital preservation and current income through conservative investments (e.g., government bonds).

Economic Conditions and Investment Strategy

• Understanding market timing: Analyzing economic states to predict market trends.
• Recognizing the three economic conditions:
  • Recovery: Rising corporate profits boost stocks.
  • Recession: General decline in stock values.
  • Transition: Shifts in economic direction impact investments.

Interest Rates and Bonds

• Interest rates significantly influence bond returns; they move inversely to bond prices.
• Rising interest rates decrease bond prices and vice versa.

Short-Term Investment Vehicles

• Key characteristics: High liquidity and low default risk.
• Primary purpose: Maintaining cash reserves or saving for goals.
• Drawbacks include lower returns and potential purchasing power loss due to inflation.