Investing Essentials With a Mathematical Twist—Monetary Growth

1. Investing Essentials With a Mathematical Twist—Monetary Growth

2. What the Research Is Telling Us • SIA • Lack of knowledge greatest stumbling block for potential investors • Potential investors express a need for reliable, unbiased education and information • NASD • 45% of respondents: Could have avoided negative experience in the market had they known more about investing at the time • 62% of respondents: Believed they were insured against losses in the stock market, or did not know

3. Investor Self Analysis • Questions that investors should be able to answer: • What’s the first thing you need to do before you decide to invest? • What are the major risks of investing? • How are risk and return related? • What types of investments have performed best over the long term? • What is the asset allocation of your portfolio? • To answer these questions, follow the Path to Investing

4. Investment Goals • In reality, you might have several goals, all with differenttime frames

5. Lining Up Goals and Investments One of the keys to investing to meet your goals is to make the most appropriate investments based on: Amount of money you’ll need Time frame to meet goals Investment risk vs. expected return

6. Investing Begins with the Basics • Risk and return • Investment types or CD’s

7. Risk and Return The greater the risk, the greater your potential return The longer the time frame, the more opportunity to offset risk Past performance is no guarantee of future results

8. Investment Choices Stocks Bonds Cash/CD Mutual funds — one of these investments, or a combination

9. Stocks Equity investments — purchasing part-ownership in a corporation Short-term volatility Historically have provided consistently highest returns over 10 years or more

10. Bonds Debt investment — lending money to a corporation, government, or government agency Stable income though market price fluctuates Potential for stronger returns than stocks in some market conditions

11. Cash Equivalents Money market accounts, CDs — least risky investment, but most vulnerable to inflation Liquid — withdraw cash as needed with little or no loss of value Good for short-term goals and emergencies Won’t provide growth to meet long-term goals

12. Mutual Funds • Sell shares to investors • Pool investors’ money to purchase broad variety of stocks, bonds, cash equivalents, or some combination of those investments • Low risk or high risk depending on the investments in the fund and its investment objectives • May help you diversify your portfolio — or spread your investment principal among many different investments

13. Maximum and Minimum Real Returns Over 1 Year (1802-1997) 1-year returns after inflation: Stocks, bonds, cash Source: Jeremy Siegel, Stocks for the Long Run, McGraw-Hill 1998

14. Maximum and Minimum Real Returns Over 5 Years (1802-1997) 5-year returns after inflation: Stocks, bonds, cash Source: Jeremy Siegel, Stocks for the Long Run, McGraw-Hill 1998

15. Maximum and Minimum Real Returns Over 20 Years (1802-1997) 20-year returns after inflation: Stocks, bonds, cash Source: Jeremy Siegel, Stocks for the Long Run, McGraw-Hill 1998

16. Inflation Persistent increase in the costs of goods and services Persistent decrease in buying power of dollar Low short-term risk, but high long-term risk

17. The Inflation Bite Assuming a 3% inflation rate, you would need more money each year to have the same buying power: Year 1: $56,000 Year 2: $57,680 Year 3: $59,410 Year 4: $61,193 Your investment would need to earn more than 3% just to beat inflation

18. Compounding: One Protection against Loss of Principal When investing earnings are added to your principal, the result is a larger base on which earnings can accumulate: • Example: • Invest $200 per month for 40 years (tax deferred) • Assume 7% annual return compounded monthly • An investment of $96,000 grows to $513,000

19. Time Increases Potential for Compounding Scenario A: $200 per month for 40 years Scenario B: $400 per month for 20 years Total investment the same: $96,000 at 7% annual interest compounded monthly figure which is better and try to explain.

20. Asset Allocation Mixture of stocks, bonds, and cash in your portfolio Balance of stability, growth, and liquidity Offsets volatility (eggs in different baskets) Allocation varies with age, time to meet goals, risk tolerance

21. Potential Asset Allocation for Your 20s and 30s Emphasis on long-term growth with stocks Most goals in the future

22. Potential Asset Allocation for Your 40s and 50s • Balancing more immediate financial needs (buying a house, college planning) with long-term goals, such as retirement • Balance of stocks and bonds for both growth and stability • As time frame for meeting goals narrows, stable investments like bonds offset risk of losing portfolio value in the short term

23. Potential Asset Allocation for Your 60s and 70s • Emphasis on capital preservation: providing income, avoiding loss • Limited to moderate investment in stock to offset inflation

24. Recap Start investing now Emphasize stocks and stock mutual funds to achieve long-term growth Allocate the balance to bonds, bond mutual funds, and cash for income and stability Emphasize capital preservation to meet short-term goals

25. Tax-Deferred and Tax-Free Investing

26. Tax Free, Tax Deferred, and Pretax: What’s the Difference? • Tax free: Earnings or income on which no tax is owed • Tax deferred: No tax is due on earnings until they are withdrawn at some point in the future • Pretax: Income before taxes are deducted

27. Tax-Free Investments • Municipal bonds • Roth IRAs • Education savings accounts • 529 plans — at least until 2011 • No tax is owed on your investment earnings • You’d have to earn 4.17% on a taxable corporate bond to match the tax-freeincome on a 3% municipal bond* • *Based on a marginal federal tax rate of 28%

28. Tax-Deferred Investments • Traditional IRAs • Employer-sponsored retirement plans — 401(k)s, 403(b)s, 457s • Annuities • Don’t pay tax on earnings as they accumulate, but tax is owed when money is withdrawn • Strong potential for compounding

29. Taxable vs. Tax-Deferred Earnings

30. Pretax Contributions • Deductible IRAs • 401(k)s, 403(b)s, 457s • You contribute pretax dollars, often through an employer-sponsored plan, which lowers your taxable income *Single filer, using standard deduction

31. Contribute the Maximum to Tax-Deferred and Tax-Free Plans • The sooner you get started, the easier it will be to meet your investment goals • Contribute the maximum: • Understand contribution limits • Work with a tax or financial adviser to develop the best strategy for your financial situation • Example: A wise person decides to invest the maximum of $5500 per year into a Roth IRA mutual fund account. This account is evaluated monthly and has averaged 10.5% earnings for the last 20 years. What would you expect this person to have after 10 years of contributing?

32. Investing for College

33. The Costs of College • Tuition rising 5% to 13% annually • By 2021, 4-year tuition is estimated at $260,000 at a private institution and $118,000 at a public college

34. Start Early, Contribute Often • The sooner you get started, the more opportunity your contributions have to compound • Open a 529 or other college savings account when each child is born and contribute every month • Use gifts made to your children to build college fund

35. Special Ways to Invest • 529 savings plans • 529 prepaid tuition plans • Independent 529 plans • Education savings accounts

36. 529 Savings Plans • Withdrawals are free of federal income tax, and sometimes state tax, if they’re used to pay for qualified education expenses • Maintain control over plan assets *This example is a hypothetical illustration and is not based on the return of any specific plan

37. Let’s Apply what we have learned • In some Practice Problems: • Monetary Growth Formula