PERSONAL

FINANCIAL MANAGEMENT
INVESTING FUNDAMENTALS

Investment program creates wealth which provides financial security and a safety net against
emergency. It is advisable to start an investment program early, let the time value of money
works, make sound investments and your finances will be stable upon your retirement.

PREPARING FOR AN INVESTMENT PROGRAM

Establishing Investment Goals

Investment goals must be written, specific, measurable, and should be classified as short,
intermediate or long-term. Investors are more motivated to work toward goals that are stated
in terms of particular things they desire and tailored to ones particular future needs.

The following questions help you to develop your investment goals:

How much money will you need for your goals?
How will you obtain the money?
How long will it take you to obtain the money?
How much risk are you willing to assume in an investment program?
What possible economic or personal conditions could alter your investment goals?
Are you willing to make the sacrifices necessary to meet your investment goals?
What will the consequences be if you do not reach your investment goals?
Given your economic circumstances, are your investment goals reasonable?

Before beginning an investment program, make sure your personal financial affairs are in order,
you are living within your mean. Next you have to accumulate fund for emergency. Only then
you can save money needed for investment and eventually start your investment program.

Performing a Financial Checkup

Do a financial checkup to make sure your financial affairs are in order.

1. Work to Balance Your Budget - make effort not to spend more than you make. Reduce or
eliminate your debt and interest first. Your consumer credit purchases should be limited
to 20% of your after tax income. Make effort to increase your cash availability to be
saved and invested.
2. Manage Your Credit Card Debt credit card carries a high rate of interest i.e. the annual
percentage rate (ARP). Five prudent ways of managing credit card are (1) pay your
balance in full, (2) do not use credit card to make small purchases that add up to a big
sum, (3) do not use its cash advance facility which is costly, (4) limit the numbers of
credit cards to two maximum and (5) get help if you get into credit card problems.
3. Start an Emergency Fund an investment program should start with an accumulation of
emergency fund which can be obtain quickly for immediate use. The amount of
emergency fund varies with individual but the common sum should equal to 3 to 9
months living expenses.

4. Have Access to Other Sources of Cash for Emergency Needs establishment of a line of
credit with a bank (overdraft facility)or cash advance from credit card. Line of credit is a
short-term loan that is approved before the money is actually needed.



Managing a Financial Crisis

To manage a financial crisis, many experts recommend that you take action to make sure your
financial affairs are in order. The eight steps that you can take are:

1. Establish larger than usual emergency fund you may want to increase the emergency fund
amount higher than the equivalent 3 to 6 months living expenses.
2. Know what you owe list all your debts and the amount of the required monthly payment
and identify the debts that must be paid.
3. Reduce spending reduce spending to basic necessity in order to save money for investing
or emergency funds.
4. Pay off credit card high interest rate and expensive credits.
5. Apply for a line of credit access to credit during emergency e.g. overdraft facility.
6. Notify credit card companies and lenders if you are unable to make payments you may get
relieve in term of lower interest, lower monthly payment or extension of payment time.
7. Monitor the value of your investment and retirement accounts tracking such account
helps you to decide which investments to sell for cash for emergency or re-allocate
investments to reduce risk.
8. Consider converting investments to cash to preserve value liquidate investments for cash
to weather an economic crisis.

Getting the Money Needed to Start An Investment Program

Once you have established your investment goals and done your financial checkup, you are
ready for your investment program provided you have the money. However, you have to ask
yourself how important it is to achieve your investment goals. Investing requires you to sacrifice
spending. The benefit is always in the future. Because of this, most people begins their
investment through employer deduction in order to maintain that investing discipline.

The Value of Long-term Investment Programs

There is no better time to begin an investment program than when you are young. With sound
investment and time value of money mechanism will ensure you are well-off in the future.
People do not start young because they have only small sum of money but, even small sum can
grow over a long period of time.

FACTORS AFFECTING THE CHOICE OF INVESTMENTS

All investors must consider the factors of safety, risks, income, growth and liquidity. Of most
important is the relationship between safety and risk. Risks are associated with all investments.
The potential return for any investment should be directly related to the risk the investor
assumes. The risk factor can be broken down into five components; inflation risk, interest rate

risk, business failure risk, market risk and global investment risk. Next factors that affect your
choice of investment are income, growth and liquidity.

Safety and Risk

Safety in an investment means minimal risk of loss while risk in an investment means a measure
of uncertainty about the outcome. Investments range from very safe to very risky. A very safe
investment attract conservative investors because they know there is very little chance that
investments will become worthless e.g. government bonds, CDs, Mutual funds, corporate bonds
etc.



The other end is speculative investment which is a very high-risk investment made in the hope
of earning a relatively large profit in a short time. They have a potential of larger return but also
if unsuccessful, lose most or all of the initial investment.

The Risk-Return Tradeoff

Two types of risks experience by investors namely a risk that you will not receive the periodic
payments and a risk that an investment will decrease in value.

