Investment Definitions and Ideas to Consider
Definitions:
· Stock: A share of ownership in a company. Shares of stock are traded (bought and sold) on public stock exchanges. Stocks have returned a historical average of about 8% annually over the last century (when the stock market is measured as a whole).
· Bond: A form of a loan. When you buy a bond from the government (or a corporation), you are lending them money that they will repay to you with interest over a set period of time. Bond markets have delivered about a 6% annual return over time.
· Stock Exchange: A place where shares of stock are traded. New York Stock Exchange is a physical location. The NASDAQ stock exchange is a non-physical network of individuals, computers, faxes, and phone systems that exchange stocks.
· Dow Jones Industrial Average: A measure of the performance of 30 large industrial company stocks. Not a good measurement of the overall direction of the stock market, but very popular (we’re stuck with it).
· NASDAQ Index: A measure of the performance of the stocks listed only on the NASDAQ stock exchange.
· S&P 500 Index: A measure of the 500 largest publicly traded stocks in the USA…provides a better measure of what the stock market is doing than the Dow Jones Industrial Average. The S&P 500 Index has averaged about 11% annual return over the last several decades.
· Mutual Fund: A fund that collects money from individuals and invests the money on behalf of the individual investors.
· Actively Managed Mutual Fund: A mutual fund that is actively managed (stocks are bought and sold) in an effort to beat the performance of the S&P 500 Index. In an average year, only 15% of all actively managed mutual funds manage to beat the performance of the S&P 500 Index.
· Index Mutual Fund: A mutual fund that simply copies the stocks in an index (Such as the S&P 500 Index). Rather than attempting to ‘beat’ the index, this type of fund simply matches it. Usually fees and taxes are much lower with this type of fund than with actively managed funds.
· IRA: Individual Retirement Account. This is an Account, not an Investment. Once money is placed in an IRA, it still must be invested in something. IRAs offer the investor the chance to deduct contributions to the IRA from their taxable income for the year the contribution is made. Investments in an IRA grow tax-deferred (they are not taxed until withdrawal at retirement). Special provisions regulate early withdrawals; in many cases, a penalty must be paid to take money out before retirement age. The amount you may contribute is limited each year.
· Roth IRA: Similar to Traditional IRA with the following exceptions: 1) Contributions are not tax deductible and, 2) The investments grow TAX – FREE (NOT tax deferred)…this means that you will never pay any taxes on the money in your account, if you wait until retirement to withdraw the funds.
· 401(k): A company-sponsored tax-deferred retirement account. Similar in many ways to an IRA, except that employers may match funds you contribute. Also contribution limits are much higher than IRAs and you may take loans against your 401(k), rather than withdrawing funds with a penalty (prior to retirement).
Guiding Principles:
· Start Early. The amount of Time is far more important than either the amount invested or interest rate earned, when calculating the future value of investments.
· It’s not what you earn…It’s what you keep: Invest as much as you can (within reason).
· Identify your objectives / match them to your investment strategies: Make sure that the money you invest for the long haul will not be needed in the short term.
· Take full advantage of Tax-free and / or Tax-deferred retirement plans: These plans can produce significant benefits, if the investor will put them to use.
· Pay an honest tithe and make financial management a matter of discussion and prayer.
· Be consistent: Consistently adding to investments over a period of time is a painless way to build a significant amount of wealth over a long time frame.
· Be patient: Having the discipline to leave your investments alone when they temporarily lose value is critical to long-term success.
**NOTE: I AM NOT A FINANCIAL PLANNER. This information is offered purely as an example. Individuals should consult with a professional before making their own investment decisions.**
Suggestions that I might make to one of my own family members on how to get started:
· Establish a family budget and eliminate consumer debt (high cost debt such as credit cards, signature loans).
· Set aside a realistic amount of funds to address short term needs (so that you can keep your hands off of long-term retirement funds).
· Maximize participation in employer-sponsored tax-deferred plans (i.e. 401(k)).
· Open a Roth IRA account with an institution such as Charles Schwab, Fidelity, or any other reputable financial institution.
o Make sure that the financial institution you open your account with will allow you to buy unlimited stocks or mutual funds (some will limit your choices).
o Call their 1-800 number (i.e. 1-800-435-4000 for Charles Schwab).
o Ask for a Roth IRA account application. You may open an account for yourself and you may also open an account for a non-working spouse.
o Fill out the application (it has hard questions like: ‘what is your name,’ SSN, etc…)
o Attach a check to it in the amount that you wish to open the account with (the institution may have minimum amounts required to open the account).
o Mail it. In a few days you will receive a confirmation statement with your account number and instructions on how to place trades within your account.
· Within your Roth IRA account, invest in an S&P 500 Index mutual fund, such as the Vanguard S&P 500 Index Fund (symbol: VFINX). Make sure to compare the fund you select with others to be sure it offers low fees and low tax liability. Go to Morningstar.com to compare funds.
· Add to it every year.
· You may wish to purchase more mutual fund shares in addition to those in your Roth IRA (remember the Roth IRA only lets you contribute a certain amount each year). If so, contact Vanguard directly and order an account application. Fill out the application (indicate which of their mutual funds you want to invest in), attach a check, and mail it in. You will receive your account number and statement in a few days.
· You may elect to sign up for an automatic investment option which will deduct a specified amount from your checking account and invest it in more mutual fund shares each month (with no effort on your part).
· As time goes on, learn more about your investment options. If you are confident you can beat the performance of the S&P 500 index over a long period of time, then make other investments that you believe will get you there. Investigate other mutual funds or other forms of investment that will bring a degree of diversification to your portfolio. Measure your performance each year and be brutally honest with yourself about your abilities.
· DO NOT try to time the market (trying to sell and buy back in when the markets are up or down)….no one can consistently guess market direction correctly and this will cost you significant gains in the long run.
Where to go to learn more:
· Fool.com
· Mfea.com
· Vanguard.com
· Morningstar.com
· The Wall Street Journal Guide to Understanding Money and Investing
· The Wall Street Journal Guide to Planning your Financial Future
· The Millionaire Next Door (it's a book)
· Smartmoney.com
· Quicken.com
· Yahoo Finance
· Bloomberg.com
· Businessweek.com
· Kiplinger.com
· Money.com