How Your Savings Grow
If you can save just $1 a day, that's $365 in a year. If you invest this
money at a 4% return, computed daily, here's how it will grow:
Savings |
|
With Daily Interest |
$ 365 |
One year |
$ 372 |
$ 1,825 |
Five years |
$ 2,929 |
$ 3,650 |
Ten years |
$ 4,487 |
$ 10,950 |
Thirty years |
$ 21,169 |
What's Your Goal?
Your first goal should be to save three to six months living expenses as
a buffer against emergencies. Fill your personal savings goal for the immediate
future:
At least
(or) |
3 x Total Monthly Expenditures: |
_____________ |
6 x Total Monthly Expenditures: |
_____________ |
Keep your financial cushion safely tucked away in an easy-access savings
account, short-term certificate of deposit (CD) or money market account.
Make sure the bank or financial institution where you keep this money is
insured by the Federal Deposit Insurance Corporation (FDIC), which protects
the money you have on deposit up to $100,000.
The next step is to decide your short-term and long-term financial goals.
Do you want to buy a home? Do you need to save for a child's college education?
Are you planning for retirement? Are you saving for a vacation? Write down
your goal(s):
_________________________________________________
_________________________________________________ |
Investing Your Money
Once you've acquired the basics, you're ready to consider some financial
vehicles that will help your money grow over the long term. To increase your
spending power, you must look for an investment that will earn enough to
outpace the rising cost of living. For example, if a savings account earns
4% interest and the rate of inflation is also 4%, your savings will not increase
in value at all. And, if the rate of inflation were to rise, your savings
might actually decline in value. Realize, however, that not all investments
will make money, and some are very risky.
Assess Your Level of Risk Tolerance
The following questionnaire is designed to help you assess your level of
risk tolerance. Questionnaire results can serve as a guide to choosing the
investments that complement your financial goals. Discuss the results with
your investment representative.
No matter what type of investor you are, it is important to diversify. That
means distributing your money across different types of investments so that
you're not putting all your eggs in one basket. You may place some of your
funds in conservative financial vehicles with a guaranteed rate of return,
while putting additional money in aggressive investments that carry more
risk but have a possibility of greater returns.
Circle the answer that best describes your response.
Agree Strongly=1pt Agree Somewhat=2pts. Disagree=3pts.
|
Agree
Strongly |
Agree
Somewhat |
Disagree |
| 1. Preservation of capital is most important to me. |
1 |
2 |
3 |
| 2. I would accept a lower yield on my bond investmants in exchange
for the relative safety of government seccurities. |
1 |
2 |
3 |
| 3. Although emerging growth stocks offer high potential return,
I would prefer a portfolio of established, high-quality equity securities. |
1 |
2 |
3 |
| 4. I would choose share price stability over higher current
return. |
1 |
2 |
3 |
| 5. Portfolio diversification is an important investment
consideration. |
1 |
2 |
3 |
| 6. I would accept a lower current yield if I could access my
money at any time. |
1 |
2 |
3 |
| 7. I would choose U.S. government bonds versus stocks as my
primary long-term investment. |
1 |
2 |
3 |
| 8. I would choose current liquidity over higher, long-term
total return. |
1 |
2 |
3 |
| Score |
Risk Tolerance |
Investment Approach |
| 8-12 pts. |
Lower
-
Concerned with capital preservation
-
Wish to avoid market's ups and downs
|
Conservative
-
Liquidity (easily converted into cash)
-
Preservation of capital
|
| 13-17 pts. |
Moderate
-
Have more available income
-
Emphasis on capital appreciation
|
Moderate
-
Income
-
Capital appreciation
-
Total return
|
| 18-24 pts. |
Higher
-
Have both time and money to ride out the market's up and downs
-
Seek maximum growth and appreciation
|
Aggressive
-
Maximum capital appreciation
|
Types of Investments
Here's a quick guide to some of the investment options available to you:
Savings Accounts. Such accounts are a good place to store your emergency
funds. They are generally insured by the FDIC up to $100,000 for all deposits
at one institution and provide easy access to your money. The chief drawback
is that interest rates tend to be low.
Money Market Deposit Accounts. These accounts usually earn slightly
higher interest than a savings account but still allow easy access to your
money. Some banks and financial institutions require an initial deposit of
$1,000 or more and limit the number of withdrawals or transfers you can make
during a given period of time.
CDs (Certificates of Deposit). CDs usually earn more interest than
a savings account and are a vary low-risk financial vehicle. They are generally
insured up to $100,000 by the FDIC for all deposits at one institution. You
agree to keep your money on deposit for a fixed period of time. Usually,
the longer the term, the higher the interest rate. There may be penalties
for early withdrawal.
