INVESTINGDEMYSTIFIED
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INVESTINGDEMYSTIFIED
Paul J. Lim
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DOI: 10.1036/0071444122
PREFACE
This book is geared for all the investors and would-be investors out there who
know the importance of managing their money for the future but who aren’t
entirely certain how to go about it. That’s probably the majority of the general
population. Public opinion polls tell us that more Americans think and worry
about money—and how to invest it—than any generation in this country’s
history. Part of this, as we’ll explain, is due to the fact that more of us are
responsible for our own financial futures than ever before. Yet fewer than one
in five of us feel like we’re doing very well at this incredibly important task,
which explains why Baby Boomers and members of Generation X worry more
about their financial well-being than their own mortality.
But while investing is now a daily part of our national conversation, the
language of investing and some basic investing concepts are still foreign to
many of us. The sad reality is, no one really teaches us how to become in-
vestors. Few high schools these days even offer economics courses, let alone
lessons in personal finance or investing. Unless your parents were investors
themselves and taught you the ins and outs of the stock and bond markets,

you were probably left to figure it out on your own.
Chances are, you were thrown head first into the markets—with little clue
about how to stay afloat—the minute you started a new job and enrolled in
the company’s 401(k) retirement plan. Those enrollment papers not only ask
you if you want to participate, but what investments you want to put money
into and how much money you want to invest in each. Terms like ‘‘small-cap
growth fund’’ and ‘‘long-term government bonds’’ are thrown at us as if we
intuitively understand what all of it means. Yet in this day and age, we have to
know what these things mean to take control of our financial futures.
Hopefully, this book will answer some of your basic questions and take
some of the mystery out of investing. When you boil it down, learning to
ix
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For Shirley-Girl
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CONTENTS
Preface ix
PART 1: GETTING READY 1
CHAPTER 1 Why We Invest 3
CHAPTER 2 Before You Get Started 15
CHAPTER 3 Demystifying the Language
of Investing 30
CHAPTER 4 What Kind of Investor Are You? 58
PART 2: YOUR ASSETS 77
CHAPTER 5 Demystifying Stocks 79
CHAPTER 6 Demystifying Bonds 109
CHAPTER 7 Demystifying Cash 135
CHAPTER 8 Demystifying Mutual Funds I 146
CHAPTER 9 Demystifying Funds II 163
CHAPTER 10 Demystifying Other Assets 185

vii
For more information about this title, click here
PART 3: SELECTING YOUR ASSETS 213
CHAPTER 11 Demystifying Stock Selection 215
CHAPTER 12 Demystifying Bond Selection 242
CHAPTER 13 Demystifying Mutual Fund Selection 260
PART 4: ORGANIZING YOUR ASSETS 287
CHAPTER 14 Demystifying Asset Allocation 289
CHAPTER 15 Demystifying Asset Location 309
Final Exam 325
Glossary 333
Answer Key 353
Index 357
CONTENTS
viii
invest is really a four-step process. First, you have to figure out who you are
and what kind of investor you plan to be. Then, you have to become familiar
with the assets that serve as the building blocks to an investment portfolio.
Then you have to figure out how to research and select those assets. And fi-
nally, you have to learn how to mix and organize those assets into a com-
prehensive and diversified portfolio that will serve your specific set of needs.
Let’s outline how we hope to address these topics in the coming chapters.
Getting Ready
In Part One, ‘‘Getting Ready,’’ we want to familiarize you not only with the
basic concepts of investing—like risk and returns—but also investing jargon.
We begin in Chapter 1 with a discussion on ‘‘Why We Invest.’’ That’s followed
in Chapter 2 with laying the groundwork. We talk about all the things you
have to consider ‘‘Before You Get Started.’’ In Chapter 3 we focus on ‘‘De-
mystifying the Language of Investing,’’ in order to expedite our conversation
about key investing terms and concepts. And then, in Chapter 4, ‘‘What Kind

