We all have things we'd like to accomplish during our lifetime, and many of them cost money. The truth is, unless we learn how to manage money and make it work for us, it may be hard to accomplish all of the things we'd like. By creating a budget that monitors spending and establishes a savings routine, you may be able to accomplish your short-term savings and emergency reserves objectives and allocate money to invest for long-term objectives. The goal of investing may be to make your money grow or to produce income - or both.
Before choosing investment options, it’s important to understand the relationship between risk and reward. As a general rule, higher-risk investments generally have higher potential rewards but also higher potential losses.
Risk is inherent to investing. You can't guarantee that you'll make money on an investment, and the possibility always exists that you may lose money. If you’re an extremely cautious investor, you may run the risk that inflation will outpace your earnings and erode your purchasing power. On the other hand, higher-risk investments tend to be more volatile, to have more "ups" and "downs," which can be disastrous for short-term investors. Risk tolerance, the ability to accept risk, varies among individuals. You should determine your risk tolerance before you invest.
Balancing your ability to take risks with your desire for reward is the foundation of successful investing. The following brief questionnaire will help you assess your level of risk tolerance. You may want to fill out the questionnaire more than once (e.g., for long and then for short-term goals).
|Choose one of the following:|
|I would never take a chance on decreasing my savings .........................(1)
I would be willing to accept some risk to my savings
to achieve modest growth....................................................................(2)
I'm willing to be aggressive to achieve my goals, even by
assuming greater risk..........................................................................(3)
|Years until savings is needed:
Five years or less .........................................................................(1)
Five to 15 years ...........................................................................(2)
15 to 25 years ..............................................................................(3)
25 years or more ..........................................................................(4)
|My priority is to:
Preserve savings and earn a modest return ....................................(1)
Generate potentially higher returns with limited risk ..........................(2)
Grow my savings assuming moderate risk .....................................(3)
Aggressively grow savings despite significant risk ............................(4)
|My emergency savings would cover expenses for:
Six months or more .....................................................................(3)
A few months ..............................................................................(2)
A few weeks ...............................................................................(1)
No emergency savings .................................................................(0)
|If the stock market dropped 15 percent, I would:
Cash out to avoid further losses ....................................................(1)
Reduce the amount invested in equities overall ...............................(2)
Do nothing ..................................................................................(3)
Buy more stock ............................................................................(4)
Add the points indicated at the end of each statement or choice. If your score is 4,5 or 6, safety is your priority. You'll likely be most comfortable with relatively conservative investments that don't have sudden or extreme fluctuations.
If you scored more than 10, your simulation may allow you to assume greater risk in your financial choices. In general, the higher your overall score, the more investment risk you are personally able to tolerate. However, this chart is only a guide to determining your risk tolerance. When you're ready to make investments, a qualified financial advisor can help you choose investments that fit your specific situation.
Once you’ve assessed your risk tolerance, review these investment styles to determine what type of investor you are.
The conservative investor. If you’re a conservative investor, you are likely not comfortable with the idea of losing any of your principal, the initial amount of money invested. You may prefer to put your money in fixed-return investment vehicles that guarantee return of principal plus interest. Savings accounts and certificates of deposit (CDs) that are generally insured by the Federal Deposit Insurance Corporation (FDIC) for up to $250,000 are examples. Be aware, however, that the rate of return may not outpace inflation, so there is still risk — inflation risk, or the risk of losing earning power.
The moderate investor. If you are a moderate investor, you don't want to lose your principal but you also realize that in order to receive higher returns you generally have to assume some risk. You may be comfortable with a combination of low- and higher-risk investments. While you may flinch when the market drops, you understand that the potential for higher long-term gain may mean having to ride out the dips.
The aggressive investor. If you are an aggressive investor, you are more willing to accept market swings. You seek a higher potential return from your investments. While this winner-takes-all attitude may hold the potential for greater gain, it also holds the potential for greater loss. This type of aggressive investing is only for the truly aggressive investor and is best suited for long-term financial goals.
Understanding the Risk/Reward Relationship
In choosing investment options, it's important to realize that risk and reward have a parallel relationship. Generally the riskier the investment, the higher the potential reward — or the potential loss.
