INVESTMENT PLANNING STRATEGIES

The planning strategies presented in this section represent some of the foundations of investment planning and management. The concepts covered are elementary.

Diversification

Diversification of the investor's portfolio is a defensive tactic, which is undertaken with a goal of reducing the investor's overall risk. The underlying assumption of a diversification strategy is that, over time, the fluctuation in value of a diversified portfolio with be less than the fluctuation of any single category of investment. Diversification may also reduce somewhat the opportunity to maximize the return on the portfolio, because it is a defensive strategy.

A well diversified portfolio would include both fixed income and equity investments, with several categories of each; e.g., stocks, bonds, and real estate.  Stocks are frequently diversified by industry.  Diversification among stocks might also be based on their beta rating (the ratio of percentage change in the price of a stock relative to the percentage change in the market).  Bonds can be diversified by length of maturity (short, medium or long term), by ratings (Standard and Poors or Moody's), or by taxable or tax exempt status. Real estate investments can be diversified by geographical location. They may also be diversified as to the use of the real estate; e.g., apartments, warehouses, shopping centers, or factory buildings.

Leverage/Margin Debt

The use of debt, or leverage, is an aggressive investment strategy that is designed to increase the profit potential of investments.

Perhaps the most common use of leverage is in the purchase of real estate.  This strategy can be especially beneficial in periods of high inflation.  Leverage is also utilized when purchasing stocks and bonds on margin. A brokerage margin account enables the investor to purchase stocks or bonds by depositing a portion of the purchase price in cash or other securities and borrowing the balance from the brokerage house. Use of a margin account allows the investor to increase the amount purchased in a single issue, or to borrow against one investment to diversify into other types of investments.

Dollar Cost Averaging

Dollar cost averaging is a widely used method of timing investments.  It requires simply that the investor purchase equal dollar amounts of a stock or mutual fund on a regular basis (weekly, monthly, or quarterly). The success of a dollar cost averaging strategy is based on the fact that the same amount of money will buy more shares when the share price is low, and fewer shares when the share price is high.

This strategy alleviates investment timing problems. It is particularly effective for mutual fund investment. Specialized expertise is not required for successful dollar cost averaging; however the investor must have the discipline to save and invest regularly, even in declining markets.

Amount Deposit at COMPOUNDED FUTURE VALUE OF $100.00 at the beginning of the month:

Hedging

Hedging is a strategy which involves the combination  of two or more securities into a single investment position, The purpose of a hedging strategy is to reduce the investor's risk. This is accomplished by minimizing the loss that would occur if the market value of the investor's stock declined.

Two types of securities are used to achieve hedging goals. The first group includes options on stocks, industry groups, and futures contracts.  Futures on stock market indexes, financial instruments, currencies, and commodities may also be utilized in a hedging strategy.

How Time Affects the Value of Money

Investor A invests $2,000 a year for ten years, beginning at age 25. Investor B waits 10 years, then invests $2,000 a year for 31 years. Compare the total contributions and the total value at retirement of the two investments.

 

Investor A						Investor B
Age	Years	Contribution	Year End Value			Age	Years	Contribution	Year End Value
25	1	$2.000	$2,188			25	1	$0	$0
26	2	$2,000	$4,580			26	2	$0	$0
27	3	$2,000	$7,198			27	3	$0	$0
28	4	$2,000	$10,061			28	4	$0	$0
29	5	$2,000	$13,192			29	5	$0	$0
30	6	$2,000	$16,617			30	6	$0	$0
31	7	$2,000	$20,363			31	7	$0	$0
32	8	$2,000	$24,461			32	8	$0	$0
33	9	$2,000	$28,944			33	9	$0	$0
34	10	$2,000	$33,846			34	10	$0	$0
35	11	$0	$37,021			35	11	$2,000	$2,188
40	16	$0	$57,963			40	16	$10,000	$16,617
45	21	$0	$90,752			45	21	$10,000	$39,209
50	26	$0	$142,089			50	26	$10,000	$74,580
55	31	$0	$222,466			55	31	$10,000	$129,961
60	36	$0	$348,311			60	36	$10,000	$216,670
65	41	$0	$545,344			65	41	$10,000	$352,427
Value at Retirement			$545,344			Value at Retirement			$352,427
Less Total Contributions			($20,000)			Less Total Contributions			($62,000)
Net Earnings			$525,344			Net Earnings			$290,427

Note: Assumes a nine percent fixed rate of return, compounded monthly. All interest is left in the account to allow interest to be earned on interest.