of Investor Are You?’’ we discuss what strategies may work well with your
sensibilities as a saver and investor.
Some investors find success by investing directly in the stock market by
buying shares of individual companies. Others prefer to go through pro-
fessionally managed mutual funds. Some have built nice nest eggs by buying
and holding a diversified basket of stocks and funds. Others have done well by
concentrating their bets on only their best ideas. Some make money by fo-
cusing on those investments that offer the greatest growth. Still others focus
not on the best investments, but the best-priced investments. In other words,
they go bargain hunting.
History has shown that money can be made in all sorts of ways, and we’ll
outline some of those different schools of investing for you.
Your Assets
In Part Two, ‘‘Your Assets,’’ we turn our attention to the building blocks of
investing. You can make money, as we just discussed, in stocks and bonds, just
as you can in real estate and gold. So we will discuss the basic types of in-
vestments you can choose from, outlining their risks and rewards. In Chapter 5
we’ll focus on ‘‘Demystifying Stocks.’’ In Chapters 6 and 7 we turn our
PREFACE
x
attention to ‘‘Demystifying Bonds’’ and ‘‘Demystifying Cash.’’ And in
Chapters 8 and 9 we will spend time with perhaps the most popular investment
for most households, mutual funds, in ‘‘Demystifying Mutual Funds I and
II,’’ Then, in Chapter 10, we turn our attention to ‘‘Demystifying Other
Assets,’’ including real estate, commodities, and a new class of fundlike
investments we will call ‘‘unmutual funds.’’
Selecting Your Assets
In Part Three we turn our attention ‘‘Selecting Your Assets.’’ We will outline
some basic ways investors can research and sort through the thousands of
choices before them, starting with stocks and bonds and then working our

way to the most popular investment vehicles, mutual funds. We will cover
those topics in Chapters 11 through 13.
Organizing Your Assets
In Part Four, we will address issues surrounding ‘‘Organizing Your Assets.’’ In
Chapter 14, ‘‘Demystifying Asset Allocation,’’ we discuss the importance of
creating an asset allocation strategy, and talk about ways to determine what
the right mix of stocks, bonds, and cash is for you. And finally, in Chapter 15,
‘‘Demystifying Asset Location,’’ we go into the different types of asset ac-
counts in which you can hold your stocks and bonds, and the strategies you
might employ.
Again, just as there is no single investment that’s right for everyone, there is
no single investment account that’s best for all investors. Some may find it
more appropriate to invest primarily in a Roth IRA. Others will find tradi-
tional IRAs better. Still others may decide that it’s beneficial to invest some
money in a regular, taxable brokerage account.
By the end of this book, no matter who you are or what kind of investments
you choose, we hope you’ll feel more comfortable as an investor—and we
hope you’ll start to invest in a manner that is both appropriate for your cir-
cumstances and suitable to your sensibilities.
PREFACE
xi
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INVESTING DEMYSTIFIED
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PART ONE
Getting Ready
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CHAPTER
1

Why We Invest
In this age of IRAs, 401(k)s, 403(b)s, 457s, and 529 savings plans, all of us are
investors—or at least we’re bound to be. Yet this wasn’t always the case.
Not so long ago, Americans could be classified into two distinct
groups. On the one hand, there were workers. On the other, there were
investors. The difference being: The working class worked long hours and
often earned little pay, while the investor class worked few hours but earned
great sums. The advantage the investor class had, of course, was access to
capital. In other words, they had money. And that money worked on their
behalf so they didn’t have to. Of course, back then, investors didn’t invest
because they had to. They invested because they wanted to—and because
they could.
But times have changed, in all sorts of ways. Today, more than 90 million
Americans in more than 50 million homes—representing around half of all
households—own shares of at least one mutual fund. That means that at the
very least, half of the country invests directly or indirectly in the stock and
bond markets.
This is a far cry from just a half a century ago, when only around 6 million
people invested. Even as recently as 1980, less than 6 percent of American
families even owned shares of a single mutual fund. By 1990 that number had
grown to around a quarter of all American households. And by the mid- to
late 1990s, more than a third of all households got into the investing game
(Figure 1-1).
3
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As big as today’s numbers are, they’re bound to grow in the coming years,
since more and more Americans are getting an early start investing. Today,
nearly a third of all workers age 24 or younger have money working for them
in the stock or bond markets. By the time we hit age 35, a majority of us invest,
primarily through mutual funds and company-sponsored retirement accounts

