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Lessons and Personal Investing

Lessons and Personal Investing
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Welcome, this is the last module of this course, Finance For Everyone. And what I wanted to do is what I've done before in my MOOCs and so on, is that I give you a lot of content for a six week course. I give you a lot of homeworks for a six week course. So what I tend to do is I try to make five weeks of it very heavy, and the sixth week is a reflection on issues. And here it will be more substantive, because we are trying to just wrap up things and connect a few things here and there.
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But also, the other aspect is, that for each week of an assignment, and for the final week, we have a final. So I've set it up so that it makes sense. That's the way it's done usually. You, of course, are in control of when and what you do, right? So think of the final module as wrap up, takeaways, and what's next.
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So, let's talk a little bit about what about finance I like. What are the lessons. The first lesson of finance that you hopefully have taken is, and I hopefully have convinced you, that's my responsibility, is that it's a way of thinking. It's not memorization. It's not about no real world applications. It's just a powerful way of thinking to help you in the real world. So I want you to recognize that and then to reflect on that. Another way to think about finance, which has been useful for me, as I find that the real world is very complex.
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The more I studied, the more difficult things seemed to be because you start doing more and more complex stuff. What finance helped me do was make the complex world easier. I think Einstein once said something to the effect that you should make complex things simpler, but not more so. So finance makes it simple enough, but keeps it challenging enough that you are always on your toes when you're applying it. The key aspect of finance which I like is there's just a few lego's if you know really well. And I, in this course, have tried to expose you to the most important one, which is time value of money.
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One aspect of finance, because of what I just said about, because it's a way of thinking, and because it's very applicable, I see it everywhere. I don't go home and open up spreadsheets and figure out what is the value of X, Y, Z. And that would be very nerdy. What it is is it's everywhere, and you can kind of think in broad, big picture ways, and then do detailed analysis wherever they are applicable. And finance is for everyone. I really mean this, and I have created this class because I see finance everywhere. And I see finance for everyone.
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And I hope the lessons that I'm talking about are making sense to you, regardless of your age, your gender, your ethnicity, where you are growing up. And one of the passions of my life is to make education accessible to everybody. Of course, you have to want to listen and participate and engage with each other. Okay? So, that's what, the second thing I wanted to cover today, is more specific, equally powerful though. And that, what we have we learned with time value of money?
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I hope you realize that time value money simple concept, but it can be applied to a lot of issues that you confront, from loans, to valuing businesses, to looking at a small decision like do I buy an iPad with a loan, take money. What is the value proposition? To make very smart decisions that are more complicated. You can go from everyday to very complicated decisions and time value money's inherent to everyday. To create value for an organization, imagine if you are instead working full time and you want to learn simple finance and apply to everything around you, you can.
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Because the same decisions that you make personally, have the same set of tools and perspective and timelines and value creation issues, organizationally. The only thing that is really changed is the eye of the beholder. And I think obviously that makes it more and more complex, but the tools and the way of thinking remains the same. Time value money is amazingly powerful. I want to talk to this in this segment a little bit about what I think the value is of Time Value of Money. Also to personal investing. I've talked about it as we have gone along. In fact, personal saving decisions, loan decisions, and all of the beginning of the course and the focus of the first two modules.
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Then we shifted to bonds a little bit which are issued by entities. Then we've been back and talk about value of decision making and then stocks which tend to be mostly corporate are entity based. Let's talk about savings and investments. One of the reasons I've left it to the end to wrap this issue up was because it kind of connects to the next important Lego of finance, which is risk and return. And we're not going to talk about it, because it requires a whole set of tools, especially statistics. So personal investing. The main thing I want to do is make it look as simple as possible, because it is.
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I think most humans, given a choice between a low return and a high return, and remember a return is what, you put in money in hope of getting something. They will mostly look for what? More return.
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There's no, I haven't met anybody who doesn't want more return. And even if it's not monetary, it could be non-monetary return, recognition. You want like more of something you like. So if this is the only thing you cared about, and go back to a financial mind frame. Where would you put all your money? So suppose you have money and you would like maximizing your return. Where would you put all of it given what we have talked about? So let's go back to bonds and stocks, the two things that you really must understand fully by now. To the extent, I mean adjusting for the fact that I'm making it available for everyone. And where will you put all your money?
