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- Herausgeber: John Wiley & Sons
- Kategorie: Ratgeber
- Sprache: Englisch
- Veröffentlichungsjahr: 2021
Take advantage of the decades ahead and invest in your financial future today You may be at the stage of your life where you're still watching every penny, but you know the earlier you invest, the more time your money has to work for you. Investing in Your 20s and 30s For Dummies provides novice investors with time-tested advice, along with strategies that reflect today's market conditions. You'll get no-nonsense guidance on how to invest in stocks, bonds, funds, and even real estate--complete with definitions of all the must-know lingo. You'll also learn about the latest investment trends, including using robo-advisors to manage your portfolio, relying on apps to make fast trades, and putting your hard-earned cash in digital currencies. Armed with the knowledge and strategies in this book, you can invest wisely, monitor your progress, and avoid risking too much. Today's investing landscape is changing at record speed, and this book helps you keep up. Find information on the latest tax laws, financial lessons learned from the COVID-19 pandemic, and popular funds for the 2020s. * Learn the investment basics you need to get started * Discover new tools and technologies that make it easier than ever to participate in the market * Build a diverse portfolio that reflects your values, financial goals, and risk tolerance * Feel more confident as you fund an investment account, choose equities or funds, and plan for the future * Make an impact with your money by selecting socially responsible investments * Figure out how much money to invest in employer-sponsored accounts or other retirement plans If you're a little unsure about stepping into the world of investing, Investing in Your 20s and 30s For Dummies gives you the confidence you need to establish a smart investment strategy. Grab your copy today.
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Developing and Testing Your Investing Beliefs
What are your investing beliefs? Most investors haven’t taken the time to consider that question, let alone answer it. During the sharp stock market slide in 2008, some investors started following particular gurus who claimed to have predicted the financial crisis. And then the 2020 COVID-19 pandemic and government-mandated shutdowns really set investors on edge due to the surprising nature of that episode. These investors wanted to believe that someone out there could predict important financial events and tell folks how to time their investments to benefit from what was about to unfold.
Such market timing is a fool’s errand. It sounds possible — and we’d like to believe that it is — but it’s not possible on the scale various charlatans would have you believe. Furthermore, many of those who boast the loudest about their market-timing ability are worse than average at it.
It’s challenging to work with someone on his investments when he has little in the way of background and beliefs. As someone seeking to educate yourself about investing, you may have a better idea of your investment beliefs than other investors do. To help you along in this process, here are some beliefs for you to consider:
Your own personal comfort matters.
A wide range of investments are available to you, including stocks, exchange-traded funds (ETFs), mutual funds, real estate, and small business. Some folks are simply more comfortable with particular investments, so you shouldn’t force yourself into a portfolio that’s recommended as being best for you. Consider the value of your time and your investing skills and desires. Investing in stocks and other securities via the best mutual funds and ETFs is both time-efficient and profitable. Real estate investing and running a small business are the most time-intensive investments.
Costs matter.
The more you pay in commissions and management fees on your investments, the greater the drag on your returns. And don’t fall prey to thinking that you get what you pay for. Take advantage of tax-deductible retirement accounts, and understand the effect of your tax bracket when investing outside tax-sheltered retirement accounts. Minimize your trading. The more you trade, the more likely you are to make mistakes. Also, you suffer increased transaction costs and higher taxes for nonretirement-account investments.
Market timing is much harder to predict than folks realize.
Don’t bail when things look bleak. The hardest time, psychologically, to hold on to your investments is when they’re down. Even the best investments go through depressed periods, which is the worst possible time to sell. Don’t sell when there’s a sale going on; if anything, consider buying more. Ignore soothsayers and prognosticators. Predicting the future is nearly impossible.
There are better times than others to sell.
When you’re really feeling good about an asset class like stocks, and those assets have had a multiple-year run and are getting widespread accolades, that’s a good time to lighten up if you have other good reasons for doing so. By contrast, you can bump up your stock allocation if you’re comfortable doing so after a major market decline.
Think long-term.
Because ownership investments like stocks, real estate, and small business are more volatile, you must keep your long-term perspective when investing in them. Don’t invest money in such investments unless you plan to hold them for a minimum of five years and preferably for a decade or longer.
Diversify.
Diversification is a powerful investment concept that helps you reduce the risk of holding more-aggressive investments. Diversifying simply means that you hold a variety of investments that don’t move in tandem in different market environments. When investing in stocks, for example, invest worldwide. You can diversify further by investing in real estate.
Emphasize value.
Over the long term, value-oriented investments tend to produce higher returns with less volatility than do pure growth-oriented investments.
Ignore the minutiae.
Don’t feel mystified by or feel the need to follow the short-term gyrations of the financial markets. Ultimately, the prices of stocks, bonds, and other financial instruments are determined by supply and demand, which are influenced by thousands of external issues, including millions of investors’ expectations and fears.
You are what you read and listen to.
Don’t pollute your mind with bad investing strategies and philosophies. The quality of what you read and listen to is far more important than the quantity.
Praise for Eric Tyson
“Eric Tyson for president! Thanks for such a wonderful guide. With a clear, no-nonsense approach to … investing for the long haul, Tyson’s book says it all without being the least bit long-winded. Pick up a copy today. It’ll be your wisest investment ever!”
— Jim Beggs, VA
“Eric Tyson is doing something important — namely, helping people at all income levels to take control of their financial futures. This book is a natural outgrowth of Tyson’s vision that he has nurtured for years. Like Henry Ford, he wants to make something that was previously accessible only to the wealthy accessible to middle-income Americans.”
