For any new investor wondering where to start, the number of options, decisions, and issues can be daunting. Having worked at a banking center across from a major university early in my career, I can tell you that most of the college students I interacted with did not have a clue about how money or investing works. I did not learn about money or investing in high school. And because many of us did not take personal finance courses after high school or college, financial advice might come from people who could have an ulterior motive for giving us one suggestion or another.
A banker might advise putting money in a CD or money market account. A broker might say stocks, bonds, and mutual funds are the best. And an insurance agent might suggest annuities and life insurance.
Before discussing saving and investing, I would be remiss if I did not review the basics. Everyone should have a spending plan in place, showing when and where money is coming from and how it is going out. Knowing how to properly use bank accounts and credit is also essential.
I like to say, “Plan with the end in mind.” Using the following tips can help you achieve financial independence and maximize your saving potential.
The first step in planning for the future is establishing a proper emergency fund. You should have four to six months’ worth of expenses in a checking/savings account at all times. This emergency fund can help with the unexpected issues life will throw at you while making sure not to disrupt your savings plans.
From there, the act of saving money should be looked at from an end-usage standpoint. Ask yourself, what is this money going to be used for? If you consider your savings in this manner, it will help you to better understand the basic and vital feature of access to your money. The higher the level of access you have to your savings plans, the better you can deal with unexpected financial situations or take advantage of financial opportunities that come along.
When most people think of saving for retirement, they think of saving money in their retirement plan at work; usually this is a plan similar to a 401(k). If your employer will match a certain level of your contributions, then contribute up to that point and not a penny more until considering the following scenario.
Let’s say you and I are going to be business partners. At some point in the future, we will sell the business and retire on the proceeds. Along the way, you contribute all the capital and take all the risk. I’ll give you a little annual carrot to encourage you to contribute to the business, and in return for that carrot, I get to decide how the proceeds will be split up when it comes time to retire. If I want 20 percent, that’s what I’ll get. If I need 60 percent at that time, that’s what I’ll get. Oh, and by the way, if you need any of your capital back before I say it’s okay to retire, then you have to pay me a penalty in addition to the percentage I want.
Does that sound like a good business proposition to you? What if I substitute the IRS for me in that arrangement, does that sound any better?
If you answered no, then consider that what I just described is exactly the relationship you have with the IRS in your IRS-qualified retirement plan, 401(k), 403(b), IRA, etc. Think about that for a minute. If you contribute to one of these plans, you are putting money into a plan that is designed to restrict access to your money because of the taxation rules over which you have no control. That is why I recommend contributing to one of these plans, but only up to the limit that your employer will match.
Where should new investors put their hard-earned money to work? You have three main categories from which to choose: bank products, insurance products, and market products.
Bank products should be used for funds you intend on accessing within the next three years. You won’t earn much interest, especially with today’s interest rates, but you are willing to give that up in exchange for principal preservation and a high level of access to the funds.
Insurance products are usually the preferred choice for funds with a bit longer time horizon (four or more years). That gives the funds enough time to actually grow. How much they grow depends on how the product works. Some pay a fixed rate of interest, some link to an external index with downside protection, and some invest directly in mutual funds. Depending on the structure of the product, it can also have tax advantages
Market products should only be used for funds that you won’t be touching for at least ten years. The reason for this? You would need that much time to make up for some of the losses you will incur along the way when the market has a correction.
The elements of a good savings plan should include all of the three categories previously mentioned. Should you choose to seek the advice of financial professionals, they should have the ability to direct you into any of these areas.
