Transcript Top Performing Equity Mutual Funds 2014

Basics of Investing III
Economics 98 / 198
Spring 2008
Copyright 2008 Lawrence Wu
Schedule
• Quiz
• Current Events
• Today’s Lecture Content
• Next Week
QUIZ
CURRENT EVENT / NEWS
Crude Oil tops $100/barrel again
• After the February 7th low of $88.11, it
began steadily rising again.
• After the President’s Day weekend, the New
York Mercantile Exchange rose prices by
$4.51, 4.7%, to $100.01 for the March
delivery.
• Due in part to OPEC’s seasonal production
cuts.
• Also, the “Big Spring” refinery in Dallas, with
a 70,000 barrel a day capacity was shut
down due to blast.
Effects
• Analysts are unsure whether the market
demand, due to the slowing economy, will
legitimize the rise in price.
• Inflation could rise due to “supply jitters”.
• Drivers could see a an increased price at the
pump due to the approaching spring “driving
season”.
* Information from Article titled “Supply worries spur crude back above $100 a barrel” from MarketWatch by
DowJones; http://www.marketwatch.com/news/story/crude-makes-swift-climb-
back/story.aspx?guid=%7B463E952B-0B60-48BA-901C-0874DDC7CE70%7D
February 19
- crude oil closes above $100 a barrel -
Dow Jones, S&P, and NASDAQ plummet as crude prices rise
above $100 a barrel for the first time
Why???
1. Alon USA in Texas shuts down
because of an explosion and a
fire
2. Speculation that OPEC will lower
production
3. March crude oil contract expires
February 20 – crude prices rise
due to short-covering in advance
of the expiration
LECTURE CONTENT
Today’s Lecture
• Basic investing concepts
– Risk-Reward / Financial Goals / Understanding Your
Appetite for Risk
• Portfolio Management
– Diversification
– Concentration
• Different investment securities
– Bonds / CDs / Money Market
– Mutual Funds / Exchanged-Traded Funds
• Market Psychology
Basic Investing Concepts
Determining Your Financial Goals
• Investing is a long car trip. There needs to
be a lot of planning that goes into it.
– How much money do you want to make? By
when?
– Will you need to live off your investments in
future years?
– What will you be using your money for?
• Having a good understanding of yourself will allow
you to align your risk tolerance with various
strategies
Determining Your Investment Style
• What kind of person and investor do
you want to be?
– Shooting for singles and doubles, aiming for slow
and steady gains?
– Sitting on the sidelines, relying on and cheering
someone else?
– Willing to take risks, go for homers, and achieve
maximum gains?
• Think about your risk tolerance, time horizons for
your investments, and your time commitment
The Risk / Return Tradeoff
• “principle that expected return rises
with an increase in risk”
– Lower risk with lower returns
– Higher risk with high returns
• Important to know your personal risk
tolerance when choosing investments
– Balance between risk and reward
Risk Tolerance
• Young people should
be in stocks
– Time is our best
friend
• BUT, need to be
able to handle the
market’s volatility
– If not… then get out!
What is Your Risk Tolerance?
Source: Investopedia. “Determining Risk and The Risk Pyramid.” May 2 2003
Source: Investopedia. “Determining Risk and The Risk Pyramid.” May 2 2003
(Expected) Return vs. Risk
Portfolio Management
Portfolio
• Definition: “collection of assets—such
as stock, bonds, and mutual funds—
held by an investor”
• Portfolio Management
– Deciding type of investment mix and
allocation for your portfolio
– Risk versus performance
Asset Allocation
• Income
• Balanced
• Growth
Active versus Passive Management
Buy, sell, buy, sell…
versus
Buy and sit?
Active versus Passive Management
• Examples (Active Management)
– Buying / selling individual stocks
– Discuss with your broker which stocks to buy
– Choosing between different mutual funds
• Example (Passive Management)
– Buying an index fund that mirrors the S&P 500
– Having your portfolio match the index fund at all
times (relatively hard and expensive)
– Typically has lower fees
Distribution of Returns of Actively Managed Funds
How many stocks should I own?
Diversification
versus
Concentration
Diversification
“Don’t put all your eggs in one basket”
Diversification
• Mixing a wide selection of investments
within a portfolio
– By industry, sizes, geographic locations, or
other characteristics
• Positive performance of some
investments may neutralize the
negative performance of others
Diversification…What’s the Catch?
• Limits your upside potential
– Hot stock makes up only 5% of your portfolio
– 50% increase will have small effect
• Many investors tend to over-diversify
– Harder to keep track, slower to react
– Know a little bit about every industries
– Over-diversification usually leads to
underperforming the market (What’s the point
then?)