— James C. Collins, coauthor of the national bestsellers Built to Last and Good to Great
“Among my favorite financial guides are … Eric Tyson’s Personal Finance For Dummies.”
— Jonathan Clements, the Wall Street Journal
“In Investing For Dummies, Tyson handily dispatches both the basics … and the more complicated.”
— Lisa M. Sodders, The Capital-Journal
“Smart advice for dummies … skip the tomes … and buy Personal Finance For Dummies, which rewards your candor with advice and comfort.”
— Temma Ehrenfeld, Newsweek
“Eric Tyson … seems the perfect writer for a … For Dummies book. He doesn’t tell you what to do or consider doing without explaining the why’s and how’s — and the booby traps to avoid — in plain English… . It will lead you through the thickets of your own finances as painlessly as I can imagine.”
— Clarence Peterson, Chicago Tribune
“Personal Finance For Dummies is the perfect book for people who feel guilty about inadequately managing their money but are intimidated by all of the publications out there. It’s a painless way to learn how to take control.”
— Karen Tofte, producer, National Public Radio’s Sound Money
More Best-Selling For Dummies Titles by Eric Tyson
Personal Finance in Your 20s & 30s For Dummies
This hands-on, friendly guide provides you with the targeted financial advice you need to establish firm financial footing in your 20s and 30s and to secure your finances for years to come. When it comes to protecting your financial future, starting sooner rather than later is the smartest thing you can do. Also check out Personal Finance For Dummies.
Mutual Funds For Dummies
This best-selling guide is now updated to include current fund and portfolio recommendations. Using the practical tips and techniques, you’ll design a mutual fund investment plan suited for your income, lifestyle, and risk preferences.
Home Buying Kit For Dummies
America’s No. 1 real estate book includes coverage of online resources in addition to sound financial advice from Eric Tyson and front-line real estate insights from industry veteran Ray Brown. Also available from America’s best-selling real estate team of Tyson and Brown — Selling Your House For Dummies and Mortgages For Dummies (Tyson co-authored with Robert Griswold).
Real Estate Investing For Dummies
Real estate is a proven wealth-building investment, but many people don’t know how to go about making and managing rental property investments. Real estate and property management expert Robert Griswold and Eric Tyson cover the gamut of property investment options, strategies, and techniques.
Small Business For Dummies
Take control of your future, and make the leap from employee to entrepreneur with this enterprising guide. From drafting a business plan to managing costs, you’ll profit from expert advice and real-world examples that cover every aspect of building your own business. Also check out Tyson’s Small Business Taxes For Dummies.
Investing in Your 20s & 30s For Dummies®, 3rd Edition
Published by:John Wiley & Sons, Inc.111 River StreetHoboken, NJ 07030-5774www.wiley.com
Copyright © 2021 by Eric Tyson
Published by John Wiley & Sons, Inc., Hoboken, New Jersey
Published simultaneously in Canada
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Library of Congress Control Number: 2021937745
ISBN 978-1-119-80540-3 (pbk); ISBN 978-1-119-80541-0 (ebk); ISBN 978-1-119-80542-7 (ebk)
Investing in Your 20s & 30s For Dummies®
To view this book's Cheat Sheet, simply go to www.dummies.com and search for “Investing in Your 20s & 30s For Dummies Cheat Sheet” in the Search box.
Table of Contents
Cover
Title Page
Copyright
Introduction
About This Book
Foolish Assumptions
Icons Used in This Book
Beyond the Book
Where to Go from Here
Part 1: Getting Started with Investing
Chapter 1: Making Sense of Your Investing Options
Growing Your Money in Ownership Investments
Keeping Money in Lending Investments
Understanding Risks and Returns
Where to Invest and Get Advice
Chapter 2: Using Investments to Accomplish Your Goals
Setting and Prioritizing Your Shorter-Term Goals
Investing in Retirement Accounts
Assessing Your Risk-Taking Desires
Chapter 3: Setting Your Return Expectations
Estimating Your Investments’ Returns
Compounding Your Returns
Chapter 4: Minimizing Your Taxes When Investing
Understanding Investment Taxes
Reducing Your Taxes When Selling Investments
Part 2: Preparing Your Investing Foundation
Chapter 5: Laying Out Your Financial Plans
First Priorities: Paying Off High-Cost Debt and Building a Safety Reserve
What about Paying Down Other Debts?
Sorting Out Your Financial Plans
Knowing the Impact of Investing for College Costs
Securing Proper Insurance
Chapter 6: Starting Out with Bank and Credit Union Accounts
Understanding FDIC Bank Insurance
Investing in Banking Account and Savings Vehicles
Negotiating with Bankers
Feeling Secure with Your Bank
Exploring Alternatives to Bank Accounts
Chapter 7: Managing Money Market Funds
Defining Money Market Mutual Funds
Looking at Money Market Fund Holdings
Protecting and Accessing Your Money in Money Funds
Using Money Market Funds in Your Investment Plan
Shopping for the Best Money Funds
Alternatives to Money Market Mutual Funds
Part 3: Investing in Stocks, Bonds, and Funds
Chapter 8: Getting Your Slice of Capitalism with Stocks
What Are Stocks?
