Like exercising and eating broccoli, investing is something we are all supposed to do.
But where to start?
Understanding a few ideas and common terms can make it easier to talk with a professional and begin.
The Ba$ics What is saving, and what is investing? Both involve putting away money, but the difference is the amount of time involved.
Adam Tatroe, a financial advisor with BMO Harris Bank in Crystal Lake, McHenry and Marengo, defines savings as money set aside for specific, short-term goals — goals to be met between one and five years.
“These are situations where there’s a guarantee that on a certain date, the money is going to be there,” Tatroe says.
Common short-term goals are car purchases, weddings, vacations and home purchase down payments.
Bank savings accounts, money market accounts, vacation or Christmas club accounts are tools to help reach short-term savings goals.
Tatroe suggests people open an account earmarked for a specific goal and then use automatic withdrawls from their checking account to fund it.
“This way, it systematically happens, and you don’t have to think about it,” he says.
A Certificate of Deposit, or CD, is another smart savings tool. A CD holds a specific sum on deposit for a designated length of time, usually about a year or two. At maturity, a CD returns the entire deposit, with a predetermined amount of interest.
“When it matures, you can go buy the house or car or go on a vacation,” Tatroe says.
Investing, meanwhile, is done with an eye further to the future.
“Investing generally involves a long-term commitment,” says Steve Middaugh, financial advisor with Edward Jones in Crystal Lake. “You invest with a long-term perspective, and assets that are invested shouldn’t be as accessible as shorter term assets.”
$tocks and Bonds The two primary investment vehicles are stocks and bonds, also known as securities. Stocks, or equities, are ownership in a company or a group of companies.
“As a part owner, you get to share in the good or bad fortune of that company,” Middaugh says.
Bonds, or fixed income instruments, allow investors to become creditors to a company or government entity.
“They are a way for individuals to loan money in exchange for being paid steady interest over the life of the bond, and [they] receive their principal back at maturity,” says NoŽl Thelander, financial advisor with Edward Jones in downtown Woodstock.
Stocks and bonds may be owned individually or through a mutual fund, which is a group of securities held in a single fund.
“Mutual funds are baskets of investments, and what you invest is spread across the basket,” Middaugh says. “Instead of buying one stock, your money is diversified across all of the fund’s stocks, or holdings.
The mutual fund manager decides day to day where to buy one stock or another.”
Stocks and bonds may be in a brokerage account, which is taxable.
“Because of changes in tax laws, it’s a good idea to evaluate your situation to avoid paying more tax than you need to,” Thelander says. “If you haven’t heard the term ‘tax diversification,’ it’s important to get some professional guidance.”
Stocks and bonds also can be in a retirement account, which is protected from taxes.†
“The types of investments in a retirement account can vary widely, from extremely conservative to very aggressive,” Middaugh says.
Retirement Fund$ Individual Retirement Accounts come in two types.†
“In a traditional IRA, you can obtain a tax deduction for your contributions, and the money grows tax deferred,” Middaugh says. “When it’s taken out, it’s taxed as income. In a Roth IRA, the money going in has already been taxed, so it’s tax free at retirement.”
A 401(k) is a retirement plan sponsored by a private employer, and it works similar to a traditional IRA.† “It’s a crucial way for working people to invest, and the employer match can be the most valuable component,” Thelander says.
Other types of employer retirement plans include the 403(b) for teachers and employees of tax-exempt organizations, and the 457 for government employees.†
“Often these account holders are counting on defined pension plans, but it’s a good idea to talk to a professional about the investments they’re allowed to control,” Thelander says.
Annuities are insurance products, which can offer a guaranteed income or growth.
“Fixed annuities are similar to CDs, offering a fixed rate of return until they mature,” Middaugh says.
“Variable annuities work like a mutual fund with a variable rate of return.”
College $avings Special accounts designated for college savings also are typically comprised of mutual funds and are designed to be tax deferred. Distributions are tax free as long as the funds are used for qualified expenses.
The Coverdell Education Savings Plan has a $2,000 contribution limit each year, but it has income limitations for contributors. The 529 College Savings Plan has no income requirements and higher annual and lifetime limits than the Coverdell, but it is flexible enough to allow small, steady contributions. Thelander says starting early can make a big difference, even if money is tight.†
“College saving is an important example of what can happen when you save over time,” she says.
“Long-term investment growth, compounding interest and tax savings can stretch your dollars.”†††