Diversifying Your Investments
Striking a balance between risk and reward is important to every investor. One way to create a balance can be through diversification. When you diversify, you distribute your investments across several types of investments or asset classes, some with higher risk and some with lower risk. In other words, don't put all your eggs in one basket. A well-diversified portfolio might include stocks, bonds and savings vehicles (e.g., CDs) to help even out the ups and downs of the market. You'll want to pick your own mix based on your risk tolerance, investment styles, investment goals and time horizon. Note that while diversification through an asset allocation strategy is a useful technique that can help to manage overall portfolio risk and volatility, there is no certainty or assurance that a diversified portfolio will enhance overall return or outperform one that is not diversified. Diversification cannot eliminate the risk of investment loss.
Types of Investments
Once you understand the roles of risk and reward in investing and have determined your own risk tolerance, consider the types of investments that might be right for you. Even with a small amount to invest, you generally have plenty of choices. Here's an overview of some of the most common opportunities.
Savings vehicles tend to be lower-risk/lower-return options. Following is a quick guide to the most common savings vehicles:
Savings accounts. A savings account is a good place to hold emergency funds, reserves, and money for short-term financial goals. Funds are typically liquid, or readily accessible, and the Federal Deposit Insurance Corporation (FDIC) generally insures savings accounts up to $250,000. The main drawback is low interest rates. The interest rate paid on a savings account is often lower than the rate of inflation, so your savings may not grow as fast as the rising price of goods and services. That may make savings accounts unsuitable for your long-term goals.
Certificates of Deposit. Also known as CDs, certificates of deposit generally earn more interest than savings accounts with equally little risk but with less liquidity. Like savings accounts, bank CDs are generally insured up to $250,000 by the FDIC. CDs typically provide higher interest rates than savings accounts in exchange for your agreement to keep the money in the CD for a fixed period of time, usually three months to five years. Generally, the longer the term of the CD, the higher the interest rate. If you take your money out before the end of the time period or CD maturity date, you'll pay a premature withdrawal penalty to the financial institution.
Money Market 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. Bank money market accounts may also be FDIC-insured up to $250,000.
Money market funds issued by other financial institutions (e.g., a stock brokerage) are not FDIC insured and may lose value. Although they seek to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the fund.
Once you’ve accumulated savings to meet your emergency and reserve account goals, you can consider types of investments to meet your long term goals. Look for investments that will earn enough to outpace the cost of living (i.e., inflation). For example, if an investment earns 4 percent interest and the rate of inflation is also 4 percent, your savings will not increase in actual value, or buying power. Don’t forget, types of investments with higher potential returns also carry greater potential risk.
Stocks. When you buy stock, you become part owner of a company. In choosing stocks, you're looking for companies that you believe will perform well over time. Be sure to thoroughly research companies you're interested in, and make sure you understand the potential for profit or loss before you invest. If the company does well, you may receive dividends (i.e., a small portion of a company’s earnings usually paid to stockholders at regular intervals) and/or be able to sell your stock at a profit. Conversely, if the company does poorly and its stock price falls, the value of your investment will decrease.
There are two types of stock: common and preferred. As an owner of common stock, you are entitled to attend annual meetings and have voting rights. Common stock is usually riskier than preferred stock. Because of this, it offers greater potential returns and losses. As a shareholder of preferred stock, you would not usually have voting rights, but you would receive a fixed dividend, which would be paid to you before common stockholders are paid. But owners of preferred stock pay for that privilege—usually your dividends wouldn't increase when the company's profits increase. When a company does well, the price of its preferred stock tends to underperform its common shares. However, when a company fails, preferred stockholders are ahead of common stockholders in recouping their investment. When selecting stocks, it's good to keep in mind factors that could influence the company's performance—and, therefore, the investment.
How to read stock tables
Stock tables, which are in daily newspapers as well as online, can be confusing – a lot of information is presented in abbreviated form. Once you learn what the abbreviations mean, most of the confusion will disappear.
|Stock||Div||Yld%||PE||Vol 100s||Hi||Lo||Close||Net chg|
Stock—Under this heading is an abbreviated form of the company's name, also called a symbol. Here, the XYZ Co.'s common stock is listed as XYZ. Not all symbols are easy to decipher. If a stock symbol's roots are not obvious to you, an online service can help you determine the full company name.
Div—Dividend is the cash return paid on the stock. This listing shows that the XYZ Co. is paying stockholders an annual cash dividend of $2 per share. A rising dividend may be a signal the company is confident of its future.
Yld%—Yield is the percentage return paid on the stock. That $2 dividend equals about 3.4 percent of XYZ Co.'s stock price. Though 3.4 percent may be below the rate on a bank CD, investors will accept it because they hope the stock price will go up as well.
