Readying Yourself With Knowledge

Basic financial concepts like inflation, time value of money or the present discounted value and net present value are ways the financially aware use to understand, explore and inform their decisions about how their money is best used. These alternative uses of money valuation concepts and tools help measure and demonstrate the importance of your recognition and understanding of money management and finance skills, techniques and behavior.

In modern economics, inflation refers to a rise in the general level of prices. The time value of money is based on the premise that due to inflation one will prefer to receive a certain amount of money today rather than the same amount in the future, all else equal. Net Present Value is a way of comparing the value of money now/today with the value of money in the future.

A dollar today is worth more than a dollar in the future, because inflation erodes the buying power of future money, while money available today is worth more because its purchasing power is greater and it can also be used to invest and grow thus creating wealth. For example, $100 today assuming a 3.0% annual inflation rate would be worth $97 a year from now, then the present value of $100 to be received one year from now is $97 ($100 less 3.0% or $3 = $97). Stated differently, using the same premise, $100 paid a year from now is only worth $97 today. Investing the $100 at 10.0% would yield $110 a year from now, making your money $7 ($110 - $3 = $107) more valuable a year from now than today and nearly 20.0% more valuable in two years.

Over time, inflation can erode the purchasing power of your money. Increases in the cost of living, while fluctuating year to year, averaged just under 2.4% annually in the 10-year period ending December 31, 2003 according to Standard’s & Poor’s Micropal. If this pace were to continue, an item you pay $10 for today would cost about $13 in 10 years, and about $16 in 20 years. Your investments would need to earn an average of nearly 2.4% each year just to maintain your present purchasing power.

You stand the best chances of having your money work hardest for you and growing your money by saving/investing over the long-term.

It's Time That Counts*

Ten-Year Period Ended December 31, 2003 S&P 500® Average Annual Total Return

Period of Investment

Remained Fully Invested 11.06%

Missed the 10 Best Days 5.94%

Missed the 20 Best Days 2.06%

Missed the 30 Best Days -1.30%

Missed the 40 Best Days -4.11%

According to a University of Michigan study, an investor who stayed in the US stock market during the entire 30-year period from 1963 to 1993 - 7,802 trading days - would have had an average annual return of 11.83 %. However, if the investor missed the 90 best days while trying to time the market, the average return would have fallen to 3.28% per annum. Other research has demonstrated, based on historical returns (including the reinvestment of all dividends) that there is a 28.8% chance that an investment in stocks will result in a loss in any one-year period. When held for five years, the chance of a loss declines to 9.7%. There has been no 20-year period during the last 75 years that has produced a negative return in either stocks or bonds.

The performance of the S&P 500 is considered one of the best overall indicators of market performance. The Standard & Poor's Index is an unmanaged group of stocks considered to be representative of the stock market in general. The S&P 500 is one of the best benchmarks in the world for large cap stocks (companies having a market capitalization between $10 billion and $200 billion). By including 500 companies, it offers diversification (A risk management technique that mixes a wide variety of investments within a portfolio designed to minimize the impact of any one security on overall portfolio performance.). Diversification is possibly the greatest way to reduce risk. This is why mutual funds are so popular.

From a historical perspective it is important for borrowers, savers and investors to know that during the past 20 years, stocks have outperformed all other major asset classes, including long-term U.S. government bonds and short-term U.S. Treasury bills. While past performance does not guarantee future results, as the below chart demonstrates, you stand the best chance of reaping the greatest rewards of stocks if you keep your money invested over a long period of time.

During one-year periods from 1926 through 2003, the stock market jumped by up to 53.80% and fell by as much as -43.36%. According to Standard & Poor’s Micropal when 20-year periods were evaluated which included reinvested dividends, however, it was found that the worst average annual total return was a positive 3.19%. Do understand as the commercials note that past performance does not guarantee future results. Stock performance is represented by the unmanaged S&P 500 Index, which includes reinvested dividends.

*Source: Standard & Poor's Micropal. All total returns include reinvestment of interest and dividends. The illustration is not intended to imply the past or future performance of any Franklin, Templeton or Mutual Series fund.