How (and Why) You Can Make Money with Stocks
Timing Your Stock Buying and Selling
Highlighting How to Invest in Stocks
Maximizing Your Stock Market Returns
Chapter 9: Securing Investment Income and Principal with Bonds
Defining Bonds
Using Bonds in a Portfolio
How and Where to Invest in Bonds
Chapter 10: Fund Investing: Mutual Funds and Exchange-Traded Funds
Understanding the Advantages of Funds
Maximizing Your Chances for Fund Investing Success
Creating and Managing a Fund Portfolio
Identifying the Best Mutual Funds and ETFs
Considering Alternatives to Investing in Funds
Chapter 11: Understanding Investment Brokers
Getting Your Money’s Worth: Discount Brokers
Checking Out Online Brokers
Part 4: Investing in Real Estate, Small Business, and Other Investments
Chapter 12: Seeking Shelter and Appreciation in Real Estate
Comparing Owning a Home to Renting
Figuring Your Home-Buying Budget
Shopping for Your Home
Investing in Investment Real Estate
Chapter 13: Financing and Putting Together Real Estate Investment Deals
Financing Your Real Estate Deals
Working with Real Estate Agents
Putting Your Deal Together
Selling Real Estate
Chapter 14: Taking Your Talents to the Small-Business Arena
Investing in Your Career
Deciding to Start Your Own Business
Turning a Business Idea into Reality
Considering Small-Business Investment Options
Chapter 15: Exploring Other Investment Vehicles
Calling on Options
Considering Gold and Other Precious Metals
Should You Invest in Currencies and Cryptocurrencies?
Contemplating Collectibles
Understanding Annuities and Cash-Value Life Insurance
Part 5: The Part of Tens
Chapter 16: Ten Things to Know about Investing Resources
Get Educated to Discern the Best from the Rest
Beware “Free”
Understand the Influence of Advertising
Value Quality over Quantity
Know How to Check Out a Resource
Beware Hype and Exaggeration
Don’t Assume Quoted Experts Know Their Stuff
Investigate Gurus’ Claims
Don’t Believe Investment-Newsletter Claims
Check Out and Keep Up with My Favorite Resources
Chapter 17: Ten Essential Tips for Investing Success
Regularly Save and Invest 5 Percent to 10 Percent of Your Income
Understand and Use Your Employee Benefits
Thoroughly Research Before You Invest
Shun Investments with High Commissions and Expenses
Invest the Majority of Your Long-Term Money in Ownership Investments
Avoid Making Emotionally Based Financial Decisions
Make Investing Decisions Based on Your Plans and Needs
Tap Information Sources with High Quality Standards
Trust Yourself First
Invest in Yourself and Others
Chapter 18: Ten Things to Know about Investing Apps
Beware of the General Dangers of Putting Apps on Your Cell Phone
Use Apps Only from Proven Companies with Good Reputations and Longevity
Consider the Alternatives to an App
Use the Best Personal Finance Apps to Have More to Invest
Be Skeptical of Investing Apps Offering “Free” Trading
Review Current and Historic Financial and Economic Data
Invest with Leading Fund Providers
Tap into the Best Investment Brokerage Firms
Examine the Best Real Estate Apps
Seek out Good Small-Business Apps
Bonus Chapter: Taking Care with Health Insurance
Making Sure You’re Covered
Finding Your Best Health Plan
Shopping for Health Insurance
Health Savings Accounts: Tax Reduction for Healthcare Costs
Index
About the Author
Advertisement Page
Connect with Dummies
End User License Agreement
List of Tables
Chapter 3
TABLE 3-1 How Compounding Grows Your Investment Dollars
Chapter 4
TABLE 4-1 2021 Federal Income Tax Rates for Single and Married Households Filing...
Chapter 10
TABLE 10-1 Longer-Term Fund Asset Allocation
List of Illustrations
Chapter 6
FIGURE 6-1: A sample Truth in Savings Disclosure statement from an online bank....
Guide
Cover
Title Page
Copyright
Table of Contents
Begin Reading
Index
About the Author
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Introduction
Investing offers so many possibilities and so many choices. Your young-adult years, which at least for the purposes of this book I define as your 20s and 30s, are filled with so much promise and potential. Your career, your interests, your personal life, and your family and friends all compete for your time and attention.
Most folks work upward of 2,000 hours per year earning a living. Managing the money that passes through their hands is an important task, one most people aren’t trained to do.
Earning money generally takes a lot of work. Managing your personal finances and saving money take discipline and sacrifice. When you have money to invest, you want to do the best you can so you earn a decent return without ending up in failed investments.
About This Book
I designed and wrote this book to help you with the important and challenging task of investing. Your young adult years are a crucial and ideal time to lay the best foundation for investing wisely. After all, some of the investments you make now and in the near future will have decades to grow and multiply.
I talk some simple numbers here to get you excited and motivated. Stocks in the United States historically have returned an average of about 9 percent per year. At that rate of return, you will double your money every 8 years. So, in 16 years, your money will be up four times, in 24 years, your money will be up eight times and in 32 years, you money will be up 16 times. Wow! This means for every $1,000 you can invest in your 20s, you could have about 16 times that amount by your 50s and be on the road to financial independence. The more you can save and intelligently invest in your younger adult years, the quicker you will reach the land of financial independence.
I’ve worked with and taught people from widely varying financial situations, so I know the investing concerns and questions of real folks just like you. I’ve seen how important having healthy and strong personal finances and investments is.
I first became interested in money matters as a middle-school student when my father was laid off from his employer and received some retirement money. I worked with my dad to make investing decisions with the money. A couple of years later, I won my high school’s science fair with a project on what influences the stock market.