401(k) Plans. If your employer offers a 401(k) plan, it may be one
of the best retirement vehicles available to you. A 401(k) is a retirement
savings plan to which you can contribute a certain percentage of your gross
income. However, contributions to a 401(k) and certain other qualified deferred
compensation arrangements cannot exceed $9,500 indexed periodically for
inflation. Typically with a 401(k) plan you have several investment options
from which to choose, including stocks, bonds, mutual funds or CDs.
Your employer may contribute matching funds to your 401(k) plan. For example,
your employer may match 50% of your contribution for any amount up to 5%
of your compensation. That means an additional 50% contribution on the first
5% you contribute to your plan. That's also why 401(k)s are so highly recommended
by financial advisors.
Contributions made to a 401(k) should reduce your current income taxes as
well. You do defer paying income tax on the contributions you make. Likewise,
the earnings in your 401(k) grow tax-deferred until the money is withdrawn.
Income tax is due when the money is withdrawn. If you withdraw money before
you turn 59-1/2, however, you may also be subject to a 10% IRS penalty. While
withdrawals are generally not permitted, certain 401(k) plans may permit
withdrawals for "hardship" reasons, such as medical emergencies or college
tuition. You do pay income tax on the amount withdrawn, and a 20% mandatory
withholding generally is required from the distribution. Moreover, the hardship
distribution may also be subject to the 10% IRS penalty.
403(b) Tax Sheltered Annuities (TSAs). Similar to a 401(k) plan, TSAs
are retirement plans for nonprofit organizations such as schools, hospitals
or social service agencies. These plans allow you to set aside a portion
of your pay on a pretax basis and the money invested in a TSA grows free
from taxation until such time as you withdraw the money. Withdrawing money
from your 403(b) plan before age 59-1/2 is generally prohibited. But there
are exceptions. Certain 403(b) plans permit hardship exceptions such as purchase
of a primary residence or college tuition. If you qualify for a hardship
withdrawal, you will still pay a 10% early withdrawal penalty plus regular
taxes. The maximum amount you can contribute to a TSA is determined by how
much you make, how long you've worked for your current employer and the amount
you contributed in prior years. The general rule is the you can contribute
up to $9,500 a year.
Individual Retirement Arrangements (IRAs). IRAs were established to
encourage people to save for retirement. Subject to certain limitations,
an individual generally may be able to contribute the lesser of $2,000 or
100% of your compensation to an IRA, and the earnings grow tax deferred until
you begin withdrawals. Your annual contribution may also be fully or partially
deductible, depending on your income level and whether you are covered by
another retirement plan. As with 401(k) and 403(b) plans, you may be subject
to a 10% IRS penalty for premature withdrawals (generally before the age
of 59-1/2), in addition to the income tax. You may have a choice of investment
options for your IRA, including stocks, bonds, mutual funds or CDs. Keep
in mind that your money must be in an IRA-approved account and that it must
be designated as an IRA.
Keogh Plans. Keoghs are retirement plans for people who are self-employed.
Usually a maximum of 25% of your net income (or a maximum of $30,000) can
be contributed to these plans on a tax-deferred basis. Keoghs are more
complicated than an IRA, 401(k) or 403(b), so get tax advice before setting
up a plan.
Stocks. When you buy stocks, you acquire shares of a company's assets.
If the company does well, you may receive periodic dividends and/or be able
to sell your stock at a profit. If the company does poorly, the stock price
may fall and you could lose some or all of the money you invested.
Bonds. When you purchase a bond, you are essentially loaning money
to a corporation, the U.S. government or a local government for a certain
period of time, called a term. The bond certificate promises that the issuing
entity will repay you on a specified date with a fixed rate of interest.
Bond terms can range from a few months to 30 years.
Bonds are generally considered a safer investment than stocks because bondholders
are paid before stockholders if a company becomes insolvent. Independent
bond-rating agencies such as Standard & Poor's and Moody's rate the
likelihood that any given bond will default. You can find bond ratings in
each agency's publications at your local library.
Although there are no penalties for selling a bond before the end of its
term, the value of the bond is subject to interest rate fluctuations. If
interest rates have risen since you bought your bond, you may have to sell
it at less than face value. It is also possible that the bond's yield will
turn out to be less than the rate inflation. Some of the bonds available
include:
-
Savings bonds, Treasury bills (commonly called T-bills) and other securities
issued by the U.S. government.
-
Zero coupon bonds, which are similar to savings bonds. No periodic payments
of interest are made. The bonds are bought at a discount and are worth their
face value upon maturity.
-
Municipal bonds (munis), which are sold by states, cities and other local
governments. They are often tax exempt, which means you will pay no taxes
on the interest earned.
-
Insured bonds, which are less risky but generally pay lower interest rates
because of the protection.
