BA 312 Blueprint Foundations of Personal Finance II
Order ID 53563633773 Type Essay Writer Level Masters Style APA Sources/References 4 Perfect Number of Pages to Order 5-10 Pages Description/Paper Instructions
Investing Module Assignment: Total 50 points
- Investing: How Prepared Are You? 15 points
- Understanding Risk & Diversification 15 points
- The Tale of Two Investors 20 points
Investing: How Prepared Are You?
How prepared are you? Asking yourself this question is an essential first step when you begin thinking about investing – because not everyone should begin investing today. Whether you have yet to embark on your investing journey or you’ve started making headway down that path, it is important to understand your current financial situation and the risks involved.
Step 1: To Save or To Invest?
In section 8-2 of your textbook, the authors provide a questionnaire designed to help you figure out if you are ready to jump into the investment world now or if you need a little more foundational work first. The questions include:
- Do you currently have an emergency fund in place (typically, savings worth 3-6 months of your living expenses)?
- Are you saving money on a regular basis?
- Do you have all of the insurance you need, such as auto, renter’s (or homeowner’s), life, and disability?
- Are you willing to engage in financial behavior in which there is the possibility of a significant gain but also a high probability of loss?
- Do you currently have cash that can be used to invest?
While you will not be asked to submit answers to the questions above, you should answer them for yourself as you explore the world of investing. Your answers to the first two questions are key in determining whether or not to dive into investing, though it’s not as simple as a “yes” or “no,” and opinions vary in some respects on when the appropriate time is to begin.
Read Bankrate’s article, Savings vs. Investing: here are the key differences for managing your money.
Step 2: Emergency Funds
Within the Bankrate article, the author discusses the importance of having an emergency fund. If you don’t yet have an emergency fund, this part of the assignment will give you foundational knowledge to begin saving today. If you already have an emergency fund started or fully funded, use this section to continue building your knowledge base and verify your savings are sufficient based on your personal circumstances.
- Read NerdWallet’s article, Emergency Fund: What It Is and Why It Matters.
- Then, utilizing the Emergency Fund Calculator at the end of the article, estimate your emergency fund needs.
- Next, click on the appropriate response based on your situation and explore the resources offered:
Step 3: The Power of Compound Interest
Regardless of whether you’re just starting out in saving for emergencies or your account is fully funded, it can be incredibly motivating to look ahead and see why your very next financial priority should include investing.
Visit NerdWallet’s Compound Interest Calculator and play around with calculations. Utilize the average rate of return for both savings accounts (0.05% average; 0.50% for high yield savings accounts) and the stock market (7%) to see the power of compound interest and to begin to understand why you might want to shift your monthly contributions to investment accounts after you’ve fully funded your emergency savings.
Step 4: Reflect
Read the quote below (taken from Bankrate’s article in Step 1) and reflect on what you’ve learned in Steps 1-3 above.
“‘When you use the words saving and investing, people – really 90-some percent of people – think it’s exactly the same thing,’ says Dan Keady, CFP, and chief financial planning strategist at TIAA, a financial services organization.” While both saving and investing are strategies that help you accumulate money, they do have some key differences you must consider.
Drawing upon points you’ve learned from Steps 1-3 above, what are the key things you need to consider or steps you need to take as you decide on your personal strategy towards saving and investing? Your answer should be specific, based on your personal situation, and should have clear evidence of having read and explored the resources above.
When making the decision to either save or invest, one should consider a few things beforehand. The individual needs to consider factors such as the amount of money that they’d like to save, or invest, the period of time, expected profits, and so on. Since investments are mostly long-term, one should first practice saving before thinking of investing. Investing also involves a higher risk of losing part or all the money, so one needs to tread carefully when making investment decisions and thinking in terms of the profits to be gained after a long time frame.
While saving and investing are alike in that they allow one to put away money with the aim of gathering interest on the money, investment offers a much larger threshold for profit but also involves much more risk. Therefore, before making the decision to invest, one should ensure that they have enough first in terms of savings and emergency funds before venturing into investments.
Understanding Risk & Diversification
Step 1: What’s the Risk?
Read Investopedia’s article, Risk Tolerance, then answer the following questions:
- What is risk tolerance?
- What are some important factors when determining what your risk tolerance is?
