Investing 101

What is investing?

The act of committing money or capital to an endeavor with the expectation of obtaining an additional income or profit.

In other words, investing means putting your money to work for you. It’s a different way to think about how to make money. Most of us were taught the only way to earn an income was by getting a job and working. And that’s what most of us do. There is a problem with this though – if you want more money you have to work more hours, and there are only so many hours in a day that we can work, therefore limiting our income – and leisure time to enjoy it. Because you can’t duplicate yourself to increase your working time, you need to send an extension of yourself to work – your money!

Making your money work for you maximizes earning potential whether or not you receive a raise, work overtime, or search for a higher paying job.

The Investor Wealth Cycle

The longest stage in the Investor Wealth Cycle, defined as participants with 10 years or longer until their planned retirement date. Generally, investors in the accumulation stage have a higher risk tolerance and larger equity allocations in the investment portfolio.

As investors near retirement, people tend to be more conservative to maintain the growth of the account and plan for distribution. Incurring large market losses before your retirement years, without the time to let the markets recover, can be disastrous. This is one to the most complicated stages as the proper balance needs to be allocated to your funds to keep up with inflation and protect your downside.

The primary concern in retirement is to plan distributions accordingly so retirees do not outlive their assets. Generating income from retirement assets can be a challenge, especially because the money may need to last 20 years or more. Call us create an income distribution strategy for your retirement assets.

What is it?


When you want to borrow money to buy a car or renovate your home, chances are you go to a bank or a local credit union. When a company wants to expand its business or when a government wants to update the utility system, it issues bonds. Because bonds provide the capital that many institutions need to keep moving ahead, the bond market is also referred to as the capital market.

A bond is a loan between the investor who purchases it and the company or government that issues it. The bond’s issuer promises to repay the loan on a certain date and to pay interest at a fixed rate. Bonds that are issued by local and state governments and the U.S. government have one more feature: the interest income they pay is generally exempt from some or all taxes.

A wide variety of bonds
The bond market is the world’s biggest financial market. In addition to corporate and government bonds, there are bonds backed by home, car and school loans. There are high-yield bonds whose issuers don’t have stellar credit ratings. There are bonds with short-, intermediate- and long-term maturities. And there are bonds that involve special wrinkles, such as call features, insurance and floating rates.

Investing for income and appreciation
Because bonds pay regular interest, investors often buy them as a source of income. But like stock, a bond’s value can rise and a bond may be sold for more than its face value. Bond mutual funds let investors reinvest income to purchase more shares. However, a bond fund’s shares can fluctuate in value because the fund must value its holdings every day to reflect what investors would be willing to pay for them in the secondary markets.

Bond market risks
There are special risks associated with certain segments of the bond market. However, rising interest rates and default risk are common to most market segments.

  1. Interest rate risk
    Generally speaking, when interest rates rise, the market price of a previously issued bond declines because newly-issued bonds offer to pay higher interest. Conversely, when interest rates come down, older bonds that pay higher interest become more valuable. Changing interest rates don’t affect the bond investor who holds a bond to maturity. And, the impact of changing interest rates differs from one type of bond to another.
  2. Default risk
    If a bond issuer falls on hard times, it may default on its interest payments or even on its return of principal at maturity. Most bonds are rated by independent rating agencies, and ratings serve as a guide in assessing a bond’s level of risk. U.S. government bonds are the highest quality bonds because there is little risk that the federal government will default.


When a company decides it needs to raise funds for future growth, it can borrow money or issue stock. Investors who buy stock actually own a share of the company. Shareholders stand to profit when the company you invest in does well and also includes certain voting privileges when it comes to important policies.

There are two ways your investment in a stock grows. First, if the share prices increases from the price you paid (cost basis), you sell at a profit. The second is when the company declares a dividend; you can collect them as income or reinvest to buy additional shares.

As a shareholder, the potential for gain is unlimited. However, a stock can also lose value if the price falls below your investment due to a decline in company profits or higher competition. National, world or economic news has historically had effects on the stock market causing volatility.

Click here to see a history of the S&P 500 Index from 1973 to 2008.

A strategy to manage the risk of investing in the stock market is to invest in a broad range of companies in different industries to achieve diversification. Millions of investors purchase professional managed mutual funds to participate in the equity market with a lower investment and more opportunity to buy and sell.