(Figure 1-2). Even low incomes aren’t stopping us. One out of six of us who
are earning less than $25,000 a year manage, somehow, to invest a portion of
our annual incomes in the stock market. And a majority of all mutual fund
shareholders have incomes of between $25,000 and $75,000 a year—hardly
Rockefeller territory (Figure 1-3).
Fig. 1-1. Percent of U.S. Households Owning Mutual Funds.
The number of Americans who invest in mutual funds has grown by leaps and bounds since the
start of the 1980s. Today, about half of all households have some exposure to the stock market
through mutual funds.
Source: Investment Company Institute
Fig. 1-2. Mutual Fund Ownership by Age.
It’s not just older investors who invest in mutual funds. A large percentage of investors of all
age groups invest in funds, including twenty-somethings.
Age 1999 2000 2001 2002 2003
24 or younger 28% 23% 32% 27% 27%
25–34 47% 49% 50% 48% 44%
35–44 55% 58% 60% 57% 54%
45–54 58% 59% 60% 59% 57%
55–64 50% 54% 54% 55% 59%
65 or older 34% 32% 41% 37% 34%
Source: Investment Company Institute
PART 1 Getting Ready
4
Why Are We Investing?
You can thank the advent of so-called self-directed retirement accounts like
401(k)s and Roth IRAs, along with the rise of low-minimum brokerage ac-
counts and cheap online commissions—all of which helped democratize Wall
Street in the 1980s and 1990s—for this investing boom. A record 36 million of
us invest through individual retirement accounts, while another 45 million
of us invest through company-sponsored retirement plans. These include

401(k) plans, to which private sector employees typically have access; 403(b)
accounts, which are 401(k)-like accounts for nonprofit workers and teachers;
and 457s, which are 401(k)-like savings plans for municipal workers. Collec-
tively, workers have around $2 trillion of their savings invested in these plans.
The recent rise of 529 college savings plans—and the exorbitant cost of sending
kids to universities—is another force driving more Americans to invest.
Figures 1-4 and 1-5 graphically illustrate the increasing number of Amer-
icans investing in 401(k)s and the billions in assets they are investing.
But there’s another reason why so many of us invest today: We have to.
We have to invest during our working years so that when we leave the
workforce and no longer bring home paychecks, our investment portfolios
can earn one for us. Try as we might, simply putting money into a safe and
comfortable bank account just won’t cut it.
The chart in Figure 1-6 will give you an idea of which rates, applied over
various periods of time, will enable you to generate enough money to meet
your goals—such as retirement, college education costs for your children, the
purchase of a new home, etc.
Fig. 1-3. Mutual Fund Ownership by Income.
A large percentage of investors of all income levels invest in funds. But as this chart indicates
Americans tend to invest in funds aggressively once their household incomes rise above
$50,000.
Age 1999 2000 2001 2002 2003
$24,999 or less 15% 17% 21% 14% 15%
$25,000–$34,999 30% 37% 38% 36% 33%
$35,000–$49,999 49% 49% 49% 48% 41%
$50,000–$74,999 62% 66% 66% 67% 59%
$75,000–$99,999 78% 77% 78% 79% 77%
$100,000 or more 78% 79% 85% 82% 83%
Source: Investment Company Institute
CHAPTER 1 Why We Invest

5
A typical bank checking account, for example, may yield only 1.5 percent in
interest income a year. At this percentage rate, guess how long it will take
to turn $1 into $2. Forty-seven years. Yet if you were to invest that money in,
say, the bond market and earned 5 percent a year on average over 47 years
(and that’s a conservative figure), you could easily grow that $1 into $10. And
if you were to invest that money in the stock market and earned 8 percent a
year, on average, you’d turn that same buck into more than $37. That’s the
power of compound interest. That’s the power of investing.
Fig. 1-4. Number of Americans Participating in 401(k) Plans (in Millions).
As the bull market roared throughout the 1990s, an increasing number of American workers
took advantage of their 401(k) tax-deferred retirement accounts.
Source: Department of Labor and Cerulli Associates
Fig. 1-5. Assets in 401(k) Plans (in Billions of Dollars).
Not only have more and more workers taken advantage of their 401(k) retirement accounts,
they are putting a staggering amount of money into these tax-deferred plans, which hold nearly
$2 trillion in assets today.
Source: Investment Company Institute
PART 1 Getting Ready
6
Just a few years ago we didn’t need to concern ourselves with these matters.
A generation ago, many workers were guaranteed income in retirement
through traditional pension plans. These investment funds were run by em-
ployers who bore all of the investment burden, decision making, and risk. But
as pension costs have risen, and as Corporate America moved to cut expenses
to improve profitability in the 1980s and 1990s, fewer and fewer companies
offered workers pension coverage. Instead, more and more workers have been
pushed into 401(k) or 401(k)-like retirement plans, which require the worker to
make all of his or her own investment decisions. And the worker, in this ar-
rangement, must bear all the risk of investing incorrectly.