Risk tolerance refers to the amount of money that an investor can endure as a loss while making an investment decision. When one has a low-risk tolerance, then they would prefer to be conservative in investments, opting for low-risk investments instead of high-risk ones.
Factors to consider when determining one risk tolerance include a time frame (how long one has to enjoy the benefits of the investment, “age-based”), risk capital (the amount of money that the investor can lose without affecting their lifestyle), investment goals, investment experience, and the nature of the investment being considered.
Step 2: Diversification
Another consideration for investing is the idea of diversification. Read the following articles about diversification, then answer the questions below.
- The Many Ways to Achieve Investment Portfolio Diversification by Investopedia
- The Importance of Diversification by Investopedia
What does it mean to have a “well-diversified” portfolio?
A well-diversified portfolio refers to a portfolio that allocates various investments in different areas (financial instruments, industries, et al.) that would react differently in similar events. That way, the investor minimizes the risk involved and still achieves the long-range financial goals.
What are some of the advantages of diversification?
Diversification minimizes the risk of loss in an investment. In case one investment fails during a certain event, the other investments are likely to perform well, thus, reducing the potential loss from the portfolio.
Diversification can help preserve capital. This is especially true for investors that are close to retirement, as they can use diversification to protect their savings.
Diversification also guarantees returns since the investor doesn’t have to rely on one source of income.
What underlying principles help explain why a diversified portfolio reduces risk?
A diversified portfolio reduces risk by providing the investor with options to spread their investment across various asset classes such as stocks, and bonds, among other categories. Diversification doesn’t cover the investor against loss but can protect them from unforeseen losses such as from bad information, which could have led them into investing unwisely.
What are some of the disadvantages of diversification?
Sometimes you may over-diversify your portfolio, and this negatively impacts the returns. For example, buying 50 individual stocks could do more harm than good, considering that many experts recommend at least 20 stocks for a diversified portfolio.
Also, including too many investments in one’s portfolio reduces the impact that each of the investments causes, thus eventually making the diversification insignificant.
Step 3: Find a Suitable Investment Strategy
Investing strategy is an important part of making decisions affecting your portfolio. Knowing your goals and knowing how you want to invest are crucial parts of making investing decisions. Using the Investor Profile Questionnaire by Charles Schwab, determine your time horizon and risk tolerance. Based on the values you find by answering questions 1-7 in the questionnaire,
- What is your investor profile and corresponding investment strategy?
- What are the characteristics of this strategy (including average annual return, best year, worst year, mix of assets, and description)?
- Based on what you know at this point, how comfortable are you with this strategy?
Currently, my investor profile and corresponding investment strategy are moderately aggressive. In this sense, I am a long-term investor that is interested in the growth of my money without needing too much of it at present. Average annual returns are 10%, with best years peaking at 34.4% and bad years going as low as -29.5%. Based on my understanding of investment, this is not a good investment plan as it has a considerably great risk for loss, just as the probability of profit.
The Tale of Two Investors
Suppose we have two different investors, John and Jane. Both of them have $150,000 to invest over the course of 20 years. Below are case facts regarding each investor, their investing strategy/decisions they make over the 20-year timeline, and the outcomes of each investor’s portfolio at the end of the period. Review the information in each, and respond to the following prompts.
Case 1:
John’s Profile:
- 50 years old
- Married
- Helped put his two kids through college
- Has not taken advantage of his employer-provided retirement plan for the last 25 years
- He has accumulated $150,000 over his life, and is ready to invest so that he can take advantage of as much in gains as possible over the next 20 years
Since John is approaching retirement, he feels hesitant to invest in individual stocks since they are an inherently riskier investment, and he feels his timeline is short since he is approaching the age at which he can retire (sometime in his sixties). John decided to invest in several bonds, specifically Treasury Notes, which is debt issued by the U.S. government. He invests $70,000 in these bonds, which mature in 20 years, and have a yield of 2.74% annually. He decides to invest another $50,000 in a mutual fund, the Vanguard Tax-Managed Balanced Fund (VTMFX). This fund invests approximately half of its funds in various kinds of bonds and about half of its funds in a variety of stocks (large-cap, small-cap, international, etc.). The fund has historically yielded 9.48% annually over the last ten years, indicating a modest performance over that time. Finally, he decides to invest the remaining $30,000 in a privately-held REIT (real estate investment trust). This trust manages residential properties in several lucrative locations: San Jose, CA, Miami, FL, and Portland, OR. The management of the REIT rents out the properties to tenants for standard leasing arrangements and reinvests the rents received into new properties after enough has been accumulated. John believes the housing market is strong and will continue to perform well in the coming years to help him build his retirement funds (residential properties have increased in value on average between the three areas previously specified around 13.72% annually for the last eight years).