Mutual Funds

By pooling the money of many investors with similar financial goals, a mutual fund can do for you what you can’t do easily on your own: Buy and sell securities with the benefit of professional research and management and relatively low trading costs. Mutual funds make it possible to own a piece of hundreds of different securities with a relatively small investment. An open-end mutual fund will buy back or redeem your shares at any time. Shares of closed-end funds trade on exchanges like individual stocks.

Different fund types
There are dozens of different types of mutual funds. Some funds are defined by the markets they invest in—U.S. stocks, international stocks, emerging market stocks, high yield bonds, for example. Others reveal something about their investment style in their name, such as dividend achievers, growth, value or small cap. According to the Investment Company Institute, there are approximately 8,000 mutual funds available to U.S. investors.

How mutual funds work
When you invest in a mutual fund, you purchase shares, based on a current net asset value (NAV), plus any sales charge. A sales charge is used to help compensate your financial professional for working with you to develop a strategy and choose funds that can help you achieve your personal goals.

A mutual fund can make money through capital appreciation, income or both.

  1. Capital appreciation
    When the securities in the fund increase in value, the fund’s share price increases.
  2. Income
    When a fund receives dividends or income, it is distributed to shareholders.

Of course, your shares may also decrease in value. How do you know how much your fund shares are worth? Funds are required to recalculate their NAV every business day. As a result, a fund’s value fluctuates. Investors can track a fund’s share price in the financial pages of major newspapers, online and over the phone by calling the fund family.

Mutual funds are exposed to the risks associated with the specific markets they invest in and the investment strategies they follow. For example, a mutual fund that invests in the U.S. stock market is exposed to economic news, corporate profit reports and changing interest rates. An international stock fund is also exposed to currency risk and political uncertainty. Keep in mind that most mutual funds are intended as long-term investments, and investment risk tends to decline over the long term.

Exchange-Traded Funds (ETFs)

An ETF is a combination of an index fund that trades like a stock. It is a security that tracks an index, commodity, or a basket of assets and experiences prices changes throughout the day as they are bought and sold.

Investing in a variety of ETFs broadens the investor’s exposure to the stock, bond, and global markets. ETFs are a unique investment as they are highly tax-efficient.

Variable Annuity

Variable annuities are tax-deferred investments structured to pay benefits over a set number of years and may include a death benefit. The investment portion of the annuity consists of various subaccounts allocated to suit your investment style and goals.

When appropriate, variable annuities are used for the additional features, or riders, available for an additional fee that must be selected at time of initial investment. Most common are the following:

  • Guaranteed Minimum Income Benefit (GMIB): ensures that the annuity payments are a least a specified minimum amount, even if the underlying investment performs poorly.
  • Guaranteed Minimum Withdrawal Benefit: (GMWB): If the principal of the variable annuity shrinks due to a market downturn, the rider is used to recoup the amount of your entire initial investment.
  • Guaranteed Lifetime Withdrawal Benefit (GLWB): This rider guarantees income payments for life with no regard to the account balance or market performance.

Fixed Annuity

The fixed or multi-year guarantee, annuity is a conservative accumulation solution where the rate is fixed and the risk is low, similar to a bank certificate of deposit (CD).

Interest earned is tax-deferred during the accumulation period. What does that mean? The interest you earn from a tax-deferred annuity is neither reportable nor taxable until it is withdrawn. When income is needed, typically in retirement after peak earning years, you are more likely to be in a lower tax bracket; therefore fewer taxes may be due.

The chart compares the annual value of a $50,000 deposit in an MYGA and a CD. The assumed interest rate on both is 4.00%. If you are in the 25% tax bracket, you would pay taxes on the earnings annually on the CD while the earnings in the MYGA are deferred and continue to build value. After 5 years the difference between the two is $2,935, more significantly, after 10 years the difference is $6,997.

The Markets

Dow Jones

The Dow Jones Industrial Average is a price-weighted average of 30 significant stocks created in 1896. It is the single most watched index in the world.

