Finance for Academics: A Guide to Investment for Income

138 Pages·2012·0.79 MB·English

by  Ronald A. Francisco (auth.)

SpringerBriefs in Finance
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Ronald A. Francisco
Finance for Academics
A Guide to Investment for Income
123
RonaldA.Francisco
DepartmentofPoliticalScience
UniversityofKansas
Lawrence,KS, USA
ISSN2193-1720 e-ISSN2193-1739
ISBN978-1-4614-3243-2 e-ISBN978-1-4614-3244-9
DOI10.1007/978-1-4614-3244-9
SpringerNewYorkDordrechtHeidelbergLondon
LibraryofCongressControlNumber:2012933790
©RonaldA.Francisco2012
Allrightsreserved.Thisworkmaynotbetranslatedorcopiedinwholeorinpartwithoutthewritten
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ForBenjamin

Preface
I first learned about finance in 1975 when Professor Allan J. Cigler told me to
buy utility stocks because for the next 2 years their dividends would be tax free.
I did, and am forever thankful to him for getting me interested in finance and
investment.Professor Cigler played another large role about 8 yearsago when he
cametomyofficeandtoldmethatourassistantprofessorsthoughttheywouldbe
getting a pension from the university. “Oh, dear” said I, “what shall we do?” He
suggested writing somethingthat would correctthe assistant professors’views on
retirementfinance.Iaskedwhetherhewantedto doitorifhewantedmetowrite
thisdocument.Hewasbusyatthetime,soIstartedwritingFinanceforAcademics
and distributing it to my colleagues. It was not long beforethe documentgrew in
size and more academicssoughtit. These were academicsfrom all over,not only
frommyuniversity,butfrommanyothersaswell.
Over the years Finance for Academics began to spread beyond the academic
community.I foundoutthisyear thatit surfacedin Floridain an investmentclass
runbyaneconomistfromtheInternationalMonetaryFund.FinanceforAcademics
was the text for this class. That alarmed me. I decided then that I would put the
documentonmywebsiteandthoughtperhapsI shouldexpandittoprovidebetter
andmorethoroughexplanations.Theresultisthisbook.
I have tried to render the arcane world of finance somewhat simpler to a
sophisticatedaudience.Financeandinvestmenthavegrownevermorecomplicated
with new sorts of investments and derivatives of old ones. Some of the most
successful investorsare mathematicianswho can understand more easily the high
level of mathematics that is today applied to investments. I have attempted to
tone down the mathematics, but still show how some of the more important
formulaework.
TIAA–CREF is the principal retirement entity for most of us. I am somewhat
hard on TIAA–CREF in several chapters, in part because the institution is more
opaquethanitneedstobeandbecauseperformancesometimessuffer.Nonetheless,
vii
viii Preface
weareluckytohaveTIAA–CREFasa retirementincomesource.We justhaveto
dealwithitmorecarefullytoprotectourinterests.
I am grateful to my wife Deborah for putting up with this interest for many
decadesandtoourson,Christopher,amathematician,whohashelpedbyexplaining
themathematicsbehindmanyafinancialequationorformulatome.
Lawrence,KS,USA RonaldA.Francisco
Contents
1 Introduction .................................................................. 1
1.1 TheOrganizationoftheBook......................................... 2
1.1.1 Risks.......................................................... 2
1.1.2 FormsofInvestments........................................ 3
1.1.3 Dividend-GrowthStocks .................................... 3
1.1.4 BondsandBondFunds...................................... 3
1.1.5 MasterLimitedPartnerships................................. 4
1.1.6 BuildYourOwnPortfolio................................... 4
1.1.7 RetirementIncome........................................... 4
1.1.8 WhatCanGoWrong?TroubleshootingInvestments ...... 4
1.2 Principles............................................................... 5
1.2.1 MaximizeIncome............................................ 5
1.2.2 MinimizeFees................................................ 5
1.2.3 LegallyMinimizeTaxes..................................... 5
1.2.4 ReinvestDividends .......................................... 5
1.3 HowDoIStart?........................................................ 6
1.4 Let’sBegin............................................................. 6
2 Risks........................................................................... 7
2.1 EconomicRisk......................................................... 7
2.2 MarketRisk............................................................ 8
2.3 Inflation ................................................................ 9
2.4 Corruption.............................................................. 10
2.5 HighFees .............................................................. 10
2.6 TheNextNewThing .................................................. 11
2.7 CurrencyRisk.......................................................... 11
2.8 Lethargy................................................................ 12
3 FormsofInvestment......................................................... 13
3.1 Stocks .................................................................. 13
3.1.1 DirectStockPurchase ....................................... 14
3.1.2 AvoidPennyStocks.......................................... 14
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x Contents
3.1.3 StockPurchasewithaBrokerage ........................... 14
3.1.4 EquityMutualFunds,IndexandExchange-
TradedEquityFunds......................................... 15
3.1.5 Closed-EndEquityFundsandPreferredStock............. 16
3.1.6 TheEfficientMarketTheory ................................ 16
3.1.7 ValueBeatsGrowth.......................................... 17
3.2 BondsandBondFunds................................................ 17
3.2.1 IndividualBondsorBondFunds?........................... 17
3.2.2 FormsofBondsandBondFunds ........................... 18
3.3 Options................................................................. 18
3.4 ShortingStocks........................................................ 19
3.5 MasterLimitedPartnerships.......................................... 20
3.6 RealEstateandRealEstateInvestmentTrusts....................... 20
3.6.1 RealEstateInvestmentTrusts............................... 20
3.6.2 RealEstate.................................................... 21
3.7 DerivativeInvestments:BuyerBeware............................... 21
3.8 Annuities............................................................... 21
3.9 Commodities........................................................... 22
3.10 StocksandBondsRedux.............................................. 23
4 Dividend-GrowthStocks.................................................... 25
4.1 InflationasaPersistentProblem...................................... 25
4.2 Dividend-GrowthStocksasaSolution............................... 26
4.3 TheWonderofCompounding ........................................ 27
4.3.1 CompoundingExamples..................................... 27
4.3.2 TheGordonEquation........................................ 28
4.4 Dividend-GrowthStocksandExchange-TradedFunds.............. 29
4.5 TheFloatandTreasuryShares........................................ 30
4.6 ThePowerofCompounding.......................................... 32
4.7 WhytheBother?WhatAboutMutualFunds?....................... 35
4.7.1 WhichMutualFund?AtWhatCost? ....................... 35
4.7.2 FindingDividend-GrowthStocks........................... 36
4.7.3 TheIncomeAdvantage...................................... 36
4.8 SectorDiversification.................................................. 37
4.8.1 Banks......................................................... 37
4.8.2 ConsumerProducts .......................................... 37
4.8.3 Energy........................................................ 38
4.8.4 FoodandRestaurants........................................ 38
4.8.5 Manufacturing................................................ 38
4.8.6 Rails .......................................................... 38
4.8.7 Retail ......................................................... 38
4.8.8 Services....................................................... 39
4.8.9 Technology................................................... 39
4.8.10 Utilities....................................................... 39
4.9 StockSplits ............................................................ 39