2005 Year in Review

Retirement Challenge: Learn About Investments the Easy

Source: Karen Chan, Extension Educator Consumer and Family Economics; Countryside Extension Center; University of Illinois; 708-352-0109

“Investing is just so confusing.” “Most of what I read about investing goes right over my head.” Many people share those feelings. It’s especially frustrating because there’s a lot at stake. Most employers now offer the type of retirement plans in which employees must choose their own investments, and poor choices could mean delaying retirement.

Karen Chan, a Certified Financial Planner and educator in Consumer and Family Economics with University of Illinois Extension, says that understanding investing can be easy. “Picture this scenario: Laura is going to open a retail clothing store, In Style. To raise money, Laura could get a loan and she could take a partner. She borrows $50,000 from Jamie. The loan is set up so that Laura will make interest-only payments twice a year for ten years. The principle ($50,000) will be due in 10 years. At 8% simple interest, Laura will pay Jamie $2000 each January and July. She also sells 10% of the business to Cheryl for an investment of $50,000. So Cheryl becomes a partner.”

Chan then “fast-forwards” 10 years into the future. “In Style turns out to be the right store at the right time and Laura is a phenomenal business woman. They’ve got stores opening everywhere. Jamie has received a total of $40,000 in interest over the ten years, and now Laura writes a check to Jamie paying back the original loan amount of $50,000. At the same time, Cheryl has decided to sell her part of the business. The business is now worth $5 million. Cheryl sells her 10% share for $500,000.”

Jamie and Cheryl invested the same amount of money. So why did Cheryl deserve to make a $450,000 profit while Jamie only got $40,000? Many people see the answer right away: Cheryl took more risk. If the business had done badly, she might not have made any profit. She could have lost some or all of her original investment. Cheryl was an owner, while Jamie was a lender. If the business closed, lenders are paid before the owners. The loan to Jamie would be paid before any money was returned to Cheryl or Laura.

Now, Chan says, you can start to apply investment terminology to this scenario. ‘While this story oversimplifies some concepts, you have the basics. Instead of calling Jamie’s money a loan, let’s call it a bond. A bond is an IOU showing that you loaned a company (or a government entity) money. If In Style had been set up as a corporation instead of a partnership, Cheryl would have been a stockholder instead of a partner. She would have owned shares of stock in the company. If you understand our story, you understand stocks and bonds.”

Continuing with this concrete example, Chan says that concepts such as dividends and capital gains are easy to understand. “You can even understand all the types of risk that investors face: market risk and business risk when you invest in stocks and everything from interest rate risk to purchasing power risk with bonds.”

University of Illinois Extension has made Chan’s approach for teaching the basics of investing available to anyone with an internet connection. Internet users can visit Extension’s “Plan Well, Retire Well” web site at Click Here. In the Choose Investments section, users can listen to Chan’s actual presentation, accompanied by slides to demonstrate the concepts and examples.

by  Editor, theCity1.com
August 29, 2005