-
Convertible bonds, which can be converted into stock.
-
High-yield bonds, commonly referred to as junk bonds, which are issued by
corporations or governments with low ratings. There are very risky.
Mutual Funds. A mutual fund is generally a professionally managed
pool of money from a group of investors. A mutual fund manager invests your
funds in securities, including stocks and bonds, money market instruments
or some combination and decides the best time to buy and sell. By pooling
your resources with other investors in a mutual fund, you can diversify even
a small investment over a wide spectrum, which should reduce risk.
There are many types of mutual funds with varying degrees of risk. Most mutual
funds charge fees, and you often pay income tax on your profits. Tax rules
can be complicated, requiring professional advice.
Annuities. Annuities may be deferred or immediate. Both are financial contracts
you make with an insurance company. However, a deferred annuity helps you
accumulate money for retirement, while an immediate annuity provides you
with a steady stream of retirement income in return for your money.
With a deferred annuity you put money in, and over time it accrues
income and interest. The payout occurs at some later date, when you receive
a steady stream of payments to supplement your other income. The contributions
you make to an non-qualified annuity are not tax-deductible. Contributions
to a qualified annuity that is funding an IRA, 401(k), 403(b) or other qualified
plan may be before tax or tax deductible. However, taxes on the earnings
in the annuity are deferred until you begin receiving payments. Because annuities
are generally administered by insurance companies, they can be set up to
include life insurance benefits, such as a death benefit to a surviving spouse.
Immediate annuities are usually purchased with one lump sum payment
and then begin an immediate payout. You receive payment on a monthly or other
regular basis, giving you needed income. You can generally choose to have
payouts guaranteed by the issuer for as long as you live or choose form a
number of other payment options.
Both deferred and immediate annuities can be either fixed or variable. The
issuer of a fixed annuity guarantees a fixed rate of interest (deferred)
or a fixed payment (immediate). Although you are protected from any downturn
in the market, you won't benefit from any upswings. A variable annuity can
earn a flexible rate (deferred) or pay a variable payment (immediate) depending
on the performance of the underlying investment options you choose. Variable
annuities are designed to accumulate money or provide an income stream that
hopefully will rise over time to keep pace with inflation. However, there
is some risk involved if the market does poorly during the time your money
is invested.
Annuities can be a complicated investment, so discuss then with a qualified
financial advisor to make sure you understand all the options and make the
smartest decisions for your financial needs.
Your home. Your home may be the largest investment you will make during
your lifetime. The market value of your home is determined by such things
as its condition, the neighborhood, school districts, square footage of the
house and house style.
Other Ways to Protect Your Financial Future
Social Security. You've paid into it most of your life, so don't forget
to include it in your financial planning. The income you receive when you
turn 65 is based on the average of your 35 highest salary years. You also
can collect 80% of your benefit at age 62. If you die, your spouse may be
entitled to your benefits. The age at which you can collect full benefits
is currently scheduled to increase gradually to 67. You can check the record
of your earnings and get a statement of your anticipated benefits by calling
Social Security at 800-772-1213.
Life Insurance. Life insurance can protect your loved ones in the
event of your death. It's important if you are married and even more important
if you have children. There are several types of life insurance:
Term Life insurance pays a fixed amount of money to your
beneficiary if you die during the term of the policy. The cost of premiums
increases as you get older.
Whole Life insurance is permanent insurance that provides a
death benefit that is guaranteed for the insured's life as long as premiums
are paid. Participating policies may pay dividends that can increase the
policy's cash value but they are not guaranteed.
Universal life insurance is considered a variation of whole
life insurance with more flexibility. Within limits, the policy owner determines
the amount and frequency of his or her premium payments and is permitted
to adjust the policy face amount up or down to reflect changes in his or
her needs. As premiums are paid and cash values accumulate, interest is credited
to the policy's accumulation fund.
Variable life insurance is similar to universal life in that
there is flexibility in connection with premium payments and death benefits.
However, with variable life, premium payments are held in separate accounts
and the policy owner chooses how the cash value will be invested. Consequently,
such a policy's cash value will fluctuate with the performance of the chosen
investment portfolios.
Health Insurance. Health coverage protects you in case of sickness
or injury. Without it you run the risk of being financially wiped out by
just one serious illness or accident. Most people receive subsidized health
benefits through their employer, but coverage can also be purchased as an
individual.
Disability Insurance. This probably one of the most overlooked forms
of insurance for working-age people. Disability coverage replaces a portion
of your income when you can't work because of illness or injury. Most policies
replace 60% to 80% of your income. (You also may receive income from Social
Security for certain disabilities, or from Workers Compensation if you are
injured on the job.) If your employer provides a 60% disability policy, you
might want to consider a supplemental policy covering 20% of your income.
