By Chris Goodmacher
Daily Bruin Contributor You’ve all heard the story ““
your cousin’s friend gets a “hot tip,” plunks
down $1,000, and boo-yah, he comes out a millionaire three months
later. As common as these stories may be, most are exaggerated, and
the stories of spectacular investment failures are more common.
With the expansion of the Internet and the new global economy, more
students are exercising their investing power, for better or
worse.
Investing basics There are a number of basics regarding
investments everyone should be aware of, and experts say one of the
best things to do is to be informed. Resources to look into include
books, reputable Web sites, investment clubs, classes and college
seminars. Once you have a good idea of what’s what, decide
how much you are willing to risk. When you take on more risk, you
increase your potential for reward, but also your potential for
loss. Then, experts say, figure out what investment tools fit your
needs and your time frame, when you will need the money. “The
amount of money you invest, and the manner in which you invest it
must be considered in the time frame you’re going to be
investing,” said Eric Sussman, professor at The Anderson
School at UCLA. For example, if you’re saving up for a
college you’re going to go to in a few months, you probably
want to put your money in a safe place, because it would be
disastrous to lose that money and not be able to pay for college.
Also, investing in a variety of things minimizes losses. “The
important thing is to diversify. You don’t want to put all
your eggs in one basket,” said Henry Chang, internal vice
president of the Undergraduate Investment Society. The most common
tools investors use cover a broad spectrum.
Stocks Buying stocks means buying into ownership of a company,
with shares being a fraction of that ownership. Along with that,
investors also get a piece of their profits. As an example,
let’s say a company is determined to be worth $5,000 by
investment bankers. The owners of the company want to divide it
into 500 shares, and this makes the price of shares $10 each. Once
they go public and the shares can be traded by anyone, the price
fluctuates. “(The price of shares) is determined by the
supply and demand balance, what people think the stock is
worth,” said Arun Chikyarappa, President of the UIS. There
are indexes that consist of various stocks whose collective
performance, their average, is used to indicate the health of the
market and the economy. The Dow Jones Industrial Average tracks the
30 biggest companies in the U.S; the NASDAQ 100 index tracks 100
major technology companies; and Standard & Poor’s 500
Index is an index of the 500 largest companies in the U.S.
“The S&P 500 is a better indicator of how the economy is
going,” Chikyarappa said. The S&P 500 has a history of
giving an average long-term yield of about 11 percent annually,
Chang said. This means that all those companies together go up in
value an average of about 11 percent each year. This growth is
explained by the fact that these are the leaders of the industry
and the U.S. economy normally grows steadily, he added.
Bonds A bond is a loan, and whoever buys one is the lender. The
borrower is whoever issued it, and could be the government, a
state, a local municipality, or a corporation. When you buy a bond,
you pay its “face value.” Once you buy it, the issuer
promises to pay you back on a particular day, the “maturity
date,” at a predetermined rate of interest, the
“coupon,” according to SmartMoney.com, an online
magazine of personal business run by the Wall Street Journal. For
example, if you buy a bond with a $1,000 face value, a 5 percent
coupon and a 15-year maturity, you would collect interest payments
totaling $50 in each of those 15 years. When the 15 years were up,
you would get your $1,000 back. A key difference between stocks and
bonds is that with bonds the principal (the initial investment) and
the interest are guaranteed by the issuer. Stocks offer no such
guarantee, but bonds are not without risk. “Bonds are
categorized along a spectrum of risk. At the top of the heap are
riskless bonds. Risk is the likelihood that you get your money
back,” Sussman said. “The least risky are the U.S.
Treasury bonds. At the other end are junk bonds, which
doesn’t mean they’re junk, they’re just a lot
higher risk,” he continued. They involve a $1,000 minimum
bond purchase usually, according to Sussman.
Mutual funds A mutual fund is a single portfolio of stocks,
bonds, and/or cash managed by an investment company on behalf of
many investors. “A mutual fund is, for example, where you
could take $1,000 from 20 people, and then you would have $20,000,
and now you can buy shares in lots of companies,” Sussman
said. If someone only had $1,000 to invest, there would be a
limited number of things they could invest just $1,000 in. Mutual
funds let investors spread a smaller amount of money over a wide
range of investments, adding the security of diversifying. But
there are fees involved, and fund managers have pressure to beat
the market, making them take some risks, according to Sussman.
Beating the market means doing better than the average increases on
the stock indexes, such as the S&P 500.
Money market funds These are mutual funds, except they
don’t invest in stocks; instead they invest in low-risk,
short term investment tools, like U.S. Treasury Bills, which are
bonds that last for less than 13 months. No money market fund has
paid out less than its original investment in 15 years, and in
their 25-year history, they have had a better overall track record
than banks, according to finance.yahoo.com. “Money market
funds are near the bottom of the risk totem pole. You’re not
going to get rich, but they’re safe,” Sussman said.
Certificates of Deposit The principle behind CDs, which are
similar to money market funds, is an investor lends a bank their
money (as little as $100, but often $1,000 or more) for a specific
amount of time. In return, the investor receives a set amount of
annual interest on the loan. When the CD contract ends, the
investor gets their initial investment back. With CDs, the
investment is insured and investors know what they are getting, but
returns are small. Also, the money invested is stuck there and if
you want it back early, there is usually a penalty. Even on a
one-year CD, investors pulling their money out early might be
penalized three months’ worth of interest, according to
finance.yahoo.com.
Individual Retirement Accounts IRAs are personal retirement
savings plans, which allow investors to set aside money until they
reach retirement age. This money earns interest, which isn’t
taxed until it is withdrawn it, and with Roth IRAs, not even then.
The key device here is compound interest, which makes investments
grow fairly large given a long enough time. “If you’re
interested in the very long term, the way to go for most students
is the Roth IRA,” Sussman said. Roth IRAs have become more
popular lately, though they do have a downside. Only $2,000 ($4,000
if married) can be put into a Roth IRA in one year, and like other
IRAs, that money is locked up for a long time.
Watch your back Other investment tools include commodities,
options, and futures. “(Options and futures) are extremely
high-risk. Most people would be better served by not touching
them,” Sussman said. “They’re used for
speculation, which is not investing in my opinion. If you want to
bet, head to Vegas and throw the dice.” But not everyone
agrees with this. “There is a lot of speculation, more so
with futures, but if you believe in the industry, it’s a
vehicle to use,” Chang said. “Again, it’s a risk
tolerance issue.” Different people have different investment
needs, and different tolerances of risk. There is also a slew of
strategies to maximize returns that investors use. Some trade
frantically every morning, while others put their money into a
safer account and wait until they retire. A disclaimer that often
comes along with any advice on investing is, as Chikyarappa said,
“Do your own independent research.”