When investing, not everyone has the same tolerance factor. Those who have higher tolerance
for risk will go for investments with higher degree of risks and expect larger returns. One basic
rule sums up the relationship between the factors of safety and risk: the potential return on any
investment should be directly related to the risk the investor assumes.

Exhibit 13-2 lists a number of factors related to safety and risks that can affect an investors
choice of investment.

Exhibit 13-4 shows typical investments for financial security, safety and income, growth and
speculation. Choosing higher risk investments, investors expect higher return.








Rate of return is the total income you receive on an investment over a specific period of time
divided by the original amount invested. The rate of return you received is often determined by
the amount of risk you are willing to take. It is possible to compare the projected rate of return
for different investment alternatives that offer more or less risk.

Example,

You invest $3,000 in a mutual fund. The mutual fund pays $50 dividend this year and the fund is
worth $3,275 at the end of the year. Your return will be $275 ($3,275 - $3,000) from capital gain
and $50 from dividend, totaling $325. Your rate of return will be $325/$3,000 = 10.8%

If an investment decreases in value, the steps to calculate the rate of return is the same, but the
answer is negative.

The key is to determine how much risk you are willing to assume and then choose quality
investments that offer higher returns without an unacceptably high risk.

Components of the Risk Factor

The factor of risk associated with a specific investment does change from time to time. the
overall risk factor can be broken down into five components namely inflation, interest rate,
business failure, market and global investment risk.

Inflation Risk - risk from a rise in the general level of prices. During periods of high inflation,
there is a risk that the financial return on an investment will not be able to keep pace
with the inflation rate. You may get the same amount in return but that amount has
gone down in term of its purchasing power. To protect from inflation risk, some
corporations are issuing inflation-protected bonds i.e. adjusting the interest received.


1. Interest Rate Risk - risk associated with changes in interest rate in the economy. The value of
investments with a fixed rate of return decreases when the overall interest rate
increases and increases when the overall interest rate decreases.

Business Failure Risk - the risk of business failure is associated with investments in stock, bonds
and mutual funds which invest in stocks and bonds. Bad management, unsuccessful
products, competition etc will cause the business to be less profitable than originally
anticipated. Lower profit may result in lower or no dividends. The best to protect
against such loses is to carefully evaluate the companies that issue the stocks you are
buying.

1. Market Risk - two risk; systematic and unsystematic, can affect the market value of stocks,
bonds, mutual funds, real estate etc. Systematic risk occurs because of overall risk in the
market and economy e.g. economic crisis, interest rates, purchasing power. This affect
the entire market as such diversification cannot be done. Unsystematic risk affects a
specific company or industry; hence diversification can eliminate unsystematic risk. The
prices of stocks, bonds, mutual funds may also fluctuate because of the behavior of
investors in the marketplace. They perceived on certain thing and that may affect prices.

Global Investment Risk - this risk is associated with investing in foreign stocks and bonds which
can be affected by changes in currency and exchange rates.




Investment Income

Investors sometimes purchase certain investments because they want a predictable source of
income from their investment. The safest investments are saving accounts, certificates of
deposits, government securities are also the most predictable sources of income. If income is a
primary objective, most investors choose bonds, preferred stock. Other investments that
provide income potential are mutual funds and real estate rental property. The downsides of
rental properties are they are vacant or incur large repair bills.

When purchasing investments for income, you should be concerned about the issuers ability to
make periodic income or dividend payments and eventual repayment of your principal sum
invested.

Investment Growth

To investors, growth means that their investments will increase in value. Companies with better
than average earnings potential, sales revenue that are increasing, and managers who can solve
problems associated with rapid expansion are often considered to be growth companies.
Growth companies may not declare dividends but re-invest the current cash to generate
greater growth and greater value in the future. Mutual funds. government and corporate bonds
and real estate offer growth potential.

Investment Liquidity

This investment focuses on its liquidity element i.e. can be converted to cash without a
substantial loss in value e.g. current and saving accounts, certificate of deposits (may incur
penalty), with other investments, you may able to sell quickly but depend on market conditions,
economic conditions, selling price etc.

ASSET ALLOCATION AND INVESTMENT ALTERNATIVES

Asset Allocation and Diversification

Asset allocation is the process of spreading your asset among several different types of
investments (asset classes) to lessen risk. The diversification provided by investing in different
asset classes provided a measure of safety and reduces risk, because a loss in one asset class is
usually offset by gain from other asset class. Typical asset classes include stocks issued by
corporations, foreign stocks, bonds and cash.

Asset allocation is the most important factor when establishing a long-term investment program
because choosing the right mix of assets will outperform the investment selections that
individual investors make over a long period of time. Typically, the asset allocation will change
and become more conservative as you get older.

The percentage of your investment that should be invested in each asset class is determined by
your age, investment objectives, your risk tolerance, your yearly saving for investment, value of
your current investment and the outlook for the economy.

Exhibit 13-4 above suggest that an investment program is like a pyramid which trade-off risk and
return. The investment pyramid has four levels. The foundation or level 1 is conservative
investments with secure and stable return. Level 2 provides safety and income while Level 3
provides growth. Level 4 which is the apex provides the most speculative yet the highest return.




