Sunday, February 15, 2009

Don't Be Afraid of Investment Terms You Do Not Understand - Part 3

Tip #69 - Don't Be Afraid Of Investment Terms You Do Not Understand - Part 3. In the first two parts of this series we talked about not letting investment terms scare you. I explained some basic investments terms that may sound overwhelming until you learn what they mean. Now that we all know what these investment terms mean, when do we invest in all of these different investments? In general, the greater risk you are willing to take on, the greater potential you have for reward and greater possibility for loss, as well. Also, take into consideration that at lower rates, your interest may not keep up with inflation. In general, it’s best to start out putting your money in the safest investments, such as savings accounts, money market accounts, and CDs. And then as you acquire more money or become comfortable with investing, then you can start to invest in things that have potential for a greater return such as bonds, mutual funds, and stocks.

If you are just starting out with putting money away, then open up a savings account to put your money into each month. Current rates are pretty low – about ½%. As you accumulate a large amount – maybe $1,000 or $2,500 depending on your bank’s rules, you can consider opening a money market account. Remember to follow the bank’s rules about number of withdrawals and keeping the minimum balance. Money market accounts are currently paying about 1% on your money. It’s not a lot, but these types of accounts are perfect for parking your emergency fund. If you are saving money to buy something down the road, then when you have a large enough amount – usually about $1000 - you can open up a CD. Remember, with a CD you are locked into a term such as 1 year or you get penalized, so only put money into a CD that won’t be needed until the term is up. I have touted credit unions before and I will again. Usually their rates are more generous and they have fewer fees so it may be worth it to try to join one for all of your accounts. My credit union actually lets you open an account similar to a CD with as little as $100 that’s currently paying 4%. So you can see the big difference in interest rates with a CD versus a savings account.

As far as investing in more complicated accounts, bonds work almost like CDs in that they are usually done for a longer term. If you see favorable terms for a government bond, then it’s worth investigating. Remember, there are some tax benefits to investing in government bonds, in addition to their relative safety. Unless you are comfortable taking on a lot of risk, mutual funds and stocks are best used for long-term investing such as retirement, if it’s at least 10-20 years away. The percentage that you invest in mutual funds depends on how much risk you are willing to undertake and how far away you are from retirement. Until you are a sophisticated investor, I don’t think there is a place for individual stocks in your portfolio. You can get the same returns from stock mutual funds, and then all of your money is not hinging on how one company performs.

Overall, a lot of what you do with your investments is what you are comfortable with. If you are comfortable losing some of your money in the hopes of a greater return, then invest in mutual funds. If you are only comfortable with risk-free investment at the expense of missing out on potential great returns, and the possibility that inflation is greater than your return, then stick with CDs, money market accounts, and government bonds. As my dad always says, only invest in things that will allow you to sleep at night. ***

In Real Life (IRL) – I shared with you how I got started investing in mutual funds. It was scary to me to think that I could lose my initial investment. But once I was investing in it for some time I got comfortable. And of course at the time mutual funds were doing well, so there was no reason for me not to be comfortable. About two years into my mutual fund investing, someone at my work started up an investment club. The idea was that a few of us would contribute $50 per month to and buy a new stock a few times per year as a club, sharing in the investments equally. Each of us had a turn to research some stocks and present which ones we thought were a good buy. After a couple of years we owned about a dozen stocks. It was a great first introduction to me to buying individual stocks. And after several months I started buying stocks on my own and also became the investment club’s treasurer. This club lasted for about 4 years and we did okay, mabye a 7-8% return. I know we didn't lose any money. Frankly for me, more important than the return was the education I got on researching and buying stocks. And it was a good way to ease into them.

Currently for my family, our investments look like this – our money for emergencies and short-term expenses is invested in savings and money market accounts. We have about 60% of our retirement funds in mutual funds and the rest in CDs and other stable accounts. We have a mix of our children’s college funds in CDs and mutual funds. And we have some not-yet allocated money in a mutual fund and EE government bonds that are still earning a good rate from when I bought them years ago. This is money will probably be used in 5-7 years for expenses such as braces, a new car, etc. I sold my last stock this past year when we built a bedroom for our son. I don't forsee buying individual stocks anytime soon as I am more comfortable with mutual funds. This is what works for our family. What works for your family and what you are comfortable with will be different.

***I am not an investment advisor nor do I aspire to be one. The point of this series was to explain the different investments available to you and to give a general idea of when different investments are typically used. You should only invest in what you feel comfortable with. And it’s always a good idea to get the advice of a non-biased investment advisor or financial planner when investing.

1 comment:

diane said...

Great info. When I first even thought about investing, everything seemed greek to me. I then joined an investment club and the hands on learning aspect of it helped me to become a more confident investor.