Used with permission from the United States Securities and Exchange Commission.
Roadmap to Saving and Investing
Knowing how to secure your financial well-being is one of the most important things you can do for yourself. You don’t have to be a genius to do it. You just need to know a few basics, form a plan, and be ready to stick to it.
To end up where you want to be, you need a financial plan. Ask yourself what you want. List your most important goals first. Decide how many years you have to meet each specific goal, because when you save or invest, you’ll need to find an option that fits your time frame. Here are some tools to help you decide how much you’ll need to save for various needs.
- The Ballpark Estimate, created by the American Savings Education Council, can help you calculate what you’ll need to save each year for retirement.
- The Financial Industry Regulatory Authority (FINRA) has a college savings calculator.
- The Social Security Administration has a benefits calculator to estimate your potential benefit amounts.
Take an honest look at your entire financial situation — what you own and what you owe. This is a “net worth statement.” On one side, list what you own. These are your “assets.” On the other side, list what you owe. These are your “liabilities” or debts.Subtract your liabilities from your assets. If your assets are larger than your liabilities, you have a “positive” net worth. If your liabilities are larger than your assets, you have a “negative” net worth.
You’ll want to update your “net worth statement” every year to keep track of how you are doing. Don’t be discouraged if you have a negative net worth -- following a financial plan will help you turn it into positive net worth.
The next step is to keep track of your income and expenses. Write down what you and others in your family earn and spend each month, and include a category for savings and investing. If you are spending all your income, and never have money to save or invest, start by cutting back on expenses. When you watch where you spend your money, you will be surprised how small everyday expenses can add up. Many people get into the habit of saving and investing by paying themselves first. An easy way to do this is to have your bank automatically deposit money from your paycheck into a savings or investment account.
How much does a daily candy bar cost? Would you believe $465.84? Or more?
If you buy a candy bar every day for $1, it adds up to $365 a year. If you saved that $365 and put it into an investment that earns 5% a year, it would grow to $465.84 by the end of five years, and by the end of 30 years, to $1,577.50. That’s the power of “compounding.”
With compound interest, you earn interest on the money you save and on the interest that money earns. Over time, even a small amount saved can add up to big money.
If you buy on impulse, make a rule that you’ll always wait 24 hours before buying anything. You may lose your desire to buy it after a day. Also try emptying your pockets at the end of each day and putting spare change aside. You’ll be surprised how quickly those nickels and dimes add up.
No investment strategy pays off as well as, or with less risk than, eliminating high interest debt. Most credit cards charge high interest rates -- as much as 18% or more -- if you don’t pay off your balance in full each month. If you owe money on your credit cards, the wisest thing you can do is pay off the balance in full as quickly as possible. Virtually no investment will give you returns to match an 18% interest rate on your credit card. That’s why you’re better off eliminating all credit card debt before investing. Once you’ve paid off your credit cards, you can budget your money and begin to save and invest.
Here are some tips for avoiding credit card debt:
Put Away the Plastic
- Don’t use a credit card unless you know you’ll have the money to pay the bill when it arrives.
Know What You Owe
- It’s easy to forget how much you’ve charged on your credit card. Every time you use a credit card, track how much you have spent and figure out how much you’ll have to pay that month. If you know you won’t be able to pay your balance in full, try to figure out how much you can pay each month and how long it’ll take to pay the balance in full.
Pay Off the Card with the Highest Rate
- If you’ve got unpaid balances on several credit cards, you should first pay down the card that charges the highest rate. Pay as much as you can toward that debt each month until your balance is once again zero, while still paying the minimum on your other cards. The same advice goes for any other high-interest debt (about 8% or above), which does not offer any tax advantages.
Savings are usually put into safe places that allow you access to your money at any time. Examples include savings accounts, checking accounts, and certificates of deposit. At most banks, your deposits may be insured by the Federal Deposit Insurance Corporation (FDIC) or National Credit Union Administration (NCUA). But there’s a tradeoff between security and availability; your money earns a low interest rate.
Most smart investors put enough money in savings to cover an emergency, like sudden unemployment. Some make sure they have up to six months of their income in savings so that they know it will absolutely be there for them when they need it.
But how “safe” is a savings account if the interest it earns doesn’t keep up with inflation? Let’s say you save a dollar when it can buy a loaf of bread. But years later when you withdraw that dollar plus the interest you earned, it might only be able to buy half a loaf. That is why many people put some of their money in savings, but look to investing so they can earn more over longer periods of time.
When investing, you have a greater chance of losing your money than when you save. Unlike FDIC-insured deposits, the money you invest in securities, mutual funds, and other similar investments are not federally insured. You could lose your “principal,” which is the amount you’ve invested. That’s true even if you purchase your investments through a bank. But when you invest, you also have the opportunity to earn more money. On the other hand, investing involves taking on some degree of risk.
Diversification can be neatly summed up as, “Don’t put all your eggs in one basket.” The idea is that if one investment loses money, the other investments will make up for those losses. Diversification can’t guarantee that your investments won’t suffer if the market drops. But it can improve the chances that you won’t lose money, or that if you do, it won’t be as much as if you weren’t diversified.
What are the best saving and investment products for you? The answer depends on when you will need the money, your goals, and whether you will be able to sleep at night if you purchase a risky investment (one where you could lose your principal).
For instance, if you are saving for retirement, and you have 35 years before you retire, you may want to consider riskier investment products, knowing that if you stick to only the “savings” products or to less risky investment products, your money will grow too slowly. Or, given inflation and taxes, you may lose the purchasing power of your money. A frequent mistake people make is putting money they will not need for a very long time in investments that pay a low amount of interest.
On the other hand, if you are saving for a short-term goal, five years or less, you don’t want to choose risky investments, because when it’s time to sell, you may have to take a loss.
While the SEC cannot recommend any particular investment product, a vast array of investment products exists, including stocks and stock mutual funds, corporate and municipal bonds, bond mutual funds, exchange-traded funds, money market funds, and U.S. Treasury securities.
Stocks, bonds, and mutual funds are the most common asset categories. These are among the asset categories you would likely choose from when investing in a retirement savings program or a college savings plan. Other asset categories include real estate, precious metals and other commodities, and private equity. Some investors may include these asset categories within a portfolio. Investments in these asset categories typically have category-specific risks.
Before you make any investment, understand the risks of the investment and make sure the risks are appropriate for you. You’ll also want to understand the fees associated with the buying, selling, and holding the investment.