Investing

Investing is not this complicated

Since high school, I've had lectures on financial planning, savings, investments, and the big word: retirement. Some people will work until they die (whether willingly or tragically unwillingly), but most of us I'm sure would like to stop having to work at some point. There are two forces stopping that: inflation and debts.

Most adults have some sort of revenue which helps pay the bills. Hopefully, your bills do not exceed that revenue. If they do, then you shouldn't waste any more time reading this blog and seek help from an actual financial professional. What I am trying to do is explain the different ways I've discovered to handle your extra money after your bills have been paid after each pay period. I am by no means a financial professional, but I hope I expose new ways to make smart decisions with your money.

Why not just put my extra money under the mattress?

A whole new light on learning the value of a dollar

 Inflation. Whether you realize it or not, the value of the dollar is not constant. I won't get into the details of how inflation works or why it happens, but the bottom line is that the value of the dollar depreciates over time.

The illustration to the left shows the purchasing power of a $20 bill in just the past three decades. I presume that most of my readers may need to work - at least - another three decades until they reach the age to qualify for their social security benefits. If you just store your money under the mattress, in a safe, or some other secure place; it will lose its value. Of course, spending your paycheck until it's gone every time is also not prudent since there are always emergencies or you want to live off more than just social security (assuming it still even exists). Essentially you need to turn your currency into something that can at least retain its value over the years or preferably increase its value over the years.

Option 1: Buy valuable stuff!

Before banks became as prevalent as they are now, people would buy works of art, jewelry, precious metals, or any intrinsic item(s) that many would conclude are valuable. The problem is determining value and do you even have enough money to even invest? I have quite a bit of money, but I can't get a loan to buy a $1 million painting nor do I have $1 million to spend on a painting. Now there are cheaper paintings, but unless you're a collector, there's a good chance you're not going to know how valuable anything intrinsic will be. You never really know how valuable an issue #1 comic book or some toy will become. There's also the issue that these items are much easier to steal, and you still have to convert them into currency to buy anything you need.

A slight caveat to this is precious metals. Gold has been a currency standard for thousands of years. Thievery is still an issue, but now you can buy certificates of gold (like a stock). Basically, a company will hold onto the gold and secure it while making money on the transactions. You can't pay bills directly with gold, so you still need a way to convert it. Unlike art and other collectibles, economists closely monitor the price of gold and generally agree that the price of gold is closely related to inflation. Gold may not be the best investment regarding increasing value, but it is often seen as a hedge against recessions meaning that it won't lose its value.

Be careful of scams when investing in gold!

Option 2: Get a savings account

This may be what most people are thinking about when savings come to mind. You can get a normal savings account which has some stricter restrictions than a checking account, but the amount of interest it earns is typically pitiful. I personally maintain a savings account with about six months worth of wages. This is strictly my emergency liquid (I can spend it immediately) cash. I don't use this as an actual savings vehicle, nor would I recommend it as such.

The inflation rate for 2017 was 2.1%

The current inflation rate of the US hovers around 2 %. The goal is to get an interesting account that exceeds the inflation rate. My rule of thumb is to get interests rates of 2% or higher. While a typical savings account won't get you anywhere close to 2%, banks and credit unions do offer another type of savings called a certificate of deposit (CD).

A CD generally will yearn higher interest rates, but you won't be able to access your money for a period of time. Banks in my area offer 4 year CDs for 2.5% interest. This may change due to the improving economy, so this is the risk you have to consider; however, CD's are arguably the safest investments that increase in value.

Option 3: Bonds

Closely related to a CD is a bond. Essentially an IOU, the creditor is obligated to pay back the bond at a specified interest value. Government bonds are the most common. Since the government is unlikely to default (you'll have worse problems than savings if that's the case), these can be seen as better than CDs. Bonds are much riskier with companies because if the company or fund goes bankrupt, then bondholders may lose their entire investment.

I never appreciated it as a kid, but I was pleasantly surprised to learn when going through my finances that my grandpa bought several bonds. Some of which have an interest rate over 4%! Keep in mind that's a guaranteed rate!

Option 4: Stocks

The stock market can be intimidating, but fortunately, modern technology and stock brokers make this option much more feasible. There are two approaches to investing in the stock market: stock portfolios and index funds.

