Invest Now for Security Later

by Michelle M. Haas-Dosher

You've done it--you've landed your first real job. And, you have money--to spend! Before blowing it on everything you can get your hands on, consider stashing some of it away. By getting into the habit of investing now, you can be set for life.

Don't believe it? Look at this example: Say Frank and Mary start working for the same company in the same year, earning the same beginning salary of $25,000, with annual increases of 4%. If Mary starts a savings program immediately putting away 5% of her salary annually with no interruptions, earning an annual return of 8%, after 30 years, she'll have accumulated $230,150.

Frank decides to wait to start a savings program. If he saves 11% of his salary annually for the last 10 years before retiring, earning an annual return of 8%, he would accumulate $114,832. Although contributing a larger amount per month, Frank would miss out on considerable returns created by the compounding process over the first 20 years, according to Credit Union National Association's economics and statistics department.

Joe Saari, president and CEO, Precision Information, LLC, a leading provider of investment education materials based in Madison, Wis., says following these simple steps can help provide you with the financial security you'll need later:

1. Start saving. Spend less than you make and get your debts under control. Establish and maintain good credit.

2. Build a cushion of cash equivalents, say in a money market account "just in case." Experts suggest three to six months of living expenses. If you're younger than 59 ½, you don't want to open an IRA (individual retirement account) or 401(k) only to pay a 10% penalty and regular income tax to use the money to cover an unexpected expense.

3. Keep a low-interest line of credit or credit card open (with a small or no balance) just in case of an emergency. The professionals at your credit union can help you obtain these credit tools and will help you with all your financial needs.
   The people at your credit union can help you obtain these credit tools and will help you with all your financial needs.

4. Carry health insurance. You'll limit the risk that unforeseen medical expenses would require you to tap into retirement savings.

Before investing

1. Do your homework. Take the time to become familiar with terms and concepts. Even if you're not going to manage your own money, you need to know enough to be an informed consumer and know whom to trust.

   Warren Buffet, one of the world's richest men and a leading investing pundit, says he does not invest in anything he does not understand. You shouldn't either.

2. Determine your goals and what you want to achieve. If you don't know where you're going, any road will take you somewhere. But if you have a particular destination in mind--say, a first home, and later, retirement--you need to have a goal and set a realistic path to reach it.

3. Build a plan that will take you where you want to go. Whether you're working with a financial adviser or you want to travel solo, you need to plan. Realize that things will change along the way, but you need to set short- and long-term goals to keep moving in the right direction.

Now you can invest

1. Once you've taken care of setting aside savings, getting insurance, and related goals, take advantage of your employer's 401(k) or 403(b). Many employers match a portion of your contributions. If you don't participate, you're losing free money. Plus, the programs are tax-deferred. Pay attention to the details of picking proper investments to help you meet your goals.

2. Assuming your 401(k) has a good range of investment options with reasonable fees, you may want to max it out before looking at other options like IRAs. Just be sure that's consistent with your goals. On the other hand, consider that first-time home buyers can build a down payment for a house in a Roth IRA and withdraw the funds (within limits) without penalty.
   Realize that things will change along the way, but you need to set short- and long-term goals to keep moving in the right direction.

Do's and don'ts

1. Don't invest all your money in one stock--including your own company's stock. Far too many Americans are overexposed in the companies they work for. Remember Enron?

2. Don't invest in anything you don't understand. If you can't figure out what the investment does or is supposed to do, you shouldn't invest. That's called gambling, not investing.

3. Do your homework. Take the time to learn about the options. Someone at your credit union might be able to help with your investment questions or refer you to someone who can.

4. Read, learn, enjoy, and ask a lot of questions. There are no dumb questions when it comes to your money. In fact, 67% of Americans say they don't know enough to make sound investment decisions.

Investment vocabulary

When you're starting to invest, one of the first steps is to learn some basic terms. This reference guide can help:

Asset allocation--Dividing your money among the basic asset classes--growth, fixed-income, and cash investments--to match your financial goals. This diversification can help investors control risk and improve the probability of achieving expected returns.

Bear market--A term that describes a prolonged period of declining stock prices.

Blue chip--A well-known corporation with a long history of growth and profits; higher quality relative to smaller or less established organizations.

Approximately two-thirds of Americans say they don't know enough to make sound investment decisions.

Bull market--A term that describes a prolonged period of rising stock prices.

Buying on margin--Buying on a loan; you're borrowing the money from a brokerage house to buy stocks. This is very risky behavior.

Capital gains--The amount of money you make on an investment when you sell it.

Capital loss--The amount of money you lose on an investment when you sell it.

Diversification--Spreading your money among a variety of investment types, rather than putting your money all in one place. This can reduce the risk of a decline in the overall portfolio from a decline in any one investment or category. For example, you may choose a mix of stocks and bonds from different issuers within technology, financial services, health care, and international investments.

Dividends--The portion of the company's profit paid out to its shareholders.

Dollar-cost averaging--A method of buying mutual fund shares by investing the same amount of money on a regular schedule (for example, $50 a month), regardless of market price. This can reduce your average share costs--you acquire fewer shares when prices are higher and more shares when prices are lower.

Nasdaq--The National Association of Securities Dealers Automated Quotations system; computerized stock market where trades are negotiated directly between buyers and sellers.

Portfolio--Consists of all the assets you own and represents the choices you've made with your money.

Prospectus--A legal document with information about a mutual fund or other types of investments. It describes the investment's objective, management style, performance over the past 10 years, background of its officers, and expenses.

Even if you're not going to manage your own money, you need to know enough to be an informed consumer and know whom to trust.

Rebalancing--Periodically revising your portfolio's asset allocation to keep it in line with your investment plan.

Risk tolerance--Every investor has the ability to tolerate a certain amount of change in his or her portfolio's value, including short-term losses from market declines. Usually, younger investors can tolerate more risk because they have ample time to recover from these short-term losses; that's not the case for older investors. Conservative investors simply don't want to experience any declines. More aggressive investors tolerate losses well because they're confident that they will recover before they're required to sell their investments. Where an investor falls on the spectrum between aggressive and conservative is called an investor's risk tolerance.

Time horizon--The length of time before you must sell investments to raise cash to meet your spending needs. Some time horizons are short, like investing for a vacation next year. Others are long, like investing for retirement. An investor with a long time horizon usually can take more risk, and vice versa. When you calculate your retirement investment time horizon, don't make the mistake of ending it on the day you expect to retire. At that point as much as one-third of your life still may lie ahead of you. Your spending needs will not stop on your retirement date!

Published October 10, 2005

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