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NOTE: The following story is educational and not about specific products or services. However, where links from this story refer you to non-deposit products and services, these investments are offered at Numerica Credit Union through CUSO Financial Services L.P.
There’s a classic scene from “The Office” where Jim pranks Dwight by sending him a fax on his personal stationary – “from himself, from the future.”
What if your future self could send you financial advice? We bet it would read: “Pay off your debt. Start investing. Please and thank me!”
Cue internal dialogue:
“But I’m just not good with money.”
“It sounds risky.”
“It’s too confusing.”
We get it. That’s why we put together this investing guide for you (and future you). In plain language, let’s learn:
- The what and why of investing
- Things to tackle before you start investing
- How to get started investing
- How to know what to invest in
- Investing best practices
What is investing, and why should I bother?
Investing is like planting a seed. You are taking an action today to prepare for the future. In this case, you plant money in smart places where it has potential to grow. One day, that seed might help you achieve a goal — pay for college, buy a house, retire comfortably, etc.
Here’s an example. What if you planted $100 in a fund that invests in the 500 largest stocks on the New York Stock Exchange and walked away for 30 years — didn’t touch it? Although past performance is not an indication of future results, the average annual return since the S&P 500 started measuring this very thing in 1923 is 12%. At this rate, the $100 would have grown to about $3,000 without you doing anything. That’s a healthy money tree!
Now imagine you became a regular gardener, planting $100 seeds on a regular basis!
This is just one way to invest money. Some investments are short-term, some are long. Some are more conservative and typically achieve lower rates of return, some involve more risk but have the possibility of larger returns.
The point is that money set aside in a shoebox doesn’t grow at all. If you want to get ahead and achieve important goals, it’s vital to plant some of your money in places where it can potentially grow.
The magic bean: compounding returns
How does this wonderful money growth happen, and what determines how much growth takes place?
When you invest money, you are looking for a rate of return on that investment. Some investments have fixed returns. In other cases, like stocks, you actually purchase shares of ownership in a company, and the factors that impact your potential return become numerous.
A magic bean of investing is called compounding, and it happens when you leave the money you earn parked in the investment, where it starts earning money itself. When your returns start earning a return and are left alone for a long period of time to multiply, that can be a recipe for good things.
Remember the example above where you planted $100 for 30 years and earned $3,000? That’s the beauty of compounding.
What if you pocketed those returns every year instead of leaving them alone for 30? What if at the end of year 1, you bought a pizza with the 12 bucks your $100 investment made instead of leaving it alone to grow more money in year 2?
Without your returns compounding year after year, the difference is staggering. Instead of $3,000 after 30 years, you would have $460 — and $360 of that would have been blown on the annual pizza you pulled the money out for.
Don’t settle for an annual pizza. That’s robbery against future you! Compounding and time are your friends when it comes to growing your money.
Do this before you start investing
Investing is one component of smart money management. Because it’s tied to your overall financial health, it’s impacted by other aspects of your finances. Before you start investing, start with a checkup on these aspects of your financial health:
Plan for investing with a budget
A budget is a simple tool to tell your money where to go. Investing is part of the “savings” portion of a healthy budget.
Remember how those $100 seeds add up? A budget is the tool you use to ensure you’re consistently planting. When you know how to budget your money, you make a plan for the exact amount you should be planting in an investment and how often to do so.
Deal with debt
Debt is the opposite of investing — you are paying interest instead of earning returns. In most cases, it is wise to pay off high-interest, consumer debt before you start investing. Why? Because you are competing against yourself, and some debt grows at rates that would outpace your investments, making it difficult to ever get ahead.
No investment strategy will succeed unless it coincides with a strategy for how to pay off your debt.
Start with savings
Your first true investment should be savings. Build up a robust fund to cover emergencies and several months of expenses. These investments should be made in a savings or money-market account* you can have easy access to.
Why not invest in a longer-term account first? For one thing, riskier assets like stocks are far more predictable in the long term than the short term. If your emergency coincides with a sharp downturn in the market, you could end up losing a lot of money. In addition, longer-term investments can have penalties and tax implications that result from withdrawing funds early.
You can’t plan for the future if you can’t pay for today. If you don’t have money readily available to pay for a car repair, for example, you may be tempted to tap longer-term investments.
Getting started investing
As you set out on your investment journey, you must begin with the end in mind.
Determine your goals
What financial milestones are you investing for?
- A special vacation?
- Putting children through college?
- Your retirement?
Be specific. If you are saving for retirement, what do you expect that retirement to look like?
As you identify these goals, it will help you create priorities.
Assess your tolerance for risk
Investments run the gamut of risk, and it is important to bring your own personality and stage of life into your investment selection. For instance, a risk-averse person or someone nearing retirement age might take a more cautious approach.