Over the course of the timeline (20 years), John holds all $70,000 of the Treasury Notes to maturity, which in turn yield him an additional $50,195 over the course of the 20 years that he held them. During the same time period, John’s investment in the mutual fund VTMFX had ballooned to a value of $280,220. He sold his VTMFX shares on the same day that his bonds matured (netting a gain of $230,220). The fund’s value increased another 33% the following year due to its heavy weighting of bonds in its portfolio, increasing in value after interest rates fell significantly that year (the investment would have been worth ~$372,000 if held through the following year). John sold his investment in the REIT after about ten years, when an unexpected housing market crash occurred regionally, affecting all of the properties in the aforementioned locations and the ability of residents to rent at said locations. He sold the REIT shares for $12,700, realizing a loss of $17,300, most of which he carried forward as tax deductions for a significant amount of time (capital loss deductions are limited to $3,000 per year). During the subsequent years after he sold the shares of the REIT, the housing market recovered 60% of the value it had lost. John realized ~$263,000 in gains (~9% annualized return).
Step 1:
Complete the table below with the categories and types, amounts, and the returns on each investment.
Investment Amount Return Treasury Notes $70000 $50195 VTMFX $50000 $230220 REIT $30000 $245700
Step 2:
Reflect on John case, minimally answering the following questions and prompts:
- Which decision led to the most gain?
- Which investment had a loss, if any?
- Describe some of the things that worked well for John and his portfolio.
- What are things he could have done differently that would have benefitted him?
Investment at REIT led to the most gain in the subsequent years after selling his shares, having gained a total of $263000
REIT had a loss in the 10th year when the unexpected crash occurred regionally, leading to a $17300 loss, but this loss was recovered where he gained a total of $263000
VTMFX where he gained $230220 and REIT in its latter days where he earned $263000
I he had invested the biggest share in VTMFX, he could have earned more as compared to the ratios he put forth.
Step 3:
Based on your knowledge and the readings,
- Did John diversify his portfolio well?
- Did he set concrete goals in alignment with his financial planning?
- How did John pick investments in his portfolio relative to his risk tolerance and his time horizon?
Not really, since he invested more on Treasury Notes which did not give a good return.
Yeah, he knew he was edging to retirement edge thus decided to invest with his savings.
Yeah, he knew when he was going to retire that is the timelines and opted to invest with what he had.
He feels that individual stocks are riskier and understands that the timelines were not on his side since he was edging retirement; thus, he made the firm decision of investing with what he had.
Case 2:
Jane’s Profile:
- 25 years old
- Single, and has recently graduated college with a business degree and is currently employed.
- He makes a comfortable living and wants to begin investing.
- Based on her current salary, Jane estimates that she will be able to contribute $150,000 over the next 20 years in various lump-sums
- Jane wants to take advantage of dollar-cost averaging, so she can realize an average return of 15% annually over the next 20 years.
Since Jane is young and independent, she wants to invest in the U.S. stock market since they historically have a better return than any other investment, and she knows her timeline is long since she has a long time before she will retire. Jane began her investing with a $20,000 lump-sum she had been saving in her bank account after she graduated college several years earlier. She decided initially to invest in large-cap stocks $5,000 in the following four stocks: Microsoft Corp. (MSFT), Bank of America Corp. (BAC), Nike Inc. (NKE), and Pfizer Inc. (PFE). After four years, she had saved another $50,000 to invest in her portfolio. She decided to invest $48,000 of this into one of her favorite companies, Netflix Inc. (NFLX). Jane’s friend Ben, who is an investing enthusiast, convinced her to invest the remaining $2,000 into an indexed option contract (a financial derivative used to speculate on market movements) because of how he described the massive gains possible with a relatively small investment. Specifically, Jane purchased index put options, an instrument used for protecting a portfolio against bear markets/downturns. During the next 16 years following, Jane incrementally invested another $15,000 into the five stocks currently part of her portfolio (MSFT, BAC, NKE, PFE, and NFLX). In addition to this, she invested $5,000 into Amazon.com, Inc. (AMZN). This brings her total invested amount to $150,000 over the course of 20 years.