Future Value of $100 Deposited Monthly

Interest Rate
 

Year	5%	8%	15%
1	$1,233.00	$1,253.00	$1,302.00
2	$2,529.00	$2,611.00	$21,814.00
3	$3,891.00	$4,081.00	$4,568.00
5	$6,829.00	$7,397.00	$8,968.00
10	$15,593.00	$18,417.00	$27,866.00
20	$41,275.00	$59,295.00	$151,596.00

Savings deposit made at the beginning of each month with interest compounded monthly.

Future Value of $ 1,000 Single Deposit

Annual Percentage Rate of Return

 

Year	5%	8%	15%
1	$1,050.00	$1,180.00	$1,150.00
2	$1,102.00	$1,166.00	$1,323.00
5	$1,276.00	$1,469.00	$2,011.00
10	$1,629.00	$2,159.00	$4,046.00
20	$2,653.00	$4,661.00	$16,367.00

Future Value of $25 Deposited Monthly

Interest Rate
 

Year	5%	8%	15%
1	$308.00	$313.00	$325.00
2	$632.00	$653.00	$703.00
3	$973.00	$1,020.00	$1,142.00
5	$1,707.00	$1,849.00	$2,242.00
10	$3,898.00	$4,604.00	$6,966.00
20	$10,319.00	$14,824.00	$37,899.00

Savings deposit made at beginning of each month with interest compounded monthly.


Monthly Deposit for Future Goals

5% Interest Rate

Goal	1 Year	3 Years	5 Years
$1,000.00	$81.10	$25-70	$14.64
$2,000.00	$162.20	$51.39	$29.29
$3,000.00	$243.31	$77.09	$43.93
$5,000.00	$405.51	$128.49	$73.72

8% Interest Rate

Goal	1 Year	3 Years	5 Years
$1,000.00	$79.80	$24-51	$13.52
$2,000.00	$159.58	$49.01	$27.04
$3,000.00	$239.37	$73.52	$40.56
$5,000.00	$398.95	$122.53	$67.60

Savings deposit made at beginning of each month with
interest compounded monthly.


Doubling Your Money


The Rule of 72 is a useful tool for investors. Use to calculate how long it will take your money to double at a given interest rate, if you reinvest the earnings.


72 Divided by the Percentage Rate of Return Equals The Number of Years Needed to Double Your Money


For example: An investment of $1,000.00
would take nine years at 8% interest rate for the money to become $2,000. (72 / 8 = 9)
At 10%, it would take 7.2 years.
How long will it take the following investments to double? Assuming 10 % return $5,000.00 to double. (72 /10 = 7.2)

Investment Rate Years


1. CD-------------------------------------------- 7%--------------------------------

2. U.S. Treasury Note ------------------- 10%-------------------------------

3. Common Stock--------------------------13%-------------------------------

4. Money Market----------------------------16%-------------------------------

Yield of Taxable and Tax Exempt Investments


Federal Tax Bracket

 

	15% 28% 33%
Tax Exempt Investment Yield	Taxable Exempt Yield

4%	4.7% 5.6% 6.0%
5%	5.8% 6.9% 7.5%
6%	7.0% 8.3% 9.0%
7%	8.2% 9.2% 10.4%

Example:
A person in a 28% tax bracket invests money in a tax exempt municipal bond fund paying 6%, he would have the same income as someone investing in a taxable fund paying 8.3%.


 

	Taxable Savings	Tax Deferred Savings
$15,000.00 Invested Today	$15,000.00	$15,000.00
Value in 20 Years Invested at 10% Annual Interest	$60,254.00	$100,912.00

 
In a taxable savings account, you pay taxes on the interest earned each year. The taxes paid reduces the amount of money available for reinvestment that could earn additional interest.


Stock Quotes
Stock prices are quoted in fractions of eighths for amounts less than a dollar or in cents..


The following represent the conversion from fraction to cents.
1/8 = 121/2 cents ($0.125) 5/8 = 62.1/2 cents ($0.625)

1/4 = 25 cents ($0.25) 3/4 = 75 cents ($0.75)

3/8 = 3 7.1/2 cents ($0.375) 7/8 = 87.1/2cents ($0.875)


Find the cost of the following stock purchases, ignoring sales commissions.
200 shares @ 30.1/44 6000 shares @ 48 7/8

2000 shares @ 19 3/4 1000 shares @ 19 5/8

Bond Quotes

Bonds are sold in units of $1,000 equal to face value. But bond prices are quoted as 100s. To find the correct dollar value, move the decimal one place to the right.
Exp: A bond quoted at 98.25 is equivalent to'98.25. Move the decimal one place the right to find the dollar price of the bond.  The correct price is $982.50.
This bond is selling for less than $1,000, so it is selling at a discount, from face value.
A bond quoted at 102 3/8 (102.375) equals $1,023 75. This bond is selling at a premium, from face value.