Concentration
“putting your eggs in a few baskets that you know
well and watching them very carefully”
Concentration
• Goal: Keep losses small and ride
profits for big gains
– Effect: big gains have major effect on your
portfolio value
• Increases risk
– Potential for big profits/losses is magnified
• Fund managers can’t do this
Other Investment Securities
Mutual Funds &
Exchange-Traded Funds
Various investment securities
• Money market funds (~3-4%)
– Type of risk-free debt investment that has slightly better
returns than savings
– Typically mature in less than 1 year
– Very liquid (i.e. easy to buy/sell and convert to cash)
– Usually automatically get this in a brokerage account
• Certificate of deposits (CDs) (3-6%)
– Certificate to the bearer to receive interest
– Issued by commercial banks from 1 month to years
– Interest varies with length of maturity
Various Investment Securities
• Bonds
– An IOU issued by a borrower to a lender
– Loaning money for pre-determined time
– Borrower pays a coupon payment during time-span as well
as lent amount
– Borrowers range from banks, government, to corporations
• Advanced / Alternative Investments
–
–
–
–
Options
Hedge Funds
Private Equity
Futures / Derivatives
Mutual Fund Basics
• Nothing more than a collection of stocks
and/or bonds
• You contribute your money to a company
that manages a large fund (made up of
other people’s money) and invests in a
portfolio
• Often, these mutual funds can manage
hundreds of millions and billions of dollars
Mutual Fund Basics
• Various types of mutual funds
– Equities, fixed-income, money market
– Mutual funds usually variation of these assets
classes
• Also, other special types: global,
international, specialty, index funds
• Costs:
– Yearly fees (0.15%-2%)
– Transaction fees paid when buy / sell shares
– This is called the “load” – look for “No Load” funds
Buying and Selling Funds
• Can buy mutual funds by contacting fund
companies directly or through brokerages
• Can withdraw your money from fund at the
end of market days usually
• If purchase mutual funds through thirdparties (brokers, banks, planners), usually
faced with extra sales charge (these are
called loads)
Advantages
Disadvantages
• Professional
• Professional
Management
• Periodic
Management
(huh?!)
Reinvestment (Dollar
• Costs
Cost Averaging)
• Dilution
• Diversification
• Taxes
• Liquidity
• Reaction Time
• Simplicity
Choosing Mutual Funds
• Always compare fund performance to stock
market averages (S&P500, NASDAQ)
– Pay attention to the years in which market
averages were down (anyone can make money in
the bull market)
– Look for solid track records
• Make sure objectives of mutual fund are in
line with your goals and risk / rewards
desires
– Aggressive growth? Slow, steady returns?
Exchange-Traded Funds
• Like mutual fund, but trades like stock
– Represents a basket of stocks that reflect
an index / industry such as the S&P500 or
alternative energy
– Diversification like an index fund, but the
flexibility of a stock
• Value of ETF updated daily as supply
and demand fluctuates
Exchange-Traded Funds
• Number of ETF for various industries and
markets
– International, oil, retail, emerging markets, etc.
• Buying and selling ETF as simple as buying /
selling a stock
– Symbols assigned to each ETF (QQQQ for Nasdaq
100 average)
– Go to broker & enter buy order for QQQQ
• Can buy / sell at any point of the day
Advantages over Mutual Funds
• Lower costs
• Greater tax efficiency
• Easier asset allocation
• No fraud (ETF’s are transparent)
• Flexibility
• Shorting opportunity
Sample ETF Symbols
ETF Ticker
Fund Name
Fund Description
IVV
iShares S&P 500 Index Fund
Large cap US stocks
IJH
iShares S&P Mid Cap 400 Index Fund
Mid cap US stocks
IWM
iShares Russell 2000 Index Fund
Small cap US stocks
EFA
iShares MSCI EAFE Index Fund
Large cap foreign developed market stocks
EEM
iShares MSCI Emerging Markets Index
Large cap emerging market stocks
Fund
RWR
streetTRACKS Wilshire REIT Index
Fund
Real estate investment trust index fund
LQD
iShares GS $ Investop Corporate Bond
Fund
US corporate bonds
SHY
iShares Lehman 1 to 3 Year Treasury
Bond Fund
US short-term Governement bonds
IEF
iShares Lehman 7 to 10 Year Treasury
Bond Fund
US long-term Governement bonds
TIP
iShares Lehman TIPs Bond Fund
US Governement inflation-protected bonds
Additional Resources for ETF’s
Index Funds & ETFs – a Tiny Useful List
http://moneychimp.com/articles/index_funds/fund_list.htm
Radical Guide to ETF Investing
http://seekingalpha.com/article/15134-the-seeking-alpha-etfinvesting-guide
TRADING PSYCHOLOGY
Trading Psychology
Emotions severely impair your judgment
in deciding whether to buy or sell stocks
HOPE
FEAR
GREED
PRIDE
Psychology & The Stock Market
• Emotions can wreak havoc on your
results and decisions
• Need to take emotion out of investing
• Do this by developing a system with
rules to follow with discipline
Next Week
• Financial Statements Primer
– Income Sheet
– Balance Sheet
– Cash Flow Statement
• Financial Ratios
– P/E, ROE, Margins, etc.
• Earning Reports, Analyst Estimates
Reading
Assigned Reading:
– SEC. Beginner’s Guide to Financial Statements
– Look at Google’s financial statements (income
statement, balance sheet, cash flow statement)
Extra Reading:
– Ratio Analysis
http://www.investopedia.com/university/ratios/
– Financial Concepts
– http://www.investopedia.com/university/concepts/