This couldn’t have come at a worse time, as more of us are living longer in
retirement, which means the stakes are higher. Obviously, living longer is a
good thing. But the concern that arises from a long life is: Who’s going to pay
for it? The average American man is now expected to live to age 74, while the
average woman lives to almost 80. Just a quarter century ago, the average man
lived to 70 while women lived to 77. And a half century ago the average life
expectancy for all Americans was just 68 (Figure 1-7).
The typical age for retirement, meanwhile, is around 65 (though this too
may go up if our health improves and if changes are made to age requirements
for Social Security and other benefits). This means that instead of having to
save and invest enough money to cover another handful of years, we now have
to invest well enough to pay for at least another 10 to 15 years worth of living
expenses.
Actually, the challenge is even bigger. Because those averages are just that:
averages. Once a person makes it to 65 and retires, the odds of living a much
Fig. 1-6. Rates of Return Needed to Reach Goals.
This table indicates the average annual returns investors would need to generate to grow their
money by these various factors. For example, if you had 25 years to invest, you could turn $1
into $3 by earning 4.5 percent a year on your money. This would indicate that you could invest
in bonds to achieve your goal. But if you only had 10 years to achieve the same goal, you would
need to earn 11.6 percent a year on average. This would indicate that you would need equities in
your portfolio.
No. Years 1.5X 2X 3X 5X 10X
3 14.5% 26.0% 44.2% 80.0% 115.4%
5 8.4 14.9 24.6 38.0 58.5
7 6.0 10.4 17.0 25.8 38.9
10 4.1 7.2 11.6 17.5 25.9
25 1.6 2.8 4.5 6.6 9.6
CHAPTER 1 Why We Invest
7

longer life are that much greater. In fact, the average person who makes it to
age 65 can expect to live another 18 years, bringing the life expectancy figure
up to 83. If you’re lucky enough to make it to age 75, you can expect to live
another 11
1
⁄
2
years, according to the actuarial tables. That would bring you to
around 87. That’s a whole lot of years of bills to pay.
Now more than ever, we are a nation of workers and investors because we
have to be. This trend is only going to continue, as future generations will live
even longer (thank you, modern medicine!) and because the cost of living
will continue to rise (thank you, inflation!). In fact, at this rate, virtually
all working adults will be investors of some kind or another a generation
Fig. 1-7. Life Expectancy in America.
Figures represent how many additional years a person can expect to live after reaching a
certain age.
At Birth All Male Female
1900 47.3 46.3 48.3
1950 68.2 65.6 71.1
1960 69.7 66.6 73.1
1970 70.8 67.1 74.7
1980 73.7 70.0 77.4
1990 75.4 71.8 78.8
2000 77.0 74.3 79.7
2001 77.2 74.4 79.8
At 65 All Male Female
1950 13.9 12.8 15.0
1960 14.3 12.8 15.8
1970 15.2 13.1 17.0

