Becoming an Investor
Learning how to invest money ranks high on the priority list of many young people. But a lack of knowledge about investing basics combined with an overwhelming smorgasbord of investment options can lead to apprehension and fear about investing.
Investing 101 - Some Basic Principles
Risk and reward are inversely related. The greater risk you are willing to take in investing your money, the greater potential reward you will reap. But there are no guarantees that taking greater risk with your money will result in greater reward.
There’s a difference between saving and investing your money. Saving money at fixed rates of return is safe and certain, even when the rate of return is low. When you save your money, you are not risking loss of your principal. Over the long run, however, investing in stocks has outperformed saving. Willingness to assume risk has a pay-off.
Know the basic types of investments, especially mutual funds. The Pyramid of Investment Risk shows low-risk, medium-risk, and high-risk categories of investments. (See diagram of the Pyramid of Investment Risk on the next page). Beginning investors should stick to low-risk and medium-risk investments and should never invest their money in something they do not understand.
Stocks . Stocks in a public company may be common stock or preferred stock. If you hold common stock, you have voting rights as a stockholder. If you hold preferred stock, you do not have voting rights but receive fixed dividends on your stock before stockholders of common stock.
Bonds . Companies may issue corporate bonds to raise needed money. Bond holders receive taxable interest on the bonds but also assume risk if the company’s credit rating changes or the company goes bankrupt. Public entities (towns, cities, counties, or states) may issue municipal bonds to finance public works projects. Look for the highest rating, not the highest interest rate.
Mutual Funds. Mutual funds are a primary investment option for small investors. Almost half of all American households have invested money in mutual funds. Many mutual fund investors remain unclear about this type of investment. Before you invest, the mutual fund company must provide you with a fund prospectus, which describes the mutual fund, its investment objectives, investment criteria, investment costs, etc. Mutual funds offer the individual small investor something that is difficult to achieve any other way—portfolio diversification and professional fund management.
Take Advantage of Employer-Provided Retirement Plans
One of the most compelling reasons for becoming a knowledgeable investor is to take advantage of employer-provided retirement benefits, even if retirement is decades away.
Get to Know your Retirement Plan
Employer-provided retirement plans are not all the same. Some employers offer a defined benefit plan, while others offer a defined contribution plan.
A defined benefit plan promises you a specified monthly benefit at retirement.
A defined contribution plan, on the other hand, are plans that you or your employer (or both) contribute to your individual account under the plan, sometimes at a set rate, such as 5 percent of your earnings annually. These contributions generally are invested on your behalf.
Steps to Wi$ing Up - Step 7-1. Women - What’s in Your Future?
Even if retirement is many years away, it’s never too early to think about the future and the money you are investing for retirement.
Take Advantage of Tax Breaks When You Invest
Reducing current income taxes is often a powerful incentive to save for retirement through employer-sponsored programs or other tax-advantaged programs. To take the best advantage of this tax-deferred accumulation period, start as early as possible, and be a consistent, regular saver/investor.
Take Advantage of Other Retirement Planning Incentives
Individual Retirement Accounts (IRAs) provide one avenue with significant tax advantages.
Avoid Investment Fraud — Caveat Emptor
If an investment offer sounds too good to be true, it probably is. Caveat emptor means, “let the buyer beware. Never invest in something you do not understand.
Steps to Wi$ing Up - Step 7-2. Learn More About Investing
As you study and learn more about investing, you are certain to come across words and concepts for which you would like a good definition. We suggest you:
- Start investing with small dollar amounts
- Enroll for the on-line course, Investing for Your Future
- Stay abreast with financial news
- Conduct a study of mutual funds
- Learn about investment clubs
The Action Plan is a critical exercise that will help you turn the lessons learned in this chapter into action steps. My action step for Becoming an Investor is to increase my retirement contributions at work.