The Time Factor

The amount of time your investments have to work for you is an important factor in managing
your investment portfolio. How long you can leave your investments; for a long-term
investment you can choose stock and mutual funds. If you need quick gain on investment, you
should go for high rated corporate bonds, certificate of deposits or short-term government
bonds. The longer that you invest in a particular asset, the better your opportunity for increasing
returns.

Your Age

A final factor to consider when choosing an investment is your age. Younger investors tend to
invest a large portion of their assets in growth-oriented investments. If the investments do not
perform, they have time to recover. Older investors tend to be more conservative and choose
safe investment such as government bonds, very safe corporate stocks and mutual funds.

Experts suggest that the percentage of your assets in growth investment should equal to
number 110 less your age e.g. If your age is 50, the percentage of your assets in growth
investment should be 60% (110 50).

An Overview of Investment Alternatives

Once you have considered the risk involved, asset allocation, the time factor your investments
can work for you, and your age, it is time to consider which investment alternatives is right for
you.

Stock or Equity Financing

Equity capital is money that a business obtains from its owners. The owner or investor can be a
single ownership or a collective ownership such as shareholders. Investor should consider at
least two factors before investing in stock. First, a corporation is not obligated to repay the
money obtained from the sale of stock or to repurchase the stock at a later date. Second, a
corporation is under no legal obligation to pay dividends. A dividend is a distribution of money,
stock or other property that a corporation pays to stockholders.

There are two types of stock; common stock and preferred stock. People purchase common
stock because (1) as a source of income if the company pays dividend, (2) growth potential if
the value of stock increases and (3) potential profit if the company splits its common stock.
Preferred stocks are purchased because it pays dividends before common stock.

Corporate and Government Bonds

There are two types of bond namely government bonds and corporate bonds. Government
bond is a written pledge of a government to repay a specified sum of money, along with
interest. Corporate bond is a written pledge of a corporation to repay a specified amount of
money, along with interest. When you buy bond you are lending money to corporations or
governments for a period of time. The maturity date is the date in which the face value of the
bond ill be paid.

The value of a bond is closely tied to the ability of the corporation or government entity to repay
the bond at maturity and pay interest payment until maturity. The value of the bond may
increase or decrease before it reaches maturity because of changes in interest rates in the
economy. Bondholders can keep the bond until maturity and receive periodic interest payments
or sell it to another investor before maturity.




Mutual Funds

A mutual fund is an investment company that pools the money of many investors (its
shareholders) to invest in a variety of securities. Professional management is an important
factor in mutual fund investments. Mutual fund is also chosen for its diversification.

The goals of investors differ as such mutual funds investments can be tailor-made to suit
individual investors need. For this reason, mutual funds are excellent choice for beginners
investments, retirement accounts etc.

Real Estate

As a rule, real estate increases in value and eventually sells for a profit, but this is no guarantees.
Real estate investment is long-term in nature. Real estate investment must be evaluated and the
key evaluation is always location. Ask yourself questions before buying real estate; is the
property priced competitively? what type of financing is available? How much are taxes? What
is the conditions of the buildings in immediate area, why are the present owners selling? Could
the property decrease in value?

Other Investment Alternatives

Speculative investment is a high-risk investment made in the hope of earning a relatively large
profit in a short time. The speculative investments include antiques and collectibles, call and put
options, commodities, coins and stamps and precious metals and gemstones.

A Personal Plan for Investing

Safety, risk, income, growth and liquidity affect investment choice. Exhibit 13-6 ranks alternative
investments in terms of factors that affect investment choices.


Individual must develop an investment plan and implement it in order to be successful.
Individuals begin investment planning by establishing realistic goals and then adhere to the
eight steps of personal action plan to be effective in investment.

FACTORS THAT REDUCE INVESTMENT RISK

Your Role in the Investment Process

Evaluation of an investment should begin before purchasing an investment and after it is
purchased. Some basic elements include:

Evaluate Potential Investments
When choosing an investment, the work is the time needed to research different
investments so that you can make informed decision. Successful investors evaluate their
investments and continue to evaluate their investments.

Monitor the Value of Your Investments
Close monitoring of your investments will keep you informed of whether your
investments increases or decreases. From there you know which investments to keep
and which one to dispose.

Keep Accurate and Current Records
Accurate recordkeeping can help you spot opportunities to maximize profits or reduce
losses when you sell your investments or in making decision whether to add or minus on
the investments.

Other Factors that Improve Investment Decisions

To achieve financial goals, you can to the experts for advice such as lawyers, accountants,
bankers, stockbrokers or insurance agents but bear in mind they are specialist in only their
areas. Financial planner is also a source since they are trained in securities, insurance, taxes, real
estates and estate planning. Tax consequences must always be taken into consideration when
selling your investments.

SOURCES OF INVESTMENT INFORMATON


To be well informed when making investments decisions, you must be guided by appropriate
information. You must be selective in the type of information that you use for evaluation
purposes. The sources are the internet, newspapers and news programs, business periodicals
and government publications, corporate reports and investor services and newsletters.