In learning about money management it is important to understand the unique history of investment returns. Over the 50 year period beginning January 1, 1953 and ending December 31, 2002, there were only three five-year periods in which the S&P 500 had produced a negative return; 1998-2002 (-2.9%), 1970-74 (-11.5%) and 1973-77 (-1.8%). The other five-year periods in this 50-year span were all positive, ranging from a low of 10.2% (1969-73) to a 250% gain (1995-99). Additionally, there were no 10-year periods in this 50-year span that resulted in a downtick in the S&P 500. The “worst” 10-year return was a 12.3%gain for the 1965-74 period. Even the 2000-02 debacle couldn’t erase the gains from the seven preceding years. The 10-year period ending December 31, 2002 saw a 143.4% rise in the S&P 500. There have been only two 10-year periods with gains of fewer than 200 percent (1974-83 and 1993-2002). Even neglecting the boom years of the late 1990s, there were several 10-year stretches in which the S&P rose more than 300 percent. Likewise, there have been no 20-, 30- or 50-year periods in which the S&P 500 has resulted in a loss.

A look at the S&P 500 shows stocks to be volatile. In the last 50 years, the annual gain or decline in this index has been in double digits on 35 occasions (or 70 percent of the time). Yet, the index has consistently trended upward. Until the 2000 decline, the S&P 500 rose in every year but one from 1982 through 1999. Only 1973-74 marked a decline in consecutive years.

As part of a consolidation/money management education you should be familiar with the following investments equity fund terms and strategies:

Types of Stock Funds

Type of Equity Fund What the Fund Buys

Growth Stocks in companies whose earnings are expected to rise

International Equity Stocks in non-U.S. companies

Global Equity Stocks in U.S. and non-U.S. companies

Sector Stocks in a particular industry, such as energy, biotechnology, transportation

Value Stocks of undervalued companies expected to increase in value

Blend Stocks of both growth and value companies

Funds that invest for growth and income

Growth and income funds are designed to pursue both long-term growth (capital appreciation) and current income. The funds vary in the degree to which they emphasize growth over income or income over growth. They typically invest in a mix of stocks for growth and bonds or dividend-paying stocks for income, and share these characteristics:

• Are generally considered less aggressive than growth funds.

• Receive dividends from stocks and/or interest from bonds in their portfolios, which can help offset stock price declines.

• Generally experience lower volatility than pure growth funds.

• Provide added diversification when combining stocks with bonds.

• Typically pay quarterly dividends.

Stock mutual funds

With more than 12,100 publicly traded common stocks in the U.S. alone, making investment decisions on your own can be overwhelming. One way to simplify investing in the stock market is through a stock mutual fund.

The mutual fund concept is simple: A number of people who share the same financial objective pool their money and have it invested and managed by professional portfolio managers. Stock mutual funds, for example, invest this pooled money in common stocks of public companies, generally with long-term capital appreciation as a goal.

Benefits of stock funds:

• Diversification. Equity mutual funds allow you to spread your money across a larger number of securities than you probably could on your own. This diversification dramatically reduces the risk of any one company's losses adversely affecting your investment as a whole.

• Professional management. Professional money managers closely monitor the securities markets and individual companies, buying and selling securities as they see opportunities arise. Few individual investors can devote time or resources to daily management of a sizable portfolio or stay up to date on the thousands of securities available in the financial markets.

• Liquidity. You may sell some or all of your mutual fund shares at any time and receive their current value (net asset value). The value may be more or less than your original cost, which may include a sales charge.

• Convenience. Mutual funds offer shareholders many services that make investing easier. You may buy or sell shares each business day, automatically add to or withdraw from your account each month, and have income dividends and capital gains paid out to you or automatically reinvested.

Understand Risk

Stocks historically have outperformed other asset classes over the long term, but as noted above tend to fluctuate in value more dramatically over the short term. These and other risks are discussed in each fund’s prospectus. A “Prospectus” is a formal legal document describing details of a corporation that makes investors aware of the risks of an investment. In the case of mutual funds, a prospectus describes the fund's objectives, history, manager background and financial statements. Front-end, back-end, sales loads, management fees, Rule 12b-1 fees are expenses associated with mutual fund investments. An investor’s returns are reduced by these fees and expenses. Funds are offered through prospectuses, which contain more detailed information, including sales charges, expenses and risk factors. Investors should carefully consider a fund’s investment goals, risks, charges and expenses before investing. You should work with your professional financial advisor and review prospectus when considering and before making any investment.

Types of stock mutual funds:

Funds that invest for capital appreciation typically invest in stocks of companies with the greatest potential for long-term growth, generally by investing in growth stocks or value stocks.

Growth stocks are from companies that have been growing faster than the general economy and their competitors, and are expected to continue to outpace them.

Value stocks are from companies, which, although they have real underlying net worth, have fallen out of favor with investors, resulting in a lower stock price.