STOCK QUOTES

 

1	2	3	4	5	6	7	8	9	10	11
High Low	S2 Week	Stock	Div	Yld	P-E%	Volume Ratio	High100s	Low	Close	Net Change
167'/2	22%	DellCptr			48	95803	1667/8	162 3/16	164	+4
95	33	Intel	.12	0.1	23	166698	903/4	88	89V4	+ I V4
3 8 Y8	22	Sears	2.00	5.1	15	17969	397/8	37 1/8	391/88	2 1/8

What It Says

 

Columns 1, 2 and 3	During the last 52 weeks, the highest price paid for a share of Sears
High, Low, Stock	common stock was $38 5/ 8 and the lowest was $22.
Column 4	Sears stock pays $2.00 yearly in dividends.
Column 5	At today's price, the investor receives a return of 5. 1 % or $ 5. 10 for
Yield	every $100 invested. The yield is obtained by dividing the annual dividend by the closing price.
Column 6	At today's price, the ratio of price to earnings is 15. This is one way
P-E Ratio	to compare stocks of firms in the same industry. In general, low P-E stocks tend to have higher dividend yields and less risk. The P E ratio is obtained by dividing the stocks price by the company's latest 12 month earnings per share.
Column 7	On this day, 1,796,900 shares of Sears stock changed hands.
Volume in 100s
Columns 8-11	During the trading day, the price was as high as $39.87'/ 2 per share
High, Low, Close,	and as low as as $37.12'/ 2' The final price was for $39.50, which was
Net Change	$2.121/ 2' more than the final price on the previous day.

BOND QUOTES

 

1	2	3	4	5
Bonds	Cur Yld	Vol	Close	NetChange
Chiquita10 1/204	10.7	144	981/4	+3/8
K Mart 6.2s97	Cv	50	91	+1/4
Disney zr05		414	45 3/4	+3/4

What It Says

 

Column 1	A bond issued by Chiquita, which matures in 2004, has a coupon rate of
Bond, Coupon Rate,	10 1/2. This stated interest rate represents the 10.5 percent paid on the bond's
Date of Maturity	$1,000 face value. The holder of this bond will receive $105 annually.  The "s" in the K Mart quotation separates the 6.2 percent rate from the 1997 maturity date. Note that this bond is listed in fractions of tenths instead of eighths.  The Disney bonds are zero coupon bonds as indicated by the "zr." They do not pay annual interest.
Column 2	At this day's price, the holder of a Chiquita bond annually will receive 10.7
Current Yield	percent or $10.70 for every $ 100 invested. The current yield is calculated by dividing the annual interest by the closing price.  The "cv' indicates that the K Mart bond is convertible and can be exchanged for K Mart stock.
Column 3	On this day, 500,000 K Mart bonds were sold. The number 50 has been
Volume	multiplied by 10,000.
Columns 4 and 5	The final price for Chiquita bonds was $982 50, which was $3.75 more
Close, Net Change	than the final price on the day before.

MUTUAL FUND QUOTES
(Wall Street Journal)

 

	2	3	4
	NAV	NetChg	YTD %Ret
FIDELITY INVEST
MAGLN	83-35	0.21	+5.8
OVRSE	32.15	+0.03	+4.2
VANGUARD GROUP
SELVALU	11-07	0.03	+1.5
STAR	16.67	0.03	+5.1

What It Says

 

Column 1	Magellan and Overseas are names of mutual funds within the Fidelity Invest-
Fund Family	ment family. Select Value and STAR are mutual funds within the Vanguard Group of funds.
Column 2	The "NAV' stands for the net asset value per share of the fund at the close of
NAV	the previous business day. A fund's NAV is calculated by adding up the value of all stocks or other securities owned by the fund, subtracting the liabilities and then dividing by the number of fund shares available. However, sales commissions are not subtracted from the NAV.
Column 3	The net change column shows the change in the NAV from the preceding
Net Change	day's quote. In this example, there was a 21 cent loss in net asset value of the Fidelity Magellan Mutual Fund as compared with the previous day. Both of the listed Vanguard funds lost three cents a share.
Column 4	"YTD % Ret" refers to the year to date percentage change in the value of the
Year to Date	fund That includes reinvestment of all distributions, subtracting annual
Percentage Return	expenses charged to investors.

Note. Readers of Wall Street journal stock tables will sometimes find one letter "codes " by certain funds. To interpret these codes, look for the "explanatory notes.
 

Visit Our Bookstore

Buy books, videos and more!

This service is provided by Alpha Trade
nbsp;