During my younger adult years, I worked hard to keep my living expenses low and to save and invest money so I could leave my job and pursue my entrepreneurial ideas. I accomplished that goal in my late 20s. I hope to give you some tools to help you make the most of your money and investments so you too can meet your goals and dreams.
This book is basic enough to help a novice get their arms around thorny investing issues. But advanced readers will be challenged as well to think about their investments and finances in a new way and identify areas for improvement. Check out the table of contents for a chapter-by-chapter rundown of what this book offers. You can also look up a specific topic in the index. Or you can turn a few pages and start at the beginning: Chapter 1.
Foolish Assumptions
No matter what your current situation is — whether you’re entering the job market right after high school, graduating college with substantial student loan debt, feeling pretty well established in your career, and so on — I thought of you as I wrote this book and made some assumptions about you:
You want expert advice about important investing topics such as getting a preinvesting financial checkup, understanding the range of investments available, and assembling a killer investment portfolio. And you want that advice quickly.
You want a crash course in investing and are looking for a book you can read cover to cover to help solidify major concepts and get you thinking about your investments in a more comprehensive way.
You’re tired of feeling overwhelmed by your investing choices and stressed out by the ever-changing economic and investing landscape, and you want to get more comfortable with your investment selections.
Icons Used in This Book
The icons in this book help you find particular kinds of information that may be of use to you:
This light bulb marks strategy recommendations for making the most of your investments.
This icon points out information that you’ll definitely want to remember.
This icon marks things to avoid and points out common mistakes people make when making and managing their investments.
This icon tells you when you should consider doing some additional research. Don’t worry — I explain what to look for and what to look out for.
Beyond the Book
In addition to the material in the print or e-book you’re reading right now, this product comes with a free access-anywhere Cheat Sheet that helps you get started with investing. To view this Cheat Sheet, simply go to www.dummies.com and enter “Investing in Your 20s & 30s For Dummies Cheat Sheet” in the Search box.
Where to Go from Here
This book is organized so you can go wherever you want to find complete information. You can use the table of contents to find broad categories of information or the index to look up more specific topics.
If you’re not sure where you want to go, you may want to start with Part 1. It gives you all the basic info you need to assess your financial and investing situation and points to places where you can find more detailed information for improving it.
Part 1
Getting Started with Investing
IN THIS PART …
Define commonly used investing jargon, including explaining the different types of investments.
Use investments to accomplish your goals, such as making larger purchases, buying a home, and investing for retirement.
Understand expected investment returns and risks.
See how investment returns are taxed and what you can legally do to minimize your taxes on your investments.
Chapter 1
Making Sense of Your Investing Options
IN THIS CHAPTER
Comparing common investments
Explaining investment terminology — risks and returns
Looking at the best investment companies and the rest
Deciphering the gobbledygook of professionals and credentials
So many subject areas and disciplines are packed full of jargon. Some of this is the result of “progress” and advances, and some of it is caused by workers in the field not going out of their way to explain and define things.
In this chapter, I give you the lay of the land regarding the enormous numbers of investment choices and foreign-sounding terminology that await you in the world of investing. I also explain the types of companies that offer investments and their strengths and weaknesses. And should you want to hire some investing help, I detail the various professionals pitching their services to you and the common credentials they hawk to convince you of their expertise.
Growing Your Money in Ownership Investments
The most exciting thing about investing during your younger adult years is that you can be more aggressive with money that you’ve earmarked to help you accomplish long-term goals. To achieve typical longer-term financial goals, such as being financially independent (also known as retiring), the money that you save and invest generally needs to grow at a rate much faster than the rate of inflation. If you put your money in a bank account that pays little or no interest, for example, you’re more likely to fall short of your goals.
Ownership investments are investments like stocks, where you own a piece of a company, real estate, or a small business that has the capability to generate revenue and profits. Over the long term, consider ownership investments if you want your money to grow much faster than the rate of inflation and don’t mind more volatility in your investments’ values.
The downside to such investments is that they can fall more significantly in value than non-ownership investments (for example, bank accounts, bonds, and so on), especially in the short term. So don’t put money into ownership investments that you may need to tap in the short term for rent money or your next vacation. To reduce the risk of ownership investments, diversify — that is, hold different types of ownership investments that don’t move in tandem.
I highlight three major ownership investments in the following sections: stocks, real estate, and small business.
Sharing in corporate growth and profits: Stocks
If you want the potential to share in the growth and profits of companies, you can gain it through buying shares of their stock. Stocks are shares of ownership in a company. You can buy stock directly in individual companies through a brokerage account, or you can buy a collection of stocks via a mutual fund or exchange-traded fund (see Chapter 10).
If you’ve followed the financial markets at all over some time or have friends or family who have spoken to you about this, you may have heard of companies/stocks like Amazon, Apple, Chipotle, McDonald’s, Microsoft, Netflix, Ross Stores, Tesla, Ulta Beauty, and so on. Those who bought and held stocks like these made big returns over the past decade. Remember, though, that we’re saying and seeing this now with the benefit of hindsight — looking in the rearview mirror. And, I’m sure you know that the future will be different than the past, so running out and buying these stocks now is far less likely to make you a mint going forward.
Now, what if I told you I've invested in and made good money in all of these stocks over the past decade? The fact is I have, but I never personally chose any of these particular stocks. I’ve owned these stocks and numerous other good companies and their stocks through mutual funds I’ve invested in. Of course, it’s impossible for any fund manager to only have a portfolio of the best winners or winners in general. Some of their stock picks will be mediocre and others worse.
