Wise investing requires knowledge of key financial concepts and an understanding of your personal investment profile and how these work together to impact investing decisions.   We will:
 
 Discuss the difference between saving and investing
 Illustrate the risk/rate-of-return tradeoff
 Explain the importance of the time-value of money and asset allocation
 Challenge you to think about your personal risk tolerance 
 Help you to recognize that your tax bracket, financial goals and time horizon are key factors in defining an appropriate investment plan and asset mix for you and your family.

The Difference Between Saving and Investing

Even though the words "saving" and "investing" are often used interchangeably, there are differences between the two.

Saving provides funds for emergencies and for making specific purchases in the relatively near future (usually three years or less). Safety of the principal and liquidity of the funds (ease of converting to cash) are important aspects of savings dollars. Because of these characteristics, savings dollars generally yield a low rate of return and do not maintain purchasing power.

Investing, on the other hand, focuses on increasing net worth and achieving long-term financial goals. Investing involves risk (of loss of principal) and is to be considered only after you have adequate savings.

Investment Return

Total return is the profit (or loss) on an investment. It is a combination of current income (cash received from interest, dividends, etc.) and capital gains or losses (the change in value of the investment between the time you bought and sold it). The published rate of return for a selected investment is usually expressed as a percentage of the current price on an annual basis. However, the real rate of return is the rate of return earned after inflation, which is further reduced by income taxes and transaction costs.

Risk

ALL investments involve some risk because the future value of an investment is never certain. Risk, simply stated, is the possibility that the ACTUAL return on an investment will vary from the EXPECTED return or that the initial principal will decline in value. Risk implies the possibility of loss on your investment.

Factors which affect the risk level of an investment include:

 Inflation
 Business failure
 Changes in the economy
 Interest rate changes.
 
The Risk / Rate-Of-Return Relationship

Generally speaking, risk and rate of return are directly related. As the risk level of an investment increases, the potential return usually increases as well. The pyramid of investment risk illustrates the risk and return associated with various types of investment options. As investors move up the pyramid, they incur a greater risk of loss of principal along with the potential for higher returns.

Diversification

You can do several things to offset the impact of some types of risk. Diversifying your investment portfolio by selecting a variety of securities is one frequently used strategy. Done properly, diversification can reduce about 70% of the total risk of investing. Think about it. If you put all of your money in one place, your return will depend solely on the performance of that one investment. Alternatively, if you invest in several assets, your return will depend on an average of your various investment returns. Here are three basic ways to diversify your investments:

 By choosing securities from a variety of asset classes, e.g. a mix of stock, bonds, cash and real estate
 
 By choosing a variety of securities or funds within one asset class, e.g. stocks from large, medium, small and international companies in different industries
 
 By choosing a variety of maturity dates for fixed-income (bond) investments.
 
By diversifying, you won. t lose as much as if you invested in just one security right before its market value goes down. However, if the market goes straight up from the time you started, you won. t make as much in a divserified portfolio either. However, historically most people are concerned about protection from dramatic losses.

Dollar-Cost Averaging

Another technique to help soften the impact of fluctuations in the investment market is dollar-cost averaging. You invest a set amount of money on a regular basis over a long period of time. regardless of the price per share of the investment. In doing so, you purchase more shares when the price per share is down and fewer shares when the market is high. As a result, you will acquire most of the shares at a below-average cost per share.

As most investors know, market timing . . . always buying low and selling high . . . is very hard to accomplish. Dollar-cost averaging takes much of the emotion and guesswork out of investing. Profits will accelerate when investment market prices rise. At the same time, losses will be limited during times of declining prices. For most people, dollar-cost averaging is not so much a way of making extra money as a way to limit risk.

The Time-Value of Money

Now that you understand the concepts of risk and return, let. s turn to an element that is at the heart and soul of building wealth and financial security...TIME.

Compounding also applies to dividends and capital gains on investments when they are reinvested.

Asset Allocation

In the final analysis, your overall investment return will be closely associated with the asset categories and allocations that you select. An investor. s group of investments, frequently called an investment portfolio, can be divided in numerous ways among stocks, bonds and cash management options. You might choose a 20/40/40 portfolio . . .20% stocks, 40% bonds and 40% cash options. Or . . . a 75/20/5 ratio . . . 75% stocks, 20% bonds, and 5% cash.

Several factors will impact the exact rate of return that you receive on your investment portfolio. Studies show that the most important one, asset allocation, will account for about 90% of your return. The selection of individual securities and market timing will account for the remaining 10% or so.

The critical question, of course, is: "What is the ideal asset allocation for you?"

Here are several factors to consider as you make this decision.

Your Investment Goals
Goals are specific things (e.g., buy a car) that people want to do with their money. As discussed in Unit 1, as people move through various life stages, their needs and financial goals change. Your selection of investments should relate closely to your financial goals; each goal will define the amount and liquidity of the money needed as well as the number of years available for the investment to grow.

Your Risk Tolerance
Risk tolerance is a person. s emotional and financial capacity to ride out the ups and downs of the investment market without panicking when the value of investments goes down. Risk tolerances vary widely. Some are associated with personality factors, while others are based on changing needs dictated by your stage in the life cycle. If you won. t sleep well at night when the principal value of your investment goes down, you should select saving and investment options with lower risk. On the other hand, it. s important to realize that investments which guarantee the safety of principal will not grow your money quickly and may not maintain purchasing power in times of inflation or over a long time span. In reality it. s necessary to take some risk just to maintain purchasing power. The question is: "What kind of risks are you willing to take?"

Your Time Horizon
As discussed earlier, time is a very important resource to investors. For example, young investors with a long time horizon may choose investments that exhibit wide price swings, knowing that time is available for fluctuations to average out. Families investing for a specific mid-life goal (e.g., funding a child. s education or purchasing a home) may choose a more moderate course which has opportunity for growth, but guarantees more safety for the principal. Individuals nearing retirement and those with the need to depend on investment income to cover daily expenses, may wish to select investments that lock in gains and provide a guaranteed income stream.

Your Tax Situation
The return on any investment is influenced by your federal, state, and local tax situation. Before selecting an investment, learn its tax consequences for you. Remember, what counts is not what you make on an investment, but what you get to keep both now and in the long run.