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In a bond or a stock? You'll put it in the highest return because all you care about is high return. So you would invest in lot of stuff, but suppose these are the opportunities available to you. And I'm going to let this stay up. And it's also few of the data decks are, actually it's not a deck, it's a slide, that I have provided and shown you earlier. And it shows, again, the average return on small stocks, S&P 500, corporate bonds, government bonds, treasury bills. And suppose this is the only five, six possible investment opportunities available to you. In the real world, there are millions. Which one would you pick if you were only looking for high rate of returns?
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It's a no brainer. You pick investing in small stocks. Heck, even within those, you pick one with the highest rate of return in the past, assuming that you expect it to happen. That's what the expectation is. Life would be very simple if all you liked was a return, you would invest in high return. However, turns out, we do not like risk. What is our attitude towards risk? And remember what is return? Return, think about it, you don't know it in the future, but you can kind of estimate average. On average, how much more stocks paid and they are likely to pay more again, at least in the long run, in the future. But what comes with small stocks is what?
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High risk, too. And you dislike that. And that issue is a little bit hypocritical, because you want high return but you dislike risk. Well, where is the risk the highest among the things that I showed you? Among the small stocks or treasury bill? Small stocks had the highest volatility, or standard deviation, among all the possibilities I just showed you. So what is the lesson of all of this? The lesson of this is that high risk and high return go together. And one way to think about it is, it's driven by r. Love for risk, but with, I mean, a love for return. [LAUGH] I got excited there. But we are always have an eye on risk.
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And in the risk we don't like, up is okay, down, we don't. And it comes, life is tough. You get, risk comes double sided, right? Many times. So what do you do? You like return, but you dislike risk. Would you ever invest in an individual stocks? And this is the 101 of investment that can take you so far in life that you won't believe it. It's called portfolio theory. It's the basis of almost the entire development of investment. And recent actions by companies like Vanguard would show you that probably your best bet is not to create your own investment strategy. I mean, portfolio, but to pick ones that already exist. So why portfolio?
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I keep coming back to portfolio and not individual securities. If you're risk averse, we knew it in the cave, that the one thing you do is don't put all your eggs in one basket. You want to diversify. And diversification, by definition, means if I have a hundred bucks, I will not put all hundred even in the company I love. Why? Because I'll go down with it and I'll go up with it. The volatility will be much more for an individual company. And how do I get rid of that volatility? I like return. I get rid of that volatility by combining stocks. And what is the most important portfolios I've shown you again?
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I've shown you portfolios of small stocks and big stocks and S&P 500, and so on and so forth. Now let me leave you with one picture here before we take a break, and this is in some senses the essence of diversification investing. And this also will be a slide that I have given to you. It's based on publicly available data 1989 to 2008. Some stocks, the standard deviation or variance of them or change in them, but remember, you don't like risk, and the S&P 500. So, I'll just talk about them, but they're up there. You can make notes or you can just open up your little slide that I have posted for you.
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So, this time you have stocks and only one portfolio. And the stocks I have picked are Disney, AT&T, Pfizer, General Motors, Alcoa, Home Depot, General Electric, Exxon, Intel, Citibank, Proctor & Gamble. I apologized that these are all U.S. based stocks. But the purpose of this is not U.S. or China or India. The purpose is to show you something that will be true regardless of the country you are picking. Globally, this will be true. So standard it, I have listed the standard deviations. I think, I encourage you to look up the definition of standard deviation. The standard deviation of something will be zero if it never changes. And there is nothing in life like that.
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So standard deviation is how much around the average do you bounce. So for a stock price, what is it? It's the rate of return is 10%, but if it's bouncing between 15 and 25, that's one thing. Or it could be bouncing between, say, 10, I mean it's 10 on average, bouncing between 12 And 15. That's another thing. If it's bouncing between, I mean 8 and 15, because it has to be lower than 10. So how much it bounces around, around the average value is what's listed. So just as an example, if you stare at it, and hopefully this is the slide with initial stocks.
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What you'll notice first thing, there are some stocks with very high volatility, and the highest one here is Intel, 40%. The next highest is General Motors, 33%. Then there are a few 30%, right? No, there's a 31%, Citibank, and this is the volatility of the return on the stock of these companies. So you have various companies listed. Please stare at them. But when you come back, I want you to also stare at the S&P 500 and tell me what is so remarkable about these numbers. So the first ten are stocks. Famous names so that you can relate to them, and the final one is a portfolio, not a stock, a portfolio of 500 of them.
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I could have chosen a bunch of other portfolios, but I chose this one because it has got all kinds of stocks in them. Think about it. It is the 101 of diversification and can take you so far, you won't believe.
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