1980 16.4 14.1 18.3
1990 17.2 15.1 18.9
2000 18.0 16.2 19.3
2001 18.1 16.4 19.4
At 75 All Male Female
1980 10.4 8.8 11.5
1990 10.9 9.4 12.0
2000 11.4 10.1 12.3
2001 11.5 10.2 12.4
Source: Centers for Disease Control and Prevention
PART 1 Getting Ready
8
from now. Don’t forget: 70 percent of us are already homeowners, a record
level of property ownership in the history of this and any other country. And
buying property is one of the oldest—and best—forms of investing over long
periods of time. So we’re much closer to achieving this goal than you might
think.
Investor, Educate Thyself
The upshot of this is, we all need to prepare and educate ourselves—and our
children—to the new realities of being members of the investing class. For
some of us that means seeking the help of qualified professionals, such as
certified financial planners, certified public accountants, brokers, or invest-
ment consultants. There is absolutely nothing wrong with seeking advice,
provided that the help you receive is sound and reasonably priced. While there
was a flurry of do-it-yourself investing activity in the late 1990s, surveys
have shown that a growing percentage of Americans are seeking professional
financial advice. For example, before the bear market of the early 2000s,
around two out of five investors sought the advice of a professional planner.
Now, after the bear, more than half of us do. This is to be expected, especially
in a world where the rules for investing are getting ever more complicated.

For other investors, the prospect of finding a good and affordable financial
consultant may seem just as daunting as finding good, affordable investments.
So this group might choose not to seek professional investment advice at all.
After all, how do you know you can trust the person advising you? And how
can you tell if the advice is (a) good and (b) worth the fee?
Still other investors may want the help of a professional but might not be
able to afford such services. As the financial services industry focuses on their
most profitable clients—the so-called high-net-worth crowd—fees for small
accounts have risen while services are being cut back. Finally, there’s yet
another category of investors: those who like managing their own money and
who are good at it.
Regardless of which group you fall within, it is still important to absorb as
much information as you can about the principles—and pitfalls—of executing
an investment plan. Even if you’re paying a professional to construct your
portfolio for you, it’s important to at least know enough to be able to tell
whether that professional advisor is working in your best interest. Educating
yourself might mean reading the Wall Street Journal religiously. It could mean
tuning into financial television networks like CNBC. Hopefully, this book will
play some role in your journey.
CHAPTER 1 Why We Invest
9
But What Does It Mean to Invest?
You’ll often hear the phrase ‘‘invest for the future.’’ Not only is this a cliche
´
,
it’s redundant. That’s because the act of investing necessarily involves the
future, on a couple of levels. Obviously, the reason we invest is to be able to
meet certain goals in the future—be it going on vacation, buying a house,
sending children to college, or building up a nest egg. But investing also takes
time. That means, by definition, it’s a future-oriented endeavor.

While spending involves instantaneous gratification—you’re giving up
something today in exchange for something else immediately—investing is
just the opposite. It’s all about delaying one’s gratification. It involves giving
up something today—i.e., the use of your money—in hopes of getting
something greater back in the future. That ‘‘something greater,’’ of course, is
more money.
The interesting thing is, there is a relationship between spending money and
investing it. When you invest, you are often interacting with would-be spen-
ders. For example, if you are a stock investor and buy shares of a company,
you are giving the firm your capital (i.e., your cash), which it will use to spend
on various projects. The hope is that the company will not only survive, but
thrive to the point where its value (and the value of your shares) will increase
substantially down the road.
Investing in bonds works the same way. When you buy a U.S. Treasury
bond, for example, you are handing over your money—and all the potential
uses you might have for that cash—so the government can gratify its needs by
spending your money. In return, you are making a calculated bet that the
federal government will not only survive, but will be able to pay you back your
investment at a future date, along with an agreed-upon amount of interest.
The greater the length of time you’re willing to delay that gratification, the
greater the odds of being rewarded for your patience. Sometimes, to invest
properly and safely, you may need to tie up your money for months, if not years,
if not decades—if not longer. Anyone who has purchased a home with a 30-year
mortgage will appreciate just how long some investments are designed to ripen.
But as any homeowner is likely to tell you, the rewards are well worth the wait.
In many ways, the greatest lie perpetrated by the Internet bubble of the
1990s was the sense that we could somehow get rich overnight by putting
money into the stock market. But an overnight investment in any market—be
it the stock market, bond market, real estate market, or whatever—is not
investing. That’s gambling.

Now, for a brief, shining moment in the late 1990s, when the stock market
was routinely returning 20, 25, or even 30 percent a year, investors truly felt
PART 1 Getting Ready
10