Learn from a teacher
Know thyself? Check. Know all thy investing options? That part is trickier.
That’s why meeting with a financial advisor is a smart move. Whether pointing you in the right direction or managing your portfolio. Find someone who takes time to understand your goals, priorities, risk tolerance, and is willing to educate you on your options.
Don’t be afraid to ask questions and invest time in independent learning and research. Bottom line is you shouldn’t invest in things you don’t know or understand. A financial advisor may be able to help with that.
Numerica members can meet with a member of our CUSO Financial Services team at no cost or obligation.
What should I invest in?
Now you’re ready to dig in to the various types of investments that are out there. There is a wide and diverse field of opportunities, but let’s focus today on cash, bonds, stocks, and mutual funds.
Also known as fixed-income investments, bonds are when the government or companies borrow money from investors and agree to pay them a rate of interest in return. Bonds are typically considered less risky investments, but losses are still possible.
With stocks, instead of loaning money to a company you actually purchase partial ownership of a company. This makes stocks more volatile, because they go up or down depending on the rising and falling value of the company. Many companies also pay regular dividends. These payments represent your share of the profits of the company.
Mutual funds are when a group of investors pool money for a specific investment strategy. A single mutual fund could invest in an assortment of stocks, bonds, or cash products, for example. A special kind of mutual fund (called an exchange-traded fund) invests in a specifically defined segment of the market, such as the S&P 500 example previously referenced.
What are IRA and 401(k) retirement plans?
Two of the most popular plans for retirement investing are the IRA and the 401(k).
IRA stands for individual retirement account. It allows individuals to direct pre-tax income toward investments that can grow tax-deferred.
401(k) plans are employer-sponsored accounts that make it easy for employees to set aside pre-tax income from paychecks for retirement. A huge benefit of some 401(k) plans is employer matching. If your employer offers to match your contribution, that is free money for retirement you’re not going to get any other way. Take advantage of it!
The Roth option
When setting up retirement accounts, there is often an option to open a Roth version. With Roth accounts, investors pay taxes on the front end but enjoy tax-free withdrawals in retirement, meaning growth on these investments is not subject to tax. Roth IRAs are available to investors who fall within certain income limitations. Most 401(k) plans also offer a Roth option.
Investment best practices
As you set off on your investing journey, there are numerous considerations for creating a disciplined investment plan. Here are 3 to leave you with.
1. Keep those eggs separate
You’ve heard the line about not keeping all your eggs in one basket? Yeah, that’s super important advice.
In investment circles, you’ll hear terms like “diversify” and “asset allocation.” These are not only strategic terms in their own way, but they are a warning against concentrating your investments too heavily in one area, such as an employer’s stock.
The price might be right, but if the stock takes a beating, so does your unbalanced portfolio. Make sure to come up with a plan that is not only calibrated toward your goals and risk tolerance, but spreads your money around into multiple investments.
2. Leave those retirement accounts alone
Remember when we talked about the importance of an emergency fund? That’s so you won’t be tempted to touch your retirement accounts, which often have 10% penalties if you cash out before retirement. You also cut your compounding magic off at the knees. Not ideal.
While you should be aware of your option to borrow money from your 401(k), there are several reasons to beware. You may be forced to pay it back more quickly than you hoped if you leave your job, which could cause you to default on the loan. A 401(k) loan is a consequential decision and should not be taken lightly. It’s smart to talk to a qualified financial advisor before making this decision.
3. Remember, you’re in this for the long haul
Investing isn’t a get-rich-quick scheme. It’s a smart choice that requires patience, discipline, and persistence.
Time is your friend. When you invest for the long haul, it puts short-term market downturns in proper perspective. It also allows you to truly benefit from compounding returns.
When is the best time to start saving for retirement? If you have some debt and aren’t quite sure, consult a qualified financial advisor for guidance. If you have paid off your debt, you should start today!
As the Chinese proverb teaches, “The best time to plant a tree was 20 years ago. The second best time is now.”
Why not modify that quote, and send this message back to future you: “The best time to plant a tree is 20 years ago, so I just did.”
Non-deposit investment products and services are offered through CUSO Financial Services, L.P. (“CFS”), a registered broker-dealer (Member FINRA/SIPC) and SEC Registered Investment Advisor. Products offered through CFS: are not NCUA/NCUSIF or otherwise federally insured, are not guarantees or obligations of the credit union, and may involve investment risk including possible loss of principal. Investment representatives are registered through CFS. The credit union has contracted with CFS to make non-deposit investment products and services available to credit union members.
*Numerica Credit Union’s in-house deposit accounts — savings, money market, and certificates of deposit — are federally insured by NCUA. These are completely separate from the aforementioned investment products and services offered through CUSO.