PE—PE (or p/e) is the price-to-earnings ratio. PE is a comparison of the day's closing stock price to the company's profit per share over the last year. Here, XYZ Co. sold for 10 times earnings. A hot growth stock may sell at 25 times earnings or even more. A troubled stock will have a low PE.
Vol 100s—Volume is the number of shares traded that day. Multiply this number by 100 to get the real volume. On this example day, 2.9 million XYZ Co. shares changed hands.
Hi and Lo—The high and low prices that day. All investors want to buy low and sell high, and many want to know the range during the day. XYZ Co.'s high this day was $59.625. The low was $58.375.
Close—Close is where the stock ended that day. This is the last price a stock sold for on the day. It's also the information investors most often seek when they look up a stock in the paper. XYZ Co.'s close was 59, or $59. In some papers, close is called "last."
Net chg—Net chg is the price change from the day before. Investors always want to know if a stock finished up or down (i.e., higher or lower) from the previous day. XYZ Co. closed up 1/2 point, or 50 cents. Some newspapers use "Chg" instead.
Bonds. Bonds are a form of loan that you make to a corporation, the federal government and its agencies, or a local government. You become a creditor for a set period of time, called a term, and are paid interest by the borrower for the use of your money. Bond terms generally range from a few months up to 30 years. If you hold the bond until it matures (i.e., until the end of its term), the issuer promises to return to you the amount you originally paid, plus a fixed rate of interest. It is possible, however, for bond issuers to default, meaning they may be unwilling or unable to pay their debts, including the debt owed to holders of their bonds. Generally, bonds are considered a safer investment than stocks because bondholders are paid before stockholders should a company become insolvent. Bonds are not FDIC insured. Bond ratings measure credit risk. Several private agencies, such as Moody's and Standard & Poor's, rate bonds based on their assessment of underlying risk that the issuer may not be able to pay back the bond's principle and interest. The better the rating, the lower the interest the bond will usually pay. Generally the higher the yield, the greater the risk.
Remember: in extreme cases, the issuer of the bond can suspend interest payments or default entirely. Issuers can also buy back, or "call," the bonds before maturity if interest rates fall. You should study the call provisions thoroughly before buying a bond.
It’s important to understand the relationship between interest rates and bonds. When interest rates go up, there is a risk that the market value of bonds will go down. If the market value of a bond you own goes down and you want to sell before the bond’s maturity date, you may receive less than you originally paid for the bond and/or less than the maturity value of the bond. The interest rate of bonds remains fixed. For example, if you try to resell a bond when interest rates in general are higher than the bond’s interest rate, your bond will not be attractive to buyers, and its market value will drop. If your bond pays a higher interest rate than the bonds that are currently being sold, your bonds will be desirable to buyers and the price may go up.
There are many types of bonds, including:
U.S. Savings bonds, Treasury bills (or T-bills) are sold by the federal government, are principal protected and not subject to interest rate risk.
Municipal bonds (or munis), sold by states, cities, and other local governments, are generally exempt from federal income taxes (i.e., you will pay no federal income tax on the interest). Depending on the issuer, municipal bonds may be exempt from state and local taxes as well.
Insured bonds generally pay lower interest rates, because a third party guarantees payment of interest and principal. Insured bonds have less risk of default.
Corporate Bonds issued by companies, may include the following types:
Zero coupon bonds, similar to savings bonds, do not pay interest during the life of the bond. You buy zero coupon bonds at a deep discount from their face value. Face value is the amount the bond will be worth when it "matures" or comes due. At maturity, you receive one lump sum equal to the initial investment plus interest that has accrued over the life of the bond.
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. They have a higher risk of default.
Mutual Funds. A mutual fund is a pool of money, supplied by investors like you, that is invested in various securities such as stocks, bonds, money market instruments, or a combination of these investments. Every share of the mutual fund represents a proportion of ownership of the fund’s total assets (e.g., investments) as well as a proportion of the income those holdings generate. The share value of a mutual fund will go up and down as market conditions change, and investors may make or lose money. Typically, mutual funds have a professional manager or team of managers making day-to-day and minute-by-minute buy and sell decisions.
Each mutual fund is different in its make-up and philosophy. As an investor, you should look for funds with objectives and risk levels that match yours. If you're interested in a diversified mutual fund covering a single class of investments, there are many broad-based funds that invest in a wide variety of stocks. If you prefer to stick with single industries, you might consider sector funds such as real estate investment trusts (REITs), technology, and telecommunication funds, among others. Mutual funds are also a good way to invest in foreign stocks. Some funds own hundreds of different securities, while others may own only a few dozen.
