Financial freedom is the concern of many of us, and we frequently here the phrase “put your money to work for you”. Buying stocks or mutual funds is the first step on the way to these goals. I wanted to give you some background on my qualifications on this topic, so you will understand where I am coming from, since I am by no means a financial advisor. I then wanted to go over some terminology for your better understanding. The next post in this series will deal with an investing strategy.
When I was a senior operations manager, I had the task of analyzing the operating metrics (financial numbers) for my location. I had to create budgets, and find ways to meet those goals. I moved into some corporate training where I taught MIS classes to new managers. These are the same reports that investors use to analyze a firm when deciding to buy the stock. So I do have an understanding of these numbers, even though I am not a financial planner. Since I oversaw a group of managers (and because I saw that participation in the 401k was low), I took it upon myself to educate my staff on this investment vehicle to encourage their involvement in saving for their own future. Now on my own as an inspector, I have been directing my own savings in stocks and funds. I may not be the most qualified, but I do have a clue on the subject.
Firstly, I want to mention the name of some investment methods, so you can see what might apply to your need. A 401k or 403b are retirement accounts provided by your employer. These two forms of saving are virtually the same; the major difference lies with the type of firm that you work for, and what the government dictates that they can offer you. Each firm is slightly different, so I will give you a generality. You will tell the human resource department how much of your salary that you want to invest. The larger the number is better for you, since you save more. The firm matches your contribution up to a certain percentage of your salary, which is typically set at 6%. This means if you put in $10 each week that your employer will give you an additional $10 for that account. You just got an instant raise, sort of. As long as you keep the money in the account until retirement, you will not be asked to pay capital gains tax, which is the tax we all want to avoid. You can borrow money from yourself by seeking a loan from your 401k account. This has advantages and disadvantages. The interest you pay on the loan is going back into your own account, so you are paying yourself interest. However, your money is no longer earning the interest paid to you by the stock or fund that you are invested in. You will also have to pay fees to the service company for the account, which you would have to pay for any other loan, but you will want to compare the fee amounts. The next common method is the IRA (individual retirement account). This is similar to the above accounts in that it is designed for you to keep your money in it till you retire. The standard amount of money that you can deposit in one year is $2000. These accounts are available from your bank or other financial institution. The next account that you should become familiar with is the 529 account. This is a college savings account to help you pay for your child’s education. This money will also be taxed by capital gains if you withdraw it before your child enters the college years. Before your child goes to college, money can be withdrawn without an undue tax burden for educational materials, like a computer. If your child obtains scholarships, you can take the money out of the account without significant penalties too. Lastly, you may hear of tax deferred accounts or other investments, but I am keeping it simple for a new home owner, so my last account is a brokerage account. To buy stocks or funds, you need a broker to represent you in the transaction. The money and the investment purchased is handled in an account form that firm, called a brokerage account. Some firms like Charles Schwab specialize in this type of account, but there are also internet companies that set up these accounts, and now you can go to your bank. These firms charge fees based on how you do business with them.
All of the above methods can place your money in a mutual fund. This fund is an investment vehicle that purchases and sells stocks on your behalf under one roof. You own a share in the fund, but not the particular stock. A stock (also called an equity) is a share in the company. The company creates various kinds of shares from preferred to common. You will be investing in common stocks, which means you are a general owner without certain privileges. Both mutual funds and stocks are divided up into three categories: growth (aggressive); income; and value. You are supposed to have a balance of all three. When you are younger, it is suggested that you take on more risk. You can afford to loose money, because you have time to regain it, so you go with growth. When you come towards retirement, you move more of your money into income, since you want to keep up that monthly income flow to pay bills. Value is the type of stock that has made the likes of Warren Buffet rich. Dividends can be paid by any of these stock types. This is the money paid to you by the company for owning their stock. It is your share of the profits. Not all stocks pay dividends. You will hear the terms load and no load funds. One way or another you will have to pay the broker for buying and selling your investments. For mutual funds, you can pay a load (charges) from the money invested, or you can pay fees in away from the actual money invested in the fund (a no load). The amount of money that you end up paying to the brokerage firm can be less with a no load fund.
Alright, this was a simple overview, but I think that covers your basics. In the next post, we will go over your investment strategy.