Waddell & Reed

Investment Basics

Procrastination is your worst enemy
Pay yourself first
The magic of compounding
Cost of missing the market
Diversify your portfolio

Procrastination is your worst enemy

Time is a fixed commodity, and you are using it up every day you wait. Time cannot be replaced. In the illustration below Prudent Polly invests $4,000 a year at age 25 for just ten years. At an assumed 8% annual rate of return, her total investment of just $40,000 would grow to $925,296 before taxes by the time Polly is 70. On the other hand, Procrastinating Pam doesn’t start investing until ten years later at age 35, and then she invests $4,000 every year for the next 35 years, through age 70. The results are amazing.

Pam stashes away $140,000, or $100,000 more than Polly, but she is not able to make up the lost time value. Although Polly invested much less money, the total value of her investment at age 70 exceeds Pam’s by over $180,000 before taxes.

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Return figures are for illustrative purposes only and do not represent the past or future performance of any actual investment. Example assumes investment is made at the beginning of each year and the reinvestment of all earnings but does not take into account any applicable fees or expenses or any taxes (unless otherwise noted).

Regular investing does not guarantee a profit or protect against loss in a declining market. Investors should consider their financial ability to continue their purchases through periods of low price levels.

Pay yourself first

For many people, the best way to accumulate money for the future is through regular saving and investing – paying yourself first. By treating investing as part of your monthly payment plan, along with your car expenses, your rent or mortgage and the utility bills, you’ll be amazed at how quickly even small amounts can add up.

With an automatic investing plan, you can take advantage of the principle of dollar-cost averaging. Dollar-cost averaging means systemically investing a fixed amount of money at regular intervals of time, regardless of the purchase price. Doing so can potentially lower your risk over a period of time and helps lower the overall cost of ownership of your investments.

The magic of compounding

Another example of time in the market, not timing, is the magic of compounding. The secret behind compounding is simple: you earn money both on your initial investment and the earnings accumulated from prior periods. More time often equals more money. As the chart shows, an investment's cumulative value over time may be attributable more to compounded earnings than to the cumulative amount invested.

compound

Return figures are for illustrative purposes only and do not represent the past or future performance of any actual investment. Examples assume the reinvestment of all earnings but do not take into account any applicable fees or expenses or any taxes (unless otherwise noted).

Regular investing does not guarantee a profit or protect against loss in a declining market. Investors should consider their financial ability to continue their purchases through periods of low price levels.

Cost of missing the market

Some say, be allocated heavily in stocks when the market is going up and get out before everyone else when the market starts going down. The problem with this approach is that not even the smartest professional can accurately predict when to be in or out. As the chart illustrates, missing even a handful of the market’s best single-day performances could have a negative impact.

Average annual returns of the S&P 500 Index for the 20-year period ending 12/31/13

aveann

Source: Vestek Systems. The S&P 500 is a group of unmanaged securities widely regarded to be representative of the stock market in general; results assume the reinvestment of dividends. An investment cannot be made directly in an index. Past performance is not a guarantee of future results.

Regular investing does not guarantee a profit or protect against loss in a declining market. Investors should consider their financial ability to continue their purchases through periods of low price levels.

Diversify your portfolio

When you diversify your investments, you spread your money among a variety of different kinds of stocks and other types of investments.

Diversification can result in a more balanced portfolio that will weather different market or economic conditions in different ways. How you diversify or balance your investments, will depend on your goals. Generally, a sound investment strategy takes risk tolerance and return potential into account as you determine how aggressive or conservative you want to.

A common way to manage risk is to invest across several different asset classes. In other words, consider including different kinds of stocks in your portfolio, along with bonds and cash equivalents.

Over time, stocks, bonds and treasuries have each performed well, even though the returns of each asset class differ considerably. Having a mix of investments allows you, potentially, to take advantage of the differences between asset classes, and has historically reduced overall portfolio volatility.

The illustration below shows the growth of $10,000 invested in December 1, 1993 through December 30, 2013. A hypothetical diversified portfolio, equally weighted among various asset classes would have helped manage the volatility depicted in this 20-year illustration much better.

crash

crash

Source: Zephyr Style Advisor. Past performance does not guarantee future results. This is for illustrative purposes only and not indicative of any investment. The data assumes reinvestment of income and does not account for taxes or transaction costs. Treasury bills are guaranteed by the U.S. Government and offer a fixed rated of return, where as both principal and yield of an investment in stocks fluctuates with changes in market conditions. Large company stocks represented by the S&P 500; Long-term government bonds by the Citigroup USBIG Treasury Index. Treasury bills by the Citigroup 1-month T-Bill. An investment cannot be made directly in an index. Government bonds and Treasury bills are guaranteed by the full faith and credit of the United States government as to the timely payment of principal and interest. Generally, as interest rates rise, bond prices fall. U.S. government bonds may be exempt from state taxes and income is taxed as ordinary income in the year received. With government bonds, the investor is a creditor of the government. Stocks are not guaranteed and have been more volatile than the other asset classes. *Based on standard deviation, a measure of how volatile a fund’s returns are.

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