Personal Finance CH 13

The possibility of an economic crisis underscores the importance of managing your personal finances and your investment program. six steps you can take to manage your money—especially if you think the economy is headed for a downturn.

1. Establish a larger than usual emergency fund. 2. Know what you owe. 3. Reduce spending. 4. Notify credit card companies and lenders if you are unable to make payments. 5. Monitor the value of your investment and retirement accounts. 6. Consider converting investments to cash to preserve value.

The following questions will help you establish valid investment goals.

1. How much money do you need to satisfy your investment goals? 2. How long will it take you to obtain the money? 3. How much risk are you willing to assume in an investment program? 4. What possible economic or personal conditions could alter your investment goals? 5. Are you willing to make the sacrifices necessary to reach your investment goals? 6. What will the consequences be if you don't reach your investment goals? 7. Considering your economic circumstances, are your investment goals reasonable?

Corporate bond

A corporation's written pledge to repay a specified amount of money with interest.

Dividend

A distribution of money, stock, or other property that a corporation pays to stockholders.

Speculative investment

A high-risk investment made in the hope of earning a relatively large profit in a short time.

Government bond

A written pledge of a government or a municipality to repay a specified sum of money, along with interest.

Assess how safety, risk, income, growth, and liquidity affect your investment decisions.

All investors must consider the factors of safety, risk, income, growth, and liquidity. Especially important is the relationship between safety and risk. Often, investors may experience two types of risk: a risk you will not receive periodic income payments and a risk that an investment will decrease in value. As a result, all investors must evaluate their tolerance for risk. Basically, this concept can be summarized as follows: The potential return for any investment should be directly related to the risk the investor assumes.In fact, some investors calculate a rate of return to determine how much you actually earn on an investment over a specific period of time. The risk factor can be broken down into five components: inflation risk, interest rate risk, business failure risk, market risk, and global investment risk. Income, growth, and liquidity may also affect your choice of investments.

Expense ratio

All the different management fees and fund operating costs for a specific mutual fund.

Emergency Fund

An amount of money you can obtain quickly in case of immediate need.

Mutual fund

An investment company that pools the money of many investors—its shareholders—to invest in a variety of securities.

Explain how asset allocation and different investment alternatives affect your investment plan.

Asset allocation is the process of spreading your assets among several different types of investments to lessen risk. Typical asset classes include large-cap stocks, midcap stocks, small-cap stocks, foreign stocks, bonds, and cash. The percentage of your investments that should be invested in each asset class is determined by your age, investment goals, ability to tolerate risk, how much you can save and invest each year, the dollar value of your current investments, the economic outlook for the economy, and several other factors. Typical long-term investment alternatives include stocks, bonds, mutual funds, and real estate. More speculative investment alternatives include options, commodities, derivatives, and collectibles. Before choosing a specific investment, you should evaluate all potential investments on the basis of safety, risk, income, growth, and liquidity. With all of these factors in mind, the next step is to develop a personal plan for investing to help you accomplish your goals.

Use various sources of financial information to reduce risks and increase investment returns.

Because more information on investments is available than most investors can read and comprehend, you must be selective in the type of information you use for evaluation purposes. Sources of information include the internet, newspapers and news programs, business periodicals, government publications, corporate reports, investor services, and newsletters.

Maturity date

For a corporate bond, the date on which the corporation is to repay the borrowed money.

Describe why you should establish an investment program.

Investment goals must be written, specific, and measurable and should be classified as short-term, intermediate, and long-term. Before beginning an investment program, you should perform a financial checkup to make sure your personal financial affairs are in order. This process begins with learning to live within your means, including managing your credit card debt. The next step is to accumulate an emergency fund equal to at least three to six months' living expenses. Then it is time to save the money needed to establish an investment program. Because of the time value of money, even small investments can grow to substantial amounts over a long period of time.

Recognize the importance of your role in a personal investment program.

It is your responsibility to evaluate and to monitor the value of your investments. Accurate record keeping can also help you spot opportunities to maximize profits or reduce losses when you sell your investments. These same detailed records can help you decide whether you want to invest additional funds in a particular investment. To achieve their financial goals, many people seek professional help. If you choose to use a financial planner or other professional, keep in mind that you are the one who must make the final decisions with the help of the professionals. Finally, it is your responsibility to determine how taxes affect your investment decisions.

Equity capital

Money that a business obtains from its owners.

Liquidity

The ability to readily convert financial resources into cash without a loss in value.

Line of credit

The dollar amount, which may or may not be borrowed, that a lender makes available to a borrower.

Business cycle

The increase and decrease in a nation's economic activity.

Rate of return

The percentage of increase in the value of savings as a result of interest earned; also called yield.

Asset allocation

The process of spreading your assets among several different types of investments (sometimes referred to as asset classes) to lessen risk.

Economics

The study of how wealth is created and distributed.

To be useful, investment goals must be _____, _____, and ______.

written specific measurable