Long Term Care Insurance. Long Term Care insurance is designed to
help pay for nursing home care or home health care expenses. This fast growing
type of insurance can protect you and your assets against the high cost of
long-term care. Most policies pay benefits when long term care is prescribed
by a physician as medically necessary or when someone can no longer physically
or mentally take care of basic needs.
Homeowners Insurance. Homeowners coverage protects your financial
investment in your home. It provides compensation for damages to your home
and its contents, and it may protect you from financial liability if someone
is injured on your property. The extent and amount of coverage needed depends
on your situation, but if you can afford it, it is wise to insure your home
for 100% of its replacement cost.
Auto Insurance. Auto insurance is more than a matter of insuring your
vehicle for loss or repairs after an accident. It is a financial safety net
that can help you offset the cost of bodily injuries to yourself or others,
lost wages due to injury, and law suits brought against you as the result
of an accident. Most states require the purchase of basic coverage and then
you determine the additional insurance you need.
Estate Planning. Another way to safeguard your family's financial
future is through estate planning. Generally, estate planning includes
inventorying your assets and making a will or establishing a trust, with
an emphasis on minimizing taxes. Estate planning is very complex and subject
to changing laws. You may want to seek professional advice.
Do You Need a Financial Advisor?
If you need help with your blueprint for the future, you may want to consult
a financial advisor, who can give you advice on everything from budgeting,
taxes, retirement and estate planning to investments, insurance and real
estate.
Some financial advisors charge you no fee; instead they make a commission
on the financial vehicles that they sell you. Other advisors are fee-only,
which means they charge you for their services but do not make a commission
on what they are selling you. Still other charge a fee for providing the
financial plan and may also receive commissions if they sell you any products.
Shop around and talk to several financial advisors. Be sure you feel comfortable
with them and can understand their explanations. Ask for their credentials.
One credential is a Certified Financial Planner (CFP) designation, which
means the planner has taken a series of courses in financial planning, has
passed an exam, has at least three years experience and takes continuing
education courses each year. Other designations include Chartered Financial
Consultant (ChFC), Certified Public Accountant (CPA) and Registered Financial
Planner (RFP). Investment advisors and broker/dealers may also be regulated
by the state. The Securities and Exchange (SEC) regulates broker/dealer and
some investment advisors. Individuals associated with these firms generally
must pass certain licensing examinations.
Do You Need a Broker?
If you plan to buy stocks and bonds as part of your investment portfolio,
you should know that most must be purchased through a broker. Brokers are
licensed professionals who monitor investments and give advice on stock
purchases. They charge fees for their services—either as a percentage
of your portfolio or a fee per transaction. They may also make commissions
from some of the investments they sell.
Discount brokerage houses have lower fees. However, they employ salaried
brokers who are primarily order takers and do not give investment advice.
If you use a discount broker, be sure you are well-informed about stocks
and can make your own investment decisions.
If you do decide to use a full service broker, be prepared:
-
Shop around for the person who is right for you. Interview
three or four brokers.
-
Ask each broker about his or her investment strategy and commission
schedule.
-
Be sure you understand the fees you will pay for opening, maintaining
and closing an account.
-
Make sure the broker is part of the Securities Investor Protection
Corporation (SIPC). The SIPC is a nonprofit corporation that can
protect your interests up to $500,000 should your broker become insolvent.
-
Call the National Association of Securities Dealers' (NASD) toll-free
hotline at 1-800-289-9999. The NASD can tell you if there has been
any disciplinary action against a particular brokerage firm or sales
representative.
Investor's Checklist
Shop around. Compare the products and fees of various banks,
financial planners, brokers and investment houses.
Ask questions. All investments carry some degree of risk, so
you should fully understand what you are getting into. Ask for a written
explanation of products, operations and fees.
Educate yourself. Spend some time at your local library gathering
information. Read investment and financial publications such as the Wall
Street Journal, Barron's Investor's Business Daily, Money Smart Money, Forbes
and the monthly Standard & Poor's Stock Reports. Moody's Investors Service
also has manuals that contain financial information on thousands of companies.
Get advice. A financial advisor, your accountant or tax advisor
are all good sources of information to help you understand the choices you
are making and what your risks will be. Make sure any salesperson or advisor
understands your goals and how much risk you are willing to assume.
Don't buy stocks or other investments pitched to you over the
telephone. And never let a salesperson pressure you into acting
immediately.
Don't put all your eggs in one basket.
Diversification—distributing your money across different types
of investments—is the key to sound investing.
Never invest in a product you don't full understand.
Finally, reevaluate your financial plan regularly. Also stop
and review your plan whenever you marry, divorce, have a child, buy a home
or retire.
