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Personal Financial Management (PFM)
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Darrell Himmelspach
dhimmels@sdccd.edu
Phone: 847-746-2790
Fax: 847-746-2791
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Investment OptionsIf you are new to investing, one of the hardest things to figure is the answer to what should be an easy question. Where can I invest my money? The reason that the answer to this question isn’t simple is because there are so many options. Each option has many variables attached to it. Your goal is to understand what the options and the variables are.
Let's say that you have money to invest right now. Will it earn a reasonable rate of return and grow over the next 10 years? Here is a list of possible investing options and certainly not a complete list, but the most common options:
A money market accountA money market account at most banks works approximately like a savings account, but it gets a better rate of return. In addition there might be a few restrictions on a money market account, like a minimum balance or a maximum number of withdrawals per year. A money market account has the same advantages and disadvantages of a savings account. A CDA Certificate of Deposit (CD) is an account that earns a better interest rate over a fixed period of time. You deposit money into the account and receive a "certificate" allowing you to draw the money at a later date. You can get six month CDs, one year CDs, five year CDs and so on. The interest rate will go up with the length of the time you hold the certificate. CDs have some advantages. They are secure if they are held by an FDIC-insured bank and the account balance falls within the $100,000 limit. It is impossible to lose the money. There are two disadvantages. You can’t get the money right away if you need it and there are penalties for early withdrawal. A U.S. savings bondA U.S. savings bond has many of the same attributes as a CD. You deposit the money for a fixed period of time and earn a rate of return. The most typical bond is a series EE bond and must be held for at least five years to mature. You can hold it for any length of time beyond five years and continue to earn the same interest.
Savings bonds are also absolutely secure, like a CD. They share the same disadvantages as a CD as well. A corporate or municipal bondA corporate or municipal bond represents a loan. The corporation or municipality needing money for a project issues bonds to raise the money. Then they pay interest on the money over time at some rate. The rate of interest depends on the prevailing interest rates at the time of issue.
Municipal bonds generally have some sort of tax advantage. You may not have to pay state or federal taxes on municipal bond interest. For this reason municipal bond rates are slightly lower to reflect this advantage. A bond mutual fundA bond mutual fund is simply a collection of bonds (generally of a certain type, like low-risk corporate bonds) owned by a pool of people. The fund lowers the risk by holding a collection of the bonds. If one company goes under it will have very little effect on the bonds held by the fund. A bond fund will generally pay interest every month. The value of fund shares will raise and fall each day depending on the rise and fall of interest rates.
Bond funds have the advantage of being able to get to the money. You can sell your shares any time and get out. Your share value will change every day with the share value going up when interest rates fall, and down when rates rise. If you think interest rates are going to rise over 10 years you may want to take that fact into account before purchasing a bond fund. Stock in some companyStock represents ownership of a company, and that is all it is. The purchase of stock in a company has a return average of 10% to 12% over the last 70 years. Investing in stocks can be risky so you need to do research on the company you would like to buy stock in. What has their performance been over the past several years? A good place to do stock research is by reading the Wall Street Journal.
Stocks are bought and sold through the stock market, like the New York Stock Exchange. You can do this yourself or hire an investment firm or broker to assist you in making investments decisions. An investment firm or broker knows how the market works and can make recommendations for stock you might want to buy. The ultimate decision is yours because it is your money. The stock or stocks you buy will rise or fall based on how well the company is doing. The price fluctuates based on news on the company, stock reports, and economic news, etc. You or your representative will take all these factors into consideration each day. If your company has a problem, of some kind, and has to shut down your stock will probably fall. If your company has just signed a big contract with someone for their products then you stock will probably go up.
Stocks have several advantages over other investments. If you buy stock in more than one company you have a portfolio. This lowers your risk by spreading your money over several companies. Also, you only pay taxes on stocks when you sell them. If you buy a stock, hold it several years, and it goes up in that time, you will pay tax on what’s call a capital gain only once. The capital gain is the money you made between the buying and selling price. You do not have to pay taxes on that capital gain each year. You only pay taxes in the year you sell the stock. Capital gains on stocks represent a form of tax-deferred compounding.
A stock mutual fundIf you are just getting into investing and have a small amount of money to invest stock mutual funds might be a possible place to put money. A stock mutual fund is simply a pool of stocks owned by a group of investors. There are different levels of risk with a mutual fund. You can go high risk, medium risk, or low risk. The risk is generally lower because it’s a larger portfolio of stocks, and the transaction fees aren’t a concern.
Stock mutual funds have the same disadvantages as stocks. If the economy has a problem, then you can lose money. If the economy does well the returns can be high. Most mutual stock funds are handled by a broker or an investment company.
Stocks and stock mutual funds are thought to represent a great place to put retirement money, because your money is being invested for long periods of time, a minimum of five years. The book "The Wealthy Barber" spends a lot of time talking about the advantages of mutual fund investing. If you are looking for a one year return on your money stocks are probably a bad place to put your money. You simply do not know what the market will do over that short a time frame.
Stock mutual funds invest their money differently depending on their charter. You can discover the exact investment mix by getting a prospectus from the company you’re putting your money into. The prospectus will tell you what types of companies the fund invests in, what its rate of return has been over five, 10, or 15 years and what stocks it holds at the moment. There are several general categories of stock mutual funds:
Funds are broken up into fund families. For example, Vanguard and ING are large fund families with many different mutual funds they manage. Each fund has a different personality because it invests in different types of companies. Making investment decisionsBefore you invest you must have a spending and savings plan. You need to enroll at your first opportunity in the Thrift Savings Plan even if it’s only at 1 or 2%. Don’t invest in other instruments until your knowledge of investing increases and you have more discretionary income. You want to maximize your tax-deferred investments like your TSP, 401(k), and Individual Retirement Accounts. Above all else DO YOUR RESEARCH! | ||
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