You don’t need to be a business genius to make money in stocks. Stocks in the United States, for example, have returned an average of 9 percent per year over the past two-plus centuries. That may not sound like a high return but at that rate of return, your money will double every eight years! Simply make regular and systematic investments, and invest in proven companies and funds while minimizing your investment expenses and taxes. Of course, there’s no guarantee that every stock or stock fund that you buy will increase in value. In Chapter 8, I explain proven and time-tested methods for making money in stocks.
Profiting from real estate
You don’t need to be a big shot to make money investing in real estate. Owning and managing real estate is like running a small business: You need to satisfy customers (tenants), manage your costs, keep an eye on the competition, and so on. Some methods of real estate investing require more time than others, but many are proven ways to build wealth. Historically, investment real estate has produced annual returns comparable to investing in stocks.
Among the key attributes of private real estate investment are the following:
You build wealth through your rental income exceeding your expenses and through property-value appreciation.
You can leverage your investment by borrowing money.
You must be comfortable dealing with property management, which includes finding and retaining tenants and keeping up (and possibly improving) your property.
This last point is super important. Buying and managing investment real estate is time intensive. Those whom I’ve seen succeed investing in real estate actually enjoy the challenge and work involved. And, over time, you can hire people to help you with managing properties if you don’t want to spend so much time personally at it.
See Chapter 12 for the details on investing in real estate.
Succeeding in small business
I know people who have hit investing home runs by owning or buying businesses. Most people work full-time at running their businesses, increasing their chances of doing something big financially with them. Investing in the stock market, by contrast, tends to be more part-time in nature.
In addition to the financial rewards, however, small-business owners can enjoy seeing the impact of their work and knowing that it makes a difference. I can speak from firsthand experience (as can other small-business owners) in saying that emotionally and financially, entrepreneurship is a roller coaster.
Besides starting your own company, you can share in the economic rewards of the entrepreneurial world through buying an existing business or investing in someone else’s budding enterprise. See Chapter 14 for more details.
Making “riskier” choices: Options, cryptocurrencies, and so on
I know from my many interactions with younger adults these days that there are some more exciting and enticing vehicles such as call options and cryptocurrencies. It’s easy to get drawn into such things when you hear a story or two about someone hitting it big.
I’m certainly open to you taking sensible risks, and the fact of the matter is that the highest returning investment vehicles I discuss in this book do indeed carry notable risks. But options and cryptocurrencies carry enormous risks and actually far less upside than what many people believe or realize.
Rest assured that at relevant places in this book, I cover these other types of vehicles (especially in Chapter 15), but please know that these are generally vehicles you should stay away from.
Keeping Money in Lending Investments
In the first section of this chapter, “Growing Your Money in Ownership Investments,” I outline how you can make your dough grow much faster than the cost of living by using stocks, real estate, and small business. However, you may want or need to play it safer when investing money for shorter-term purposes, so you should then consider lending investments. Many people use such investments through local banks, such as in a checking account, savings account, or certificate of deposit. In all these cases with a bank, you’re lending your money to the bank.
Another lending investment is bonds. When you purchase a bond that has been issued by the government or a company, you agree to lend your money for a predetermined period of time and receive a particular rate of interest. A corporate bond may pay you 4 percent interest annually over the next ten years, for example.
An investor’s return from lending investments is typically limited to the original investment plus interest payments. If you lend your money to a company through one of its bonds that matures in, say, five years, and the firm doubles its revenue and profits over that period, you won’t share in its growth. The company’s stockholders are likely to reap the rewards of the company’s success, but as a bondholder, you don’t. You simply get interest and the face value of the bond back at maturity.
Similar to bank savings accounts, money market mutual funds are another type of lending investment. Money market mutual funds generally invest in ultra-safe things such as short-term bank certificates of deposit, U.S. government–issued Treasury bills, and commercial paper (short-term bonds) that the most creditworthy corporations issue.
Many people keep too much of their money in lending investments, thus allowing others to enjoy the rewards of economic growth. Although lending investments appear safer because you know in advance what return you’ll receive, they aren’t that safe. The long-term risk of these seemingly safe money investments is that your money will grow too slowly (perhaps not even keeping you ahead of or even with the rate of inflation) to enable you to accomplish your personal financial goals. In the worst cases, the company or other institution to which you’re lending money can go under and fail to repay your loan.
Understanding Risks and Returns
Who among us wants to lose money? Of course you don’t! You put your money into an investment in the hope and expectation that you will get back more in total than you put in. And you’d rather your chosen investments not fluctuate too widely in value. When it comes to investing, no concepts are more important to grasp than risk and return, which I explain in this section.
Realizing risks
The investments that you expect to produce higher returns (such as stocks) fluctuate more in value, particularly in the short term. However, if you attempt to avoid all the risks involved in investing, you probably won’t succeed, and you likely won’t be happy with your investment results and lifestyle. In the investment world, some people don’t go near stocks or real estate that they perceive to be volatile, for example. As a result, such investors often end up with lousy long-term returns and expose themselves to some high risks that they overlooked, such as the risk of inflation and taxes eroding the purchasing power of their money.
You can’t live without taking risks. Risk-free activities or ways of living don’t exist. You can sensibly minimize risks, but you can never eliminate them. Some methods of risk reduction aren’t palatable because they reduce your quality of life.
