Investing Essentials

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Investing Essentials
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• 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

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• Investor Self Analysis
• Questions that investors should be able to
  answer
• Whats 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

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• The Path to Investing

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

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• 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 youll need
• Time frame to meet goals
• Investment risk vs. expected return

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• Investing Begins with the Basics
• Risk and return
• Investment types

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• 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

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• Investment Choices
• Stocks
• Bonds
• Cash
• Mutual funds one of these investments, or a
  combination

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

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• 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

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• 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
• Wont provide growth to meet long-term goals

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• 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

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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
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• 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
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• 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
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• Analyzing Risk

• The more conservative your investments, the
  greater the risk of inflation
• The more aggressive your investments, the greater
  the risk of losing your principal.

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• 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

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• 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

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• 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
• An investment of 96,000 grows to 513,000

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• 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
• Accumulated investment in Scenario A 513,000
• Accumulated investment in Scenario B 210,500
• Difference in results is effect of compounding
  over time

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• 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

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

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• 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

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• 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

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• 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

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To Learn More, Visit Path to Investing
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• Core content from the basics to more
  sophisticated concepts

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• Guided Trips expert-led, interactive journeys
  on key financial topics

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• Vantage Points investment issues relevant to
  particular groups

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• Topical Features put the latest financial news
  in perspective

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• Quizzes and Games test your investment savvy

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To Learn More, Visit Path to Investing
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• Objective. Practical. Accessible. Essential.
• www.pathtoinvesting.org
• The Foundation for Investor Education

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Tax-Deferred and Tax-Free Investing
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• Tax Free, Tax Deferred, and Pretax Whats 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

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• Tax-Free Investments
• Municipal bonds
• Roth IRAs
• Education savings accounts
• 529 plans at least until 2011
• No tax is owed on your investment earnings
• Youd 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

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• Tax-Deferred Investments
• Traditional IRAs
• Employer-sponsored retirement plans 401(k)s,
  403(b)s, 457s
• Annuities
• Dont pay tax on earnings as they accumulate,
  but tax is owed when money is withdrawn
• Strong potential for compounding

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• Taxable vs. Tax-Deferred Earnings

This example is a hypothetical illustration and
is not based on the return of any specific
investment
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• 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
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• Multiple Tax Benefits
• Some investments offer more than one tax
  benefit
• 401(k)s
• Pretax contributions
• Tax deferred
• Deductible IRAs
• If you qualify, you can deduct contributions on
  your tax return and have tax-deferred earnings

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• 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

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Investing for College
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• 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

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• 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

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

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• 529 Savings Plans
• Withdrawals are free of federal income tax, and
  sometimes state tax, if theyre 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
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• Prepaid Tuition Plans
• Lock in future college costs at todays prices
• Purchase certificates that can be redeemed
  against future tuition costs
• Many plans have high contribution limits
• Many plans are free of investment risk

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• Types of Prepaid Plans
• State plans
• Can be used at most public institutions in the
  state
• May guarantee admission to at least one school
• Private plans
• Can only be used at sponsoring institution
• No guarantee of admission
• May be able to transfer tuition certificates to
  another institution
• Independent 529 plan
• Can be used at over 220 private colleges that
  participate in the plan
• No guarantee of admission
• Can purchase up to 5 years of tuition

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• Education Savings Accounts
• Can be used to pay for K-12, as well as higher
  education
• Tax-free withdrawals
• Lower limits on contributions

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• Choosing the Right Plan
• 529 savings plans
• Greatest flexibility in school choice
• Some investment risk with the potential for
  greater return
• Prepaid tuition plans
• Some limits on where the student can attend
  school
• Free of investment risk
• Education savings accounts
• K-12 expenses, as well as higher education
• Lower contribution limits