Over the course of the timeline (20 years), Jane has not sold any of the stocks she originally purchased. Since Jane is now older (forty-five), she spoke with her financial advisor, who recommended that she reallocate her portfolio’s funds to new investments with a different timeline in mind. The first stock Jane sells her investment in Microsoft, which she sells for $273,665. She then sold her investment in Amazon and Pfizer for $17,411 and $25,766, respectively. Finally, Jane exits her positions in Netflix, Bank of America, and Nike, which sell for $423,731, $17,650, and $36,323, respectively. The only stock Jane sold for a loss was Bank of America, which lost a lot of its value during the same housing crash mentioned in Case 1. The index option contracts Jane bought 16 years ago were sold for only $150 since they have an expiration date, and Jane would rather have sold them for a loss than have them expire worthless. Jane sold these contracts a little more than a year after she purchased them, three months before expiration. The market downturn Jane was planning for never happened within the timeframe of the options’ expiration, and she felt that she did not know enough about the instruments to continue investing with them (she could have rolled the options over into new ones with a new expiration further out, as opposed to selling them for a loss). Overall, Jane sold her investments for $794,698, netting a ~$645,000 gain (~21.5% annualized return).
Step 1:
Complete the table below with the categories and types, amounts, and the returns on each investment. You will need to add more rows to include all the securities involved.
Investment Amount Return MSFT $5000+$15000 $253665 BAC $5000+$15000 -$2350 NKE $5000+$15000 $16323 PFE $5000+$15000 $5766 NFLX $48000+$15000 $360731 Indexed Option Contrast $2000 -$1850 AMZN $5000 $12411
Step 2:
Reflect on Jane’s case, minimally answering the following questions and prompts:
- Which decision led to the most gain?
- Which investment had a loss, if any?
- Describe some of the things that worked well for Jane and her portfolio.
- What are things Jane could have done differently that would have benefitted her?
Investment at MSFT was the decision that earned her many returns.
BAC with a loss of $2350 and Indexed Option Contrast with a loss of 1850
Investments at Microsoft and Netflix led to huge returns. Thus they are the ones that worked well for her and her portfolio.
She could have increased her investments at Microsoft and Netflix.
Step 3:
Based on your knowledge and the readings,
- Did Jane diversify her portfolio well?
- Did she set concrete goals in alignment with her financial planning?
- How did Jane pick investments in her portfolio relative to her risk tolerance for a person her age?
Not really; she invested an equal amount of money even in firms that only gave her losses.
Yeah, her goals were to save within the period of 20years which she did.
By balancing the amount to invest in each firm
Case Follow-up:
Compare and contrast the two investor’s abilities to diversify their portfolios.
- Who did a good job of diversifying?
- Could either of them improve their efforts to diversify?
- What would you want to emulate from John and Jane’s investing actions?
Jane- She invested equal amounts to several companies, thus ensuring that in case of a loss, it will not be huge.
Yeah- John could have tried to balance the ratios of his investments or to invest in more companies.
To ensure that I actualize the plans that I make no matter the progress, For instance, even with slower progress, Jane was able to reach her plan of investments.
Compare and contrast the two investor’s strategies for their portfolios.
- Who did a good job of setting goals?
- Did either of them make decisions in alignment with their risk tolerance/risk capital?
- What would you want to emulate from John and Jane’s investing strategies?
Jane set the goals all by herself, even with her tender age.
John made a decision not to invest in individual stocks, which he felt was riskier.
The courage to keep going. This is demonstrated by John when he fails to back out in his investing even after recording a loss.
Compare and contrast the two investor’s results for their portfolios.
- Why did one portfolio perform better than the other?
- Did either of the portfolios utilize specific investing strategies? If so, describe them.
- What would you want to emulate from John and Jane’s portfolios?
Because the rates of returns were high for the organizations of the portfolio that performed in a better way.
No
Investing spirit and age do not define a person’s investments. Every person can invest in whichever age group.
RUBRIC
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