Risks are also composed of several factors. Following are the major types of investment risks and a few of the methods you can use to reduce these risks while not missing out on the upside that investments offer:
Market-value risk:
Although stocks can help you build wealth, they can also drop 20 percent or more in a relatively short period of time. Entering 2020, who was thinking about how a pandemic and the government’s response might impact stock prices? Then, in a few weeks, stocks slid more than 30 percent due to government-mandated economic shutdowns. Although real estate, like stocks, has been a rewarding long-term investment, various real estate markets get clobbered from time to time.
Individual-investment risk: A down market can put an entire investment market on a roller-coaster ride, but healthy markets also have their share of individual losers. Just as individual stock prices can plummet, so can individual real estate property prices.
With lending investments, you have a claim on a specific amount of a currency. Occasionally, currencies falter. Most folks ignore this low frequency but very high impact risk when thinking about lending investments.
Purchasing-power risk:
Inflation
— which is an increase in the cost of living — can erode the value of your money and its
purchasing power
(what you can buy with that money). I often see skittish investors keep their money in bonds and money market accounts, thinking that they’re playing it safe. The risk in this strategy is that your money won’t grow enough over the years for you to accomplish your financial goals. In other words, the lower the return you earn, the more you need to save to reach a financial goal. As a younger investor with so many years and decades of investing in your future, you need to pay the most attention to the risk of generating low returns.
Liquidity risk:
Some investments are more
liquid
(how quickly an investment can be converted to cash) than others and more readily sold at fair market value on short notice. Bank savings accounts have no real liquidity risk. A real estate investment, by contrast, takes time and money to sell, and if you must sell most real estate quickly, you’ll likely get a fair amount less than its current full market value.
Career risk:
In your 20s and 30s, your ability to earn money is probably your biggest asset. Education is a lifelong process. If you don’t periodically invest in your education, you risk losing your competitive edge. Your skills and perspectives can become dated and obsolete. Although that doesn’t mean you should work 80 hours a week and never do anything fun, it does mean that part of your “work” time should involve upgrading your skills.
Managing risks
Throughout this book as I discuss various investments, I explain how to get the most out of each one. Because I’ve introduced the important issue of risk in this chapter, I would be remiss if I also didn’t give you some early ideas about how to minimize those risks. Here are some simple steps you can take to lower the risk of investments that can upset the achievement of your goals:
Do your homework.
When you purchase real estate, various inspections, for example, can save you from buying a money pit. With stocks, you can examine some measures of value and the company’s financial condition and business strategy to reduce your chances of buying into an overpriced company or one on the verge of major problems.
Diversify. Placing significant amounts of your capital in one or a handful of securities is risky, particularly if the stocks are in the same industry or closely related industries. To reduce this risk, purchase stocks in a variety of industries and companies within each industry. Even better is buying diversified mutual funds and exchange-traded funds. Diversifying your investments can involve more than just your stock portfolio. You can also hold some real estate investments to diversify your investment portfolio.
If you worry about the health of the U.S. economy, the government, and the dollar, you can reduce your overall investment risk by also investing overseas so that you have a globally diversified portfolio of stocks. Most large U.S. companies do business overseas, so when you invest in larger U.S. company stocks, you get some international investment exposure. You can also invest in international company stocks, ideally through funds.
Minimize holdings in costly markets.
Although I don’t believe that most investors can time the markets — buy low, sell high — spotting a greatly overpriced market isn’t too difficult. You should avoid overpriced investments because when they fall, they usually fall farther and faster than more fairly priced investments. Also, you should be able to find other investments that offer higher potential returns. Throughout this book, I explain some simple yet powerful methods you can use to measure whether a particular investment market is of fair value, of good value, or overpriced.
View market declines in a different light.
Instead of seeing declines and market corrections as horrible things, view them as potential opportunities or “sales.” If you pass up the stock and real estate markets simply because of the potential market-value risk, you miss out on a historic, time-tested method of building substantial wealth. Try not to give in to the human emotions that often scare people away from buying something that others seem to be shunning.
Making sense of returns
Each investment has its own mix of associated risks that you take when you part with your investment dollar and, likewise, offers a different potential rate of return. When you make investments, you have the potential to make money in a variety of ways.
To determine how much money you’ve made or lost on your investment, you calculate the total return. To come up with this figure, you determine how much money you originally invested and then factor in the other components, such as interest, dividends, and appreciation or depreciation.
If you’ve ever had money in a bank account that pays interest, you know that the bank pays you a small amount of interest in exchange for your allowing the bank to keep your money. The bank then turns around and lends your money to some other person or organization at a much higher rate of interest. The rate of interest is also known as the yield. So if a bank tells you that its savings account pays 1.5 percent interest, the bank may also say that the account yields 1.5 percent. Banks usually quote interest rates or yields on an annual basis. Interest that you receive is one component of the return you receive on your investment.
If a bank pays monthly interest, the bank also likely quotes a compounded effective annual yield. After the first month’s interest is credited to your account, that interest starts earning interest as well. So the bank may say that the account pays 1.5 percent, which compounds to an effective annual yield of 1.53 percent.
When you lend your money directly to a company — which is what you do when you invest in a bond that a corporation issues — you also receive interest. Bonds, as well as stocks (which are shares of ownership in a company), fluctuate in market value after they’re issued.
When you invest in a company’s stock, you hope that the stock increases (appreciates) in value. Of course, a stock can also decline, or depreciate, in value. This change in market value is part of your return from a stock or bond investment.
