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Part II – Investment School

Basic Concepts

Profit Drivers

Interest (Yield)

This refers to how much your asset is returning as percentage of its value. For example, an asset that is worth 100 at the beginning of the year and has a 10% will pay its holder 10 over the course of the year.

Compounded Interest

Interest accumulates on top of itself every year if you continue investing helping you accelerate the growth of your investment. This idea explains why the earlier you start, holding everything else constant, your investment will grow faster due to compounding interest.

Dividend

A payment made by a company (e.g. monthly, quarterly, annually) to reward stockholders with some of the company’s earnings.

Cost Drivers

Inflation

Refers to how much price levels increase year by year. If you do not invest your money inflation will erode the value of that money so you will actually be losing money every year. Furthermore, inflation should be taken into consideration to calculate the real return of your investment. If your assets returns 6% per year but inflation was 1%, then your real return adjusted for inflation is 5%.

Commissions (Fees)

How much you to investment services and banks to for their services (trading, management, etc.)

Taxes

Investing is subject to taxation so be sure you comply with your local, state and federal taxation system.

Marketplace

Exchange

It is a market where buyers and sellers exchange assets. An exchange is usually based around an asset class (e.g. stock exchanges, commodity exchange, etc.)

Brokers

They are the intermediaries between you and the market. Through their platforms brokers allow you to trade your assets.

Liquidity

How easy is it to convert your asset into cash? If you own an obscure stock with very low trading volume it might be difficult to find a buyer for that stock

Asset Classes

Asset (Security):

An asset is an anything with economic value which can be owned or controlled.

There are many classes of assets. Some of the main ones include:

Equity (Stock)

Equity is an asset that represents ownership over a portion of a company.

Bond (Fixed Income)

Bond is an asset that represents ownership over a portion of a debt of a company or government. Think about it as money that you lend to a company or government in exchange for a fixed interest rate over a fix period of time.

Cash and Cash Equivalents

Cash is the most liquid asset since you can use it to buy/sell pretty much anything. Other assets have similar liquidity to cash and they are known as cash equivalents (Certificates of Deposits, Money Mutual Fund, Treasury Bills, etc.). However, unlike cash, they due to tend to pay a low interest even if they are relatively risk free.

Commodity

Commodity is any good that can be exchanged for another unit of that same type of good. In investing it usually refers to natural resources such as gold, coffee, oil, natural gas, coal, etc.

Alternatives Assets

Alternative Assets are a variety of asset classes and investment products with higher expected profit margins but also higher risk. That is why these typically make a very small portion of your portfolio. Also many of these products are limited to institutional investors (e.g. corporations, governments, pension funds, etc.)

Examples of alternative assets could be investments in real estate, hedge funds, private equity, venture capital, foreign exchange or derivatives.

Funds

Mutual Funds

Mutual Funds are a collection of stocks, bonds or asset classes put together and managed by an investment company that charges investors of the fund a fee for managing their assets.

Index Funds

Like a mutual fund an index fund is a collection of assets but, instead of being chosen on their return potential, an index fund contains all the different types of asset that make up a specific index (e.g. Dow Jones, S&P 500, NASDAQ) in hopes of mirroring the market and provide a good return.

Exchange-Traded Funds

ETF’s are similar to index funds in that they cover a collection of assets but they are structured differently. While you buy shares of an index fund or a mutual fund directly from investment company that manages it, an ETF behaves similarly to a stock in that it is traded in an exchange. This tend to make them more cost effective and easier to trade multiple times a day.

Portfolio Management

Portfolio

Your portfolio is the basket of all the different type of assets that you own.

Asset Allocation

Whether you build your own portfolio or have an automated service do it for you, you will have to choose how you allocate your assets based on your risk profile and your goals. For example, you might allocate a large percentage of your investment in stocks if you expect a higher return but are willing to accept a higher risk of losing money.

Diversification

We have all heard about how important it is to not but all your baskets in one basket and the same applies when building your portfolio. You can diversify your portfolio by acquiring assets that are already diversified so to speak (e.g. see ETF above) or you could build a portfolio with different asset classes across industries to minimize your risk.

Passive vs. Active

When it comes it comes to investing there are different strategies and styles. However, all investors need to know whether they want to actively or passively manage their investments. Active investors tend to constantly shift their portfolio mix in order to maximize gains. Passive investors tend be less involved day-to-day with their investments.

Dollar Cost Averaging

You might see this term thrown around. It means that one should invest smaller amounts of money across a period of time and not all at once in order to minimize loss due to market volatility.

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