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Learn the Language | Budget and Save | Save and Invest | Take Control of Debt | Protect Your Wealth
You have budgeted and identified an amount to save monthly. Where are you going to put your savings? By investing, you put the money you save to work making more money and increasing your wealth.
An investment is anything you acquire for future income or benefit. Investments increase by generating income (interest or dividends) or by growing (appreciating) in value. Income earned from your investments and any appreciation in the value of your investments increase your wealth.
There is an art to choosing ways to invest your savings. Good investments
will make money; bad investments will cost money. Do your homework. Gather as much information as you can. Seek advice from people at your bank or other trained financial experts. Read newspapers, magazines and other publications. Identify credible information sources on the Internet. Join an investment club.
Compound interest helps you build wealth faster. Interest is paid on previously earned interest as well as on the original deposit or investment. For example, $5,000 deposited in a bank at 6 percent interest for a year earns $308 if the interest is compounded monthly.
In just 5 years, the $5,000 will grow to $6,744.
When you are saving and investing, the amount of expected return is based on the amount of risk you take with your money. Generally, the higher the risk of losing money, the higher the expected return.
The simplest way to begin earning money on your savings is to open
a savings account at a financial institution. You can take advantage of compound interest, with no risk.
Financial institutions offer a variety of savings accounts, each of which pays a different interest rate. The box below describes the different accounts. Find the best one for your situation and compare interest rates and fees. You can choose to use these typical accounts to save for the near future or for years down the road.
TOOLS FOR SAVING
Once you have a good savings foundation, you may want to diversify your assets among different types of investments. Diversification can help smooth out potential ups and downs of your investment returns. Investing is not a get-rich-quick scheme. Smart investors take a long-term view, putting money into investments regularly and keeping it invested for five, 10, 15, 20 or more years.
Types of savings Accounts
Savings account (in general)
Access your money at any time. Earn interest. Move money easily from one account to another.
Savings insured by the FDIC up to $100,000.
Money market account
Earn interest. Pay no fees if you maintain a minimum balance. May offer check-writing services.
Savings insured by the FDIC up to $100,000.
Certificate of deposit (CD)
Earn interest during the term (three months, six months, etc.). Must leave the deposit in the account for the entire term to avoid an early withdrawal penalty. Receive the principal and interest at the end of the term. Savings insured by the FDIC up to $100,000.
Savings bonds. U.S. savings bonds are government-issued and government-backed. There are different types of savings bonds, each with slightly different features and advantages. Series I bonds are indexed for inflation. The earnings rate on this type of bond combines a fixed rate of return with the annualized rate of inflation. Savings bonds can be purchased in denominations ranging from $50 to $10,000.
Treasury bonds, bills and notes. The bonds the U.S. Treasury issues are sold to pay for an array of government activities and are backed by the full faith and credit of the federal government. Treasury bonds are securities with terms of more than 10 years. Interest is paid semiannually. The U.S. government also issues securities known as Treasury bills and notes. Treasury bills are short-term securities withmaturities of three months, six months or one year. They are sold at a discount from their face value, and the difference between the cost and what you are paid at maturity is the interest you earn. Treasury notes are interest-bearing securities with maturities ranging from two to 10 years. Interest payments are made every six months. Treasury Inflation Protected Securities (TIPS) offer investors a chance to buy a security that keeps pace with inflation. Interest is paid on the inflation-adjusted principal.
Some government-issued bonds offer special tax advantages. There is no state or local income tax on the interest earned from Treasury and savings bonds. And in most cases, interest earned from municipal bonds is exempt from federal and state income tax. Typically, higher income investors buy these bonds for their tax benefits. stocks—owning Part of a Company
When you buy stock, you become a part owner of the company and are known as a stockholder, or shareholder. Stockholders can make money in two ways—receiving dividend payments and selling stock that has appreciated. A dividend is an income distribution by a corporation to its shareholders, usually made quarterly. Stock appreciation is an increase in the value of stock in the company, generally based on its ability to make money and pay a dividend. However, if the company doesn’t perform as expected, the stock’s value may go down.
There is no guarantee you will make money as a stockholder. In purchasing shares of stock, you take a risk on the company making a profit and paying a dividend or seeing the value of its stock go up. Before investing in a company, learn about its past financial performance, management, products and how the stock has been valued in the past. Learn what the experts say about the company and the relationship of its financial performance and stock price. Successful investors are well informed.
Mutual Funds—Investing in Many Companies Mutual funds are established to invest many people’s money in many firms. When you buy mutual fund shares, you become a shareholder of a fund that has invested in many other companies. By diversifying, a mutual fund spreads risk across numerous companies rather than relying on just one to perform well. Mutual funds have varying degrees of risk. They also have costs associated with owning them, such as management fees, that will vary depending on the type of investments the fund makes. Before investing in a mutual fund, learn about its past performance, the companies it invests in, how it is managed and the fees investors
are charged. Learn what the experts say about the fund and its competitors.
Stocks, bonds and mutual funds can be purchased through a full-service broker if you need investment advice, from a discount broker, or even directly from some companies and mutual funds. Remember, when investing in these products: Find good information to help you make informed decisions. Make sure you know and understand all the costs associated with buying, selling and managing your investments. Beware of investments that seem too good to be true; they probably are.
We have seen that by budgeting to save, saving and investing, wealth can be created. But what if debt limits your ability to save and invest?
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Source: Federal Reserve Bank of Dallas Building Wealth, 2006. Reprinted with permission. |