Stocks can also pay dividends, which are the company’s way of sharing some of its profits with you as a stockholder and thus are part of your return. Some companies, particularly those that are small or growing rapidly, choose to reinvest all their profits back into the company.
Unless you held your investments in a tax-sheltered retirement account, you owe taxes on your return. Specifically, the dividends and investment appreciation that you realize upon selling are taxed, although often at relatively low rates. The tax rates on so-called long-term capital gains and stock dividends are currently and historically lower than the tax rates on other income. I discuss the different tax rates that affect your investments and explain how to make tax-wise investment decisions that fit with your overall personal financial situation and goals in Chapter 4.
Where to Invest and Get Advice
Discussing the companies through which you can invest and where to get investing advice may seem out of place to you if you started reading this book from the beginning. But I’m doing this because I strongly believe that you should begin to think about and understand the lay of the land in these important areas so you can make the best choices.
Selecting the firm or firms through which to do your investing is a hugely important decision. So is the decision about from whom to get or pay for investing advice. In this section, I address both of these topics.
Finding the best fund companies and brokers
Insurance companies, banks, investment brokerage firms, mutual funds — the list of companies that stand ready to help you invest your money is nearly endless. Most people stumble into a relationship with an investment firm. They may choose a company because their employer uses it for company retirement plans or they’ve read about or been referred to a particular company. Maybe one of your parents or another relative recommended or got you started with a particular investment company.
When you invest in certain securities — such as stocks and bonds and exchange-traded funds (ETFs) — and when you want to hold mutual funds from different companies in a single account, you need brokerage services. Brokers execute your trades to buy or sell stocks, bonds, and other securities and enable you to centralize your holdings of mutual funds, ETFs, and other investments. Your broker can also assist you with other services that may interest you.
Deciding which investment company is best for you depends on your needs and wants. In addition to fees, consider how important having a local branch office is to you. If you want to invest in mutual funds, you’ll want to choose a firm that offers access to good funds, including money market funds in which you can deposit money awaiting investment or proceeds from a sale.
For the lowest trading commissions, you generally must place your trades online. But you should be careful. A low brokerage fee of, say, $7 or $10 per trade doesn’t really save you money if you trade a lot and rack up significant total commissions. (As you may know, some brokers are offering free online trading for stocks and certain other securities, but of course, they have to make this up elsewhere with fees for other needed services and by paying you little to nothing on your cash balances.) Also you pay more in taxes when you trade more frequently and realize shorter-term (one year or less) profits.
Trading online is an easy way to act impulsively and emotionally when making important investment decisions. If you’re prone to such actions, or if you find yourself tracking and trading investments too closely, stay away from this form of trading and use the internet only to check account information and gather factual information. Increasing numbers of brokers offer account information and trading capabilities via apps, which, of course, can also promote addictive investment behaviors.
Please see Chapter 9 for more details on selecting the best investment brokerage firms and my top investment firm selections that offer mutual funds and ETFs and/or brokerage services.
Finding an acceptable advisor
I would always counsel folks who took personal finance courses I taught or who contacted me seeking advice to get educated before engaging the services of any financial advisor. How can you possibly evaluate the competence of someone you may hire if you yourself are financially clueless? You’ve got this book, so read it before you consider hiring someone for financial advice.
By taking the themes and major concepts of this book to heart, you greatly minimize your chances of making significant investment blunders, including hiring an incompetent or unethical advisor. You may be tempted, for example, to retain the services of an advisor who claims that he and his firm can predict the future economic environment and position your portfolio to take advantage. But you find in reading this book that financial advisors don’t have crystal balls and that you should steer clear of folks who purport to be able to jump into and out of investments based upon their forecasts.
Finding a competent and objective financial advisor isn’t easy. Historically, most financial consultants work on commission, and the promise of that commission can cloud their judgment. Among the minority of fee-based advisors, almost all manage money, which creates other conflicts of interest. The more money you give them to invest and manage, the more money these advisors make. That’s why I generally prefer seeking financial (and tax) advice from advisors who sell their time (on an hourly basis) and don’t sell anything else.
Because investment decisions are a critical part of financial planning, take note of the fact that the most common designations of educational training among professional money managers are MBA (master of business administration) and CFA (chartered financial analyst). Financial planners often have the CFP (certified financial planner) credential, and some tax advisors who work on an hourly basis have the PFS (personal financial specialist) credential.
Advisors who provide investment advice and oversee at least $100 million must register with the U.S. Securities and Exchange Commission (SEC); otherwise, they generally register with the state that they make their principal place of business. They must file Form ADV, otherwise known as the Uniform Application for Investment Adviser Registration. This lengthy document asks investment advisors to provide in a uniform format such details as a breakdown of where their income comes from, their education and employment history, the types of securities the advisory firm recommends, and the advisor’s fee schedule.
You can ask the advisor to send you a copy of his Form ADV. You can also find out whether the advisor is registered and whether he has a track record of problems by calling the SEC at 800-732-0330 or by visiting its website at www.adviserinfo.sec.gov. Many states require the registration of financial advisors, so you should also contact the department that oversees advisors in your state. Visit the North American Securities Administrators Association’s website (www.nasaa.org), and click the Contact Your Regulator link on the home page.