The two most common types of mutual funds are equity funds that invest primarily in common stocks and fixed-income funds or "bond funds" that typically invest in bonds or money market securities. Less common are "balanced funds" invested in both equity and debt.
By investing in mutual funds, you can diversify your types of investments and help to balance risk – but there are literally thousands of mutual funds and their relative risk varies widely.
Mutual funds are sold by prospectus, which is available from your registered representative. Carefully consider investment objectives, risks, charges, and expenses before investing. For this and other information about any mutual fund investment, please obtain a prospectus and read it carefully before you invest. Investment return and principal value will fluctuate with changes in market conditions such that shares may be worth more or less than original cost when redeemed. Diversification cannot eliminate the risk of investment losses.
Your Home. Many people don't think of a home in investment terms, but it may be the largest, single investment you'll make. That's why it's important to choose your home with an eye toward long-term value. Keep your home in good repair to maintain or even improve its market value. Market value is based on such things as house style, square footage, location/neighborhood, school district, property taxes and transportation. Consider as many factors as you can when purchasing. For example, the quality of the school district may seem unimportant to you if your children are grown. However, when you decide to sell your house, potential buyers with children may not want to look in your area. Read more helpful tips at Life Advice: Your Home.
Most financial experts agree: save for retirement sooner rather than later. It’s never too early to begin investing for retirement. If you don’t already have one, consider establishing a tax-favored retirement account, such as one of the following:
401(k) Plans. If your employer offers a 401(k) plan, it may be one of the best retirement savings vehicles available to you, particularly if the employer matches all or a portion of your contribution. With a 401(k) plan you may contribute up to a certain percentage of your gross income (i.e., total income before taxes). Typically, 401(k) plans offer numerous investment choices, but you will need to choose from those your employer offers.
Earnings in a 401(k) grow tax-deferred. Income tax is due when the money is withdrawn, usually after retirement. If you withdraw money before you turn 59 ½ you may be subject to a 10 percent tax penalty unless the withdrawal is made for a "qualified" reason (as defined by the IRS), such as medical emergencies or college tuition. You pay ordinary income tax on the taxable portion of the withdrawal, 10% penalty tax if applicable, and a 20 percent mandatory federal income tax withholding generally is required from the distribution amount. Some 401(k) plans may also permit loans against your account balance. There is typically a maximum loan amount, and the loan must be repaid, with interest, within a specified time period.
403(b) Plans. A 403(b) plan is similar to a 401(k), but is offered to employees of public and private school systems—K through college—and non-profit, tax-exempt organizations, such as churches, libraries, etc. Your plan administrator can explain how it works and how it differs from the 401(k).
Individual Retirement Accounts (IRAs). IRAs were established by Congress to encourage people to save for retirement by providing tax advantages. Qualifying individuals may contribute up to $5,500 annually (an additional $1,000 may be contributed if you are over 50) to an IRA. Tax benefits will depend upon the type of IRA you select, your income level and whether you or your spouse are covered by another tax-advantage retirement plan (e.g., a 401(k) plan).
Traditional IRA: The earnings on your IRA are tax-deferred. Depending on how much money you earn, you may be eligible to deduct your IRA contribution from your gross income for tax purposes. But, there are penalties for withdrawing money from your traditional IRA before you reach the age of 59 1/2, and withdrawals of deductible contributions will be taxed as ordinary income.
Roth IRA: Eligibility is determined by the amount of your annual income. You may not deduct contributions to your Roth IRA from your taxable income, but growth in your Roth IRA is tax-free, assuming you meet plan requirements. Roth contributions can be withdrawn income and penalty tax free. You may incur a 10 percent penalty if you withdraw your earnings from a Roth IRA within the first five years after establishing a Roth IRA, and your earnings will also be subject to payment of ordinary income taxes. Assuming you meet the five-year test, the requirements for penalty-free withdrawals from a Roth IRA are essentially the same as those for making withdrawals from a Traditional IRA, that is, there will generally not be a penalty if you die, are disabled, or if you are older than 59 1⁄2.
You should consult with and rely on your own independent legal and tax advisers regarding your particular set of facts and circumstances
Keogh Plans. Keogh plans are tax-deferred retirement savings plans for people who are self-employed. Generally, a maximum of 25 percent of net income, up to a maximum amount per year, can be contributed on a tax-deferred basis. Keogh plans are more complicated than IRAs or 401(K) plans. To make sure your plan is properly implemented, be sure to get professional tax advice.
