Financial Planning: Basics of Investing
Once you've learned the importance of saving for your retirement, the next thing you'll want to figure out is where and how that money is invested. "Huh?" you ask. Basically, I want you to know how your investment is divided because that makes a big difference in how much money you will make. So, crack open that nest egg and see what's inside your 401k, Roth IRA, traditional IRA, or anywhere else you've got your money invested, and mix it up!
Before you say, "Carmen, you're killing me," hear (ahem, read) me out. This stuff isn't as complicated as you think. First, let's go through the basic types of investments (a.k.a. assets):
- Stocks: These are considered the best form of saving for retirement because they earn more returns than any other type of investment. There are many different types of stocks—U.S. and International, large-cap, mid-cap, and small-cap. Cap stands for market capitalization (the company's share price multiplied by the number of a company's outstanding shares). Large-cap stocks are from more established companies and therefore have less of a risk. Small-cap stocks are just the opposite. And, the more risk you take, the better your chances of earning a higher return on your investment.
- Bonds: When you buy a bond, you're getting a guaranteed rate of return for a fixed period of time. This means they're less risky than stocks. The three types of bonds are: corporate, issued by companies; municipal, issued by local governments; and Treasuries, issued by the federal government. Municipal and treasury bonds usually have the lowest rate of return because of their stability, while corporate bonds offer higher returns, but at a higher risk (after all, as we've learned this year, companies can go out of business at any time). The upside to a corporate bond however, is if a company does go under, its bondholders get paid before its stockholders (that is, if they get anything at all.)
- Mutual funds: Many experts will tell you to look at a mutual fund as a basket. This basket holds a variety of bonds, stocks, and cash equivalents. There are a lot of mutual funds to choose from—higher to lower risk. Mutual funds are a simple and more affordable way to diversify your assets because you invest a certain amount of money and your assets are automatically divided according to the market manager's expertise.
For more information on the ABCs and 123s of stocks, bonds, and mutual funds go to: money.cnn.com. And if you're feeling brave, go to morningstar.com, which is packed with information on different types stocks, bonds, and mutual funds. Membership is free!
The takeaway: A 401k or IRA are two nice, tax-friendly tools to get your retirement fund started, but aren't considered a form of investing all by their lonesome. Think of your retirement fund as a hungry machine: You've got to keep feeding it to keep the motor churning, keep tinkering with it so that it runs properly.
Want more money-saving tips? Check out our Recession Proofing Boot Camp!