Chapter 2
Using Investments to Accomplish Your Goals
IN THIS CHAPTER
Investing for short-term consumption goals
Working toward a home purchase
Planning for financial independence/retirement
Assessing your desire to take risk
Saving and investing money can make you feel good and in control. Ultimately, most folks are investing money to accomplish particular goals. Saving and investing for a car purchase, expenses for higher education, a home purchase, new furniture, or a vacation are typical short-term goals. You can also invest toward longer-term goals, such as your financial independence or retirement decades in the future.
In this chapter, I discuss how you can use investments to accomplish common shorter- and longer-term goals.
Setting and Prioritizing Your Shorter-Term Goals
Unless you earn really big bucks or expect to have a large family inheritance to tap, your personal and financial desires will probably outstrip your resources. Thus, you must prioritize your goals.
One of the biggest mistakes I see people make is rushing into a financial decision without considering what’s really important to them. Because many people get caught up in the responsibilities of their daily lives, they often don’t take time for reflection often because they feel that they lack the time. Take that time, because people who identify their goals and then work toward them, which often requires changing some habits, are far more likely to accomplish something significant.
In this section, I discuss common “shorter-term” financial goals — such as establishing an emergency reserve, making major purchases, owning a home, and starting a small business — and how to work toward them. Accomplishing such goals almost always requires saving money.
Accumulating a rainy-day fund
The future is unpredictable. Take the uncertainty simply surrounding your job: You could lose your job, or you may want to leave it.
Consider what happened in 2020 with the COVID-19 pandemic and the unexpected and lengthy government-mandated shutdowns in some parts of the country, which led to large layoffs in particular industries like restaurants, retail, and travel-related businesses. While the 2020 recession was unusual in many respects, recessions aren’t unusual and even when the overall economy is growing, some employers let employees go. Suppose an elderly relative, for example, needs some assistance for a period of time? Look, I’m not trying to be a pessimist or negative, but problems happen, and sometimes there are financially downsides that can come with them.
Because you don’t know what the future holds, preparing for the unexpected is financially wise. Enter the emergency or rainy-day fund.
The size of your emergency fund depends on your personal situation. Begin by considering how much you spend in a typical month. Here are some benchmarks for how many months’ worth of living expenses you should have:
Three months’ living expenses:
When you’re starting out, this minimalist approach makes sense if your only current source of emergency funds is a high-interest credit card. Longer-term, you could make do with three months’ living expenses if you have other accounts, such as a 401(k), or family members and close friends whom you can tap for a short-term loan.
Six months’ living expenses:
If you don’t have other places to turn for a loan, or if you have some instability in your employment situation or source of income, you need more of a cushion.
Twelve months’ living expenses:
Consider this large a stash if your income fluctuates greatly or if your occupation involves a high risk of job loss, finding another job could take you a long time, or you don’t have other places to turn for a loan.
Saving for large purchases
Most people want things — such as furniture, a vacation, or a car — that they don’t have cash on hand to pay for. I strongly advise saving for your larger consumer purchases to avoid paying for them over time with high-interest consumer credit. Don’t take out credit card or auto loans — otherwise known as consumer credit — to make large purchases.
And, don’t be duped by a seemingly low interest rate on, for example, a car loan. You could get the car at a lower price if you don’t opt for such a loan.
Paying for high-interest consumer debt can undermine your ability to save toward your goals and your ability to make major purchases in the future. Don’t deny yourself gratification if it’s something you really need and want and can afford given your overall financial situation; just figure out how to delay it. When contemplating the purchase of a consumer item on credit, add up the total interest you’d end up paying on your debt, and call it the price of instant gratification.
Investing for a small business or home
In your early years of saving and investing, deciding whether to save money to buy a home or to put money into a retirement account (for the tax benefits and to work toward the goal of future financial independence) presents a dilemma. In the long run, owning your own home is usually a wise financial move. On the other hand, saving sooner for retirement makes achieving your goals easier and reduces your income tax bill.
Presuming that both goals are important to you, you can save toward both goals: buying a home and retiring. If you’re eager to own a home, you can throw all your savings toward achieving that goal and temporarily put your retirement savings on hold.
You can make penalty-free withdrawals of up to $10,000 from Individual Retirement Accounts (IRAs) toward a first-time home purchase. You may also be able to have the best of both worlds if you work for an employer that allows borrowing against retirement account balances. You can save money in the retirement account and then borrow against it for the down payment on a home. Consider this option with great care, though, because retirement account loans generally must be repaid within a few years or when you quit or lose your job (ask your employer for the details).
When saving money for starting or buying a business, most people encounter the same dilemma they face when deciding to save to buy a house: If you fund your retirement accounts to the exclusion of earmarking money for your small-business dreams, your entrepreneurial aspirations may never become reality. Generally, I advocate hedging your bets by saving money in your tax-sheltered retirement accounts as well as toward your business venture. An investment in your own small business can produce great rewards, so you may feel comfortable focusing your savings on your own business.
Saving for kids’ higher educational costs
Do you have little ones or plan to have them in your future? You probably know that rearing a child (or two or more) costs really big bucks. But the biggest potential expense awaits when they reach young adulthood and consider heading off to college, so your instincts may be to try to save money to accomplish and afford that goal.
The college financial-aid system effectively penalizes you for saving money outside tax-sheltered retirement accounts and penalizes you even more if the money is invested in the child’s name. Wanting to provide for your children’s future is perfectly natural, but doing so before you’ve saved adequately toward your own goals can be a major financial mistake.
This concept may sound selfish, but the reality is that you need to take care of your future first. Take advantage of saving through your tax-sheltered retirement accounts before you set aside money in custodial savings accounts for your kids.