As of December 1, 2011 the components included the following companies:

  • 3M
  • Alcoa
  • American Express
  • AT&T
  • Bank of America
  • Boeing
  • Caterpillar
  • Chevron Corporation
  • Cisco Systems
  • Coca-Cola
  • DuPont
  • ExxonMobil
  • General Electric
  • Hewlett-Packard
  • The Home Depot
  • Intel
  • IBM
  • Johnson & Johnson
  • JPMorgan Chase
  • Kraft Foods
  • McDonalds
  • Merck
  • Microsoft
  • Procter & Gamble
  • Travelers
  • United Technologies
  • Verizon
  • Wal-Mart
  • Walt Disney

The components of the DJIA have changed 48 times in its 114 year history. When companies are replaced, the scale factor used to calculate the index is adjusted so that the value of the average remains the same. A summary of the more recent changes to the index include the following:

  • On February 19, 2008, Chevron and Bank of America replaced Altria Group and Honeywell. Chevron had previously been a Dow component from July 18, 1930, to November 1, 1999.
  • On September 22, 2008, Kraft Foods replaced the American International Group (AIG) in the index.
  • On June 8, 2009, General Motors and Citigroup were replaced by The Travelers Companies and Cisco Systems, which became the third company traded on the NASDAQ to be part of the Dow.

S&P 500

The S&P 500 is an index of 500 stocks chosen for market size, liquidity and industry grouping, among other factors. The S&P 500 is designed to be a leading indicator of U.S. equities and is meant to reflect the risk/return characteristics of the large cap universe. Companies included in the index are selected by the S&P Index Committee, a team of analysts and economists at Standard & Poor's. The S&P 500 is a market value weighted index - each stock's weight is proportionate to its market value.

The S&P 500 is one of the most commonly used benchmarks for the overall U.S. stock market. The Dow Jones Industrial Average (DJIA) was at one time the most renowned index for U.S. stocks, but because the DJIA contains only 30 companies, most people agree that the S&P 500 is a better representation of the U.S. market. In fact, many consider it to be the definition of the market.

A number of financial products based on the S&P 500 are available to investors. These include index funds and exchange-traded funds. However, it would be difficult for individual investors to buy the index, as this would entail buying 500 different stocks.

Investing Strategies

Buy Low, Sell High

“Be Fearful when others are greedy, and greedy when others are fearful.” –Warren Buffet

Dollar Cost Averaging

Dollar Cost Averaging is a mutual fund accumulation and purchasing strategy. This strategy allows the individual to purchase more shares when prices are low and fewer shares when prices are high. In fluctuating market overtime, the average cost per share is lower than the average price of the shares.

Investment Date Amount Invested Price Per Share Shares Bought
7/1/10 $1,000 $15 66.67
8/1/10 $1,000 $10 100
9/1/10 $1,000 $20 50
Total Invested: $3,000
Number of Shares Purchased: 216.67
Average Price of Shares Traded: $15
Average Cost Per Share: $3,000 ÷ 216.67 = $13.85

DCA does not guarantee profits in a declining market because prices may continue to decline for some time.

Rule of 72

In finance, the Rule of 72 is a method used for estimating an investment’s doubling time. If you take 72 and divide it by the interest rate, the result is the number of years it will take for your money to double.

Example: At 30 years old, you have a lump sum investment of $10,000 that you would like to invest until retirement at age 65. How long would it take to double? How many times would it double if you had 35 years to invest? What is the end result?

Estimated Annual Return Time Until First Double (72 ÷ x%) Number of Doubles Possible Over 35 Years (35 ÷ yrs to double) Value of $10,000 After 35 years
4.00% 18 years 1.94 $38,800
8.00% 9 years 3.88 $72,800
12.00% 6 years 5.83 $292,800

Timing the Market

The temptation to time the market is understandable. Everyone wants to be invested on days when the market is up and out of the market on days it’s down. However, even experienced investment professionals are reluctant to make timing predictions about the stock market. Why? You have to be right twice; on the way in AND on the way out.

Missing key days in the market can have a significant impact on long-term results. Investors who pull their money out of equities in volatile times risk missing some of the stock market’s biggest gains. Many of the best days in the market follow the worst days, and usually occur when many market timers are still sitting on the sidelines.

It’s Time that counts, not Timing. The table shows that investors, who missed the market’s best days for the 20 year period, earned an average of 3.50% less per year than those who never left the market through all the ups and downs.

Standard & Poor’s 500 Index. Source: Prudential Investments, LLC.