Stock portfolios referring to buying individual stocks in the anticipating that they will grow in value. Like Option 1, determining what stocks to buy is very challenging. You could get lucky and initially buy stocks for a company such as Apple and be worth millions of dollars or buy stocks in companies like Enron and lose all of your money. Of course, stocks aren't intrinsic and represent a percentage of a company. This fact is how Mark Zuckerberg could become a billionaire overnight. He doesn't actually have a billion dollars in his bank account. His Facebook shares are just worth a billion dollars. Needless to say, this has the highest possible rate of return while also having the greatest risk.

Stock market value tends to rise.

When watching any news report on the stock market or even the economy in general, you may have heard terms like "Dow Jones" and "S&P 500". These are stock indexes. To put it simply, they represent a total of the stock market. It is actually possible to invest your money in an index fund. The basic idea behind this can be seen in the image to the right. Even though the stock market has volatility, it still grows in value over time.

It should also be pointed out that the selling of stocks at a profit is subject to capital gains tax. Remember that the next time people want to raise capital gains tax. It's not just rich people that pay it.

Option 5: IRAs

IRA's use CD's and bonds, but they have tax benefits. CD's and bonds are great, but you will have to pay taxes on any interest earned. Traditional IRA's allow all of the interest accrued to be tax-free until withdrawn. This is great because this allows your money to grow the maximum possible rate through conventional methods. Roth IRA's will pre-tax your investments, but you won't pay taxes on the interest earned. Being taxed before your money can grow may not be pleasant, but there is a tendency for taxes to increase, so it's possible that Roth IRA's may be protected from future tax increases. Both IRA's can't be withdrawn until the person reaches 60 (technically 59 1/2) years of age. Since there is such a long time span, this is ideal for retirement accounts.

I haven't seen this outside of the military, but the government offers an IRA called the thrift savings plan (TSP). This program takes advantage of mutual funds and IRA tax benefits. I'm currently getting the returns of a mutual fund without any taxes being taken out. The problem is that since I am no longer on active duty, I cannot make any further contributions. As of January 2018, TSP replaced the typical pension program that made the military very attractive as a career option. Personally, I hope the government expands using TSP-like programs and get rid of pensions. A guaranteed paycheck is great, but it is becoming quite a burden on our taxes.

Option 6: Life Insurance

Like my bonds, I was also pleasantly surprised at my life insurance policy purchased for me when I was 1 year old. Obviously, life insurance is more valuable to your beneficiaries, but it is possible to cash out your life insurance policy. This is where life insurance can be an investment vehicle. I won't name the company, but they have taken advantage of this fact and created new policies that serve as retirement policies. Basically, if you die early, your dependents still get a life insurance payout, but if you live until retirement, you can start withdrawing the value of the life insurance policy. 

This carries the same risks as a bond, but I currently have an interest rate exceeding 7%! I don't know how common this is, but I strongly recommend talking to an insurance agent about this. It may not be as lucrative in the future as it becomes more popular.


Option 7: Real Estate 

Property is the classic investment and why the 2008 recession was especially tragic. Real estate is a lot like option 1 in that it's intrinsic, but it is a great way to store your money and possibly increase it. If HGTV is any indicator, real estate is quite a lucrative industry. Aside from the investment vehicle, I personally think there's a point of pride in owning a home that separates it from other investment options.

Another key difference from other investment options is that you can affect the value of your investment by maintaining your home and improving it. You can increase your home's value by thousands of dollars with a few hundred dollars worth of fiber! Plus you can actually enjoy your investment as it grows in value.

 
Option 8: Pay someone else to save your money!

Most banks and credit unions have some sort of investment center. There are investment firms that you can look into as well, but they may need you to contribute at least above $50k in order for you to make any real returns to cover their overhead. What they will most likely offer you is something called a mutual fund. The basic idea is that you pool your money together with everyone else in the fund, and a fund manager "plays" with your money with the intent to gain the maximum return possible.

401K's and other retirement packages use this option frequently. The military is now adopting this approach through their TSP program in lieu of pensions. The company I currently work for uses an investment firm to manage our retirement. Yes there are overhead costs, but the fact that you can still get high returns while paying someone speaks to the power of the stock market.

My advice would be to take advantage of this option if you can especially if your company will match your contributions. Again, I don't recommend this for small savings accounts, but if you do have a savings account with over $50k, you would be financially irresponsible to not use this option. Ultimately, there's no need to have a large amount of liquid cash. If you have more than six month's salary in your checking account, then you are throwing money away. Assets such as the above investment options provide you the ability to store your money for retirement while also increasing the money you've already earned.