Definitions:

• Assets – represents the value of all real things that can reasonably be expected to be converted into cash within one year in the normal course of business. Current assets include cash, accounts receivable, inventory, marketable securities, prepaid expenses and other liquid assets that can be readily converted to cash. In personal finance, current assets are all assets that a person can readily convert to cash to pay outstanding debts and cover liabilities without having to sell fixed assets. Current assets are important to businesses because they are the assets that are used to fund day-to-day operations and pay ongoing expenses. Depending on the nature of the business, current assets can range from barrels of crude oil, to baked goods, to foreign currency.

• Net worth - the amount by which a company or individual's assets exceed their liabilities (bills that are due to creditors and suppliers within a short period of time. For a company, this is known as shareholder's (or owner's) equity and is determined by subtracting liabilities on the balance sheet from assets. For example, if a company has $45 million worth of liabilities and $65 million worth of assets the company's net worth (shareholder's equity) would be $20 million ($65 million - $45million). Alternatively, an individual may have only three assets, $100,000 worth of common stock, $30,000 worth of bonds and title to a $190,000 house. Conversely they have only one liability, $150,000 owing on their mortgage. The individual's net worth would be $170,000 ([$100,000 + $30,000 + $190,000] - [$150,000]).

In addition, some funds that invest for capital appreciation are broad-based, investing in a wide range of companies and industries. Others have a narrower focus, and may invest in companies of a certain size, such as small- or mid-cap funds, or in specific sectors like technology or utilities.

In general, these funds seek capital growth through price appreciation of the securities in their portfolios and are usually subject to more volatility than funds that invest for growth and income.

Post-July 1st 2006 student loan and consolidation find the cost of borrowed student loan money (interest rate) is relatively cheap in comparison to other borrowing cost such as the Prime Rate which as of September 2006 is 8.25%. Low student loan interest rates (6.80% fixed for Federal Stafford loans disbursed after July 1, 2006, 6.54% variable in-school, grace & deferment rate for most Federal Stafford loans disbursed before July 1, 2006 and 7.14% for these loans during repayment) coupled with alternative use of funds opportunities at repayment (interest rate offered on saving and investment products) allows the borrower to put her or his money to more productive use earlier in one’s career thus allowing you to seek safer, less risky investments that work longer and harder through the accrual and compounding of interest.

The rule of 72 is a very useful tool and skill to understand because it gives you a quick benchmark to determine how good a potential investment is likely to be by estimating the number of years required to double your money at a given interest rate. In turn, it also tells you approximately how costly an interest rate will be when paying on a loan. To apply the rule, divide the interest rate into 72.

Applying the Rule of 72

Interest Rate Estimate Number of Years to Double

3.0% 24.0

5.00% 14.4

10.20% 7.06

You can also run the rule backwards, to estimate at what interest rate is necessary to double your money in a set number of years. For example, to double your money in six years, just divide 6 into 72 to find that it will require an interest rate of about 12 percent.

The concept of alternative use of money works similarly to your financial advantage and benefit when discretionary funds are used to pay off more expensive debt such as credit cards. When using discretionary money, especially from employment and student loans, you should consider the value you are receiving in return for the use of your dollars. Smart money savvy people seek the greatest value for their dollars. A choice between paying extra on a 3.50% student loan and a 16.99% credit card should be a no brainer. There is more bang (financial benefit), actually 13.49 percentage points more bang, for your buck when paying on a 16.99% debt versus a 3.50% debt.

Paying Off a Student Loan Early – Anxiety or Poor Financial Sense

Assuming you have the discipline and a long-term investment approach and horizon, it is worth the risk of paying more in interest, in order to have money to invest in lieu of paying down low interest debt. This of course is dependent on your tolerance and definition of debt, low-interest and investment.

You must always be mindful that you should have a balanced approach to debt and financial planning that reflects your personal and professional goals. You should be committed to saving and investing as early and often in your career as possible. This early accumulation of funds is necessary and can be used to finance (down payments and cash payments) some of your most important and expensive personal and professional goals such as your home, retirement, kid’s education and philanthropic endeavors.

It is important to balance debt reduction with the development and accumulation of cash, cash equivalents and diversified investments. Your financial plans are greatly benefited by assembling a professional team of experienced and knowledgeable financial advisors. Living below ones means is also a documented success strategy and component in creating discretionary funds for saving and investing. These are basic fundamental principles in developing a sound, regularly balanced and diversified financial foundation that will assist and support your success and happiness.