Annuities. Annuities are financial contracts issued by an insurance company. Annuities may be deferred or immediate.
With a deferred annuity, payout is deferred to some later date when you elect to receive income payments. A deferred annuity grows tax deferred; earnings are not taxed until you withdraw money. Ordinary income taxes are generally due on the taxable amounts of the withdrawal. Withdrawals of earnings prior to age 59 1/2 may be subject to a 10 percent tax penalty. There may also be surrender charges if you withdraw money from an annuity within a certain time frame, typically within the early years of the contract.
Immediate annuities are purchased with one lump sum payment, and payouts usually begin immediately. You receive payments on a regular basis, providing you with a steady stream of income. Generally, you can choose a payment option that guarantees payments by the issuer for as long as you live or choose from a number of other payment options. Annuities include a death benefit to a surviving spouse or other named beneficiary.
When withdrawing from an annuity, ordinary income taxes generally apply and withdrawal charges may also apply. Withdrawals will reduce the living benefit, death benefit and account value. Withdrawals prior to age 59½ from a TSA or prior to age 70½ from a 457(b) (before separation of service) are
generally prohibited and where allowed, a 10% Federal income tax penalty generally applies in addition to ordinary income taxes. Consult with your tax advisor to determine whether an exception to these tax rules may apply.
Annuity products are long-term investments designed for retirement purposes and can be a complicated financial product. Product availability and features may vary by state. Before purchasing an annuity, discuss its specifics with a qualified financial professional and your tax advisor to make sure you understand the annuity and your options.
Like most annuity contracts, MetLife’s contracts contain charges, limitations, exclusions, holding periods, termination provisions and terms for keeping them in force. Contact your financial representative for costs and complete details.
Variable annuity products are offered by prospectus only, which is available from your registered representative. You should carefully read the product prospectus and consider the product's features, risks, charges and expenses, and the investment objectives, risks and policies of the underlying portfolios, as well as other information about the underlying funding options. This and other information is available in the prospectus, which you should read carefully before investing. All product guarantees are subject to the financial strength and claims-paying ability of the issuing insurance company. The amounts allocated to the variable investment options are subject to market fluctuations so that, when withdrawn, they may be worth more or less than their original value. There is no guarantee that any of the variable investment options will meet their stated goals or objectives.
Annuities are issued by MetLife Insurance Company USA; 11225 North Community House Road, Charlotte, NC 28277, Metropolitan Life Insurance Company; 200 Park Avenue, New York, NY 10166, and First MetLife Investors Insurance Company (in NY Only); 200 Park Avenue, New York, NY 10166. Variable products and MetLife Shield Level Selector are distributed by MetLife Investors Distribution Company (member FINRA); All are MetLife companies.
At first you may feel that you do not need the services of a broker or financial professional. You may decide to invest your money using online services or through traditional vehicles such as savings accounts or CDs until you have accumulated enough savings to diversify your holdings. Spend some time reading about different investments to familiarize yourself with the terms used.
When you are ready to diversify, you may want to find a qualified financial advisor. They can help you learn about available investment vehicles and help you get off to a strong start on building your own personal investment strategy.Any discussion of taxes is for general informational purposes only, does not purport to be complete or cover every situation, and should not be construed as legal, tax or accounting advice. Clients should confer with their qualified legal, tax and accounting advisors as appropriate.
The Intelligent Investor: The Classic Text on Value Investing
by Benjamin Graham
Publisher: Collins; New Ed edition
The Wall Street Journal Complete Money and Investing Guidebook
by Dave Kansas
Publisher: Three Rivers Press
The Generation Y Money Book: 99 Smart Ways to Handle Money
by Don Silver
Publisher: Adams-Hall Publishing; 1st edition
The Financial Planning Association (FPA) supports the financial planning process in order to help people achieve their goals and dreams.
National Association of Investors Corporation, the nation's largest nonprofit organization dedicated to investment education, with more than 50 years of service delivering investing knowledge and practical investing experience.
Kiplinger's Online is a source for personal finance information.
Morningstar provides data and commentary on mutual funds, stocks and variable annuities.
Bloomberg Online provides financial news and market reports.
This site has many articles to help the individual investor.
Raging bull provides access to information previously reserved for investing professionals.