Remember your first piggy bank? Most of us encountered the concept of saving at a very early age. It may have been a parent, teacher, or family friend who taught you to "save for a rainy day." So what's the difference between saving and investing? In both cases, you're setting aside money for the future, whether it's for a house, a trip, or a college education. The big difference between saving and investing can be summed up in one word: risk.
All investments involve risk, including possible loss of principal.
Remember: Your goals are your guide. Looking for short-term security? Consider saving. Looking for long-term gain? Think about investing. There is a place for both strategies in your financial plan.
Whether you're planning to travel, volunteer, or start a whole new career, retirement can be an opportunity to live your dreams. If you are looking for ways to maximize the money you are saving for retirement, you can start by investing in an individual retirement account (IRA). An IRA is a way to save for retirement that gives you tax benefits you wouldn't receive if you used a regular account. Potential tax benefits make the IRA an attractive investment option for workers. IRAs help investors build a strong retirement portfolio in addition to 401(k)s and other employer-sponsored plans. There are two basic types of IRAs: the Traditional IRA and the Roth IRA.
If you've ever "chipped in" for a pizza, a taxi ride, or a birthday gift, then you know the power of pooling your resources. When people pool their resources, they often have access to more than they would on their own.
With a mutual fund, many different investors pool their money to purchase a wide range of stocks, bonds, or money market securities. There is strength in numbers, and mutual funds give investors buying power. Stocks, bonds, or money market securities are purchased by a fund manager, who researches and makes choices about which investments to make.
Mutual funds help investors reduce their risk. Buying shares in a mutual fund gives investors the benefit of being diversified and not putting all of their eggs in one basket. Rather than investing in only one company's stock, the fund manager purchases many different types of investments. Being diversified can help reduce your risk. Of course, diversification cannot assure a profit or protect against loss in a declining market.
If you are new to investing, choosing your investments may seem like a particularly daunting task. A major advantage of deciding to invest in mutual funds is that you don't need to know everything about investing. Your major responsibility is to choose a fund whose investment objective and risk level are appropriate for you.
Investors who purchase stock are trading their money for a piece of ownership (or "equity") in a company. Stock is sold in units called shares. Share prices fluctuate based on supply and demand. When a company is highly profitable, more people want to own a piece of it. The more that people clamor for stock in a particular company, the more the share price increases. When fewer people are interested, the share price goes down.
Once an investor becomes a shareholder (or stockholder) in a company, the investor shares in the company's profits. Some companies pay dividends (a portion of their profits) to their shareholders. Shareholders can also experience profits when the value of the stock increases. Of course, share prices of even the best-managed, most profitable corporations are subject to market risk and fluctuate daily.
Stocks offer investors a way to participate in the long-term growth of the U.S. economy. Over time, stocks offer a higher level of return potential than other less volatile investments.
When you purchase a bond, you become a lender, allowing a corporation or government agency to borrow your money for a specific period of time. In return, the agency pays back what you loaned them (your principal) plus interest. Bonds are known as fixed-income investments, because they earn interest at a specific rate over a predetermined period of time. When the bond "matures" the value is paid to the investor.
What distinguishes bonds from other short-term investments is the length of time the loan remains in effect. Treasury bills and other money market securities mature in a year or less. Bonds have longer-term maturities. Bond prices fluctuate with changes in interest rates, rising when interest rates fall and falling when interest rates rise. The longer the maturity of the bond or bond fund, the more the price will rise or fall in response to a given change in interest rates. Bond prices also respond to changes in creditworthiness of the issuer. Bonds of a company whose finances are deteriorating will probably fall in price as the risk of default (failing to meet required interest and principal payments) increases.
Remember how cheap a movie was when you were a kid? How about a slice of pizza or a stamp? If you remember a time when everyday items cost less than they do today, then you've experienced inflation.
Inflation is the rising costs of goods and services. Why is inflation important? With inflation, tomorrow's $100 bill won't buy as much as today's $100 bill. If inflation averages 3% each year for the next 30 years, $100 worth of groceries will cost almost $250. Does this sound unreal? Just ask one of your older relatives: "What did you pay more for: your first house or your latest car?"
So what can you do? Choose the right asset allocation strategy. Before you decide how to invest, consider your time frame and risk tolerance. Once you've determined how long you'll need to invest and how much fluctuation you can tolerate, you can begin to choose an asset allocation strategy. Your strategy will serve as a blueprint for investing, guiding your decisions about how much of your savings to invest in stocks, bonds, and money market securities.