About Investing On Your Own
1 - Get A Financial Start
You’re starting to get ahead. Maybe you just got a raise or a well-deserved
promotion. Perhaps you received a windfall as a gift or inheritance. Or maybe
you just want to save more and invest your money so it's working for you. The
question is: How?
The best way is by planning, saving, and investing for each of your financial
goals. This may sound complicated, but it really isn't. You can succeed as an
investor by following a few simple rules. And by starting now, you’ll greatly
improve your chances of success.
You may be surprised at how much you can accomplish by investing even small
amounts of money over time—if you start earlier rather than later.
Consider 2 investors of the same age, with the same annual income, and with
similar investment goals. The only difference is that one starts investing
earlier than the other.
Investor 1 begins at age 25 and contributes $2,000 each year for 10 years and
then stops adding money to the account. Investor 2 invests $2,000 each year for
30 years, starting at age 35. Assuming both earn a hypothetical investment
return of 8% per year after expenses, can you predict which investor comes out
ahead?
2 - Create Your Investment Plan
How to Create Your Investment Plan
You have financial goals. You want to save for retirement, a child's education,
or a new house. But attaining any goal requires more than just saving regularly.
You need to make sound investment decisions—decisions you can and should being
making NOW.
Where should you begin? Stocks, bonds, and cash investments. Large, small, and
international companies. The choices may seem overwhelming, but they're really
not. Becoming a savvy investor is easier than you might think. You don't need to
be a financial wizard; you do need to learn to do just a few things right.
Identify Your Goals and Time Horizon
Why do you want to invest your money? To save for retirement, a child's
education, a house, a vacation, or all of the above? Before you can create an
investment plan, you need to know what you want to do with your money—and when
you'll need it.
Check your time horizon:
Your time horizon is important because your investments will rise and fall in
value throughout the time you own them.
The longer your time frame, the greater your ability to ride out the ups and
downs of the markets. Because you won't need your money right away, you can more
reasonably select investments whose values might fluctuate in the short term in
hopes of earning greater returns over the long term.
If you're saving for retirement, for example, your time horizon may span several
decades. With time on your side, you can place a greater emphasis on stocks. Of
the 3 primary asset classes—stocks, bonds, and cash investments—stocks
historically have turned in the highest long-term returns, although with the
widest short-term price swings.
By contrast, if you're investing for a short-term goal, such as a luxury cruise
in a year or so, a more stable investment such as a money market fund is
sensible because you would have little time to recoup any investment losses from
a market downturn.
Consider all your goals:
How can you invest to meet your goals? First, prioritize them according to a
time frame. Rely on cash investments for your short-term goals, those you plan
to finance in a year or so. For goals you must meet within 3 to 5 years, you
have enough time to take a bit more risk by emphasizing shorter-term bond
investments. For your longer-term goals, you'll need a mix of stock and bond
investments—and possibly some cash investments.
Whatever your goals, the key is to get started now. Every day you delay
represents a missed opportunity for your money to grow, as the following example
illustrates.
Understand the asset classes:
Stocks - Stock represents a share of ownership in a
corporation. Stock returns are based on a company's dividends and profits and
how investors assess its potential for future profits. Historically, stocks have
provided the highest returns over time, but stock prices fluctuate—sometimes
dramatically. Investors typically choose stocks for growth of capital, which can
help them stay ahead of inflation over the long term.
Bonds - Bonds are IOUs issued by governments,
government agencies, and corporations. Interest-rate changes directly affect the
prices and returns of bonds, but in general, bond prices fluctuate less than
those of stocks. Investors typically choose bonds to receive income and to
diversify stock portfolios.
Cash investments - A cash investment is a very
short-term IOU issued by a government, corporation, bank, or other financial
institution. Using the interest payments from such IOUs, money market mutual
funds provide income—most often, less than that provided by bond funds—while
maintaining a stable price of $1 a share. Investors typically rely on this type
of fund to stash money they'll need for emergencies and short-term goals.
Spread the risks around.
Financial experts agree you should hold a mix of investments from among the
asset classes to help reduce the volatility—or fluctuation in market value—of
your portfolio. That's because diversification spreads the risk around: A good
performance in one area can often temper a subpar performance in another.
No one combination of investments is right for everyone.
The key question to ask yourself is: “Will I be able to stick to my investment
plan through the ups and downs I'll likely face?”
Select Your Investments
Once you're satisfied with your asset allocation, your next step is to select
the right investments. Should you choose individual stocks and bonds, or should
you invest in mutual funds?
Although you could build a portfolio of individual stocks, to minimize the risk,
you'd need to buy at least 100 stocks carefully chosen to ensure broad
diversification. A properly diversified portfolio of individual bonds would be
similarly difficult to achieve.
That's why,
for most people, mutual funds are probably the best investment vehicle.
Start with mutual funds:
The idea behind mutual funds is simple. Many people put their money into a fund.
Then the fund, managed by investment professionals, invests the pooled money in
a variety of stocks, bonds, or cash investments to achieve a specific investment
objective. Each investor shares proportionately in the gains and losses of the
fund and in any income the fund earns—less the costs of managing the fund.
Mutual funds efficiently provide diversification and are easy to buy and sell.
With thousands of mutual funds to choose from, where do you begin? Here are 3
rules for using mutual funds to create your investment plan:
For your stock holdings, you should cover all segments of the U.S. stock
market—including the stocks of small, midsize, and large companies, both growth
and value, across all industries. As a guideline, keep in mind that larger
companies—in terms of the market value of their stock—constitute 70% of the
stock market. As you become a more experienced investor, consider including a
portion of your stock portfolio in international stocks.
For your bond holdings, you should include bonds issued by the U.S. government
or its agencies as well as investment-grade corporate bonds. Your bond holdings
should have an average maturity of 5 to 10 years. If you're in a high tax
bracket and you're investing outside a retirement account, you should consider
high-quality, tax-exempt municipal bond funds.
For your short-term needs and your emergency fund, you should choose a money
market fund or, if you’re willing to take some risk of losing a modest amount of
principal, a high-quality, short-term bond fund that could potentially yield
higher returns.
While you could create a portfolio by purchasing a variety of stock and bond
funds, you also could decide to keep things simple and purchase a couple of
funds. A broadly diversified balanced fund that invests in stocks and bonds may
be all you need, if it matches your asset-allocation strategy. Or your portfolio
could consist of a single broadly diversified stock fund and a single broadly
diversified bond fund, purchased in the percentages that match your target asset
allocations.
Although the income from a municipal bond fund is exempt from federal tax, you
will pay tax on capital gains realized from a fund's trading or from the
redemption of shares. For some investors, a portion of the fund's income may be
subject to the alternative minimum tax. Income may also be taxed by state and
local governments.
Watch out for costs:
Costs count for a lot in mutual funds. High costs can severely damage your
long-term returns, so you need to understand all the costs you may be paying.
Remember, the money’s coming out of your pocket, so it pays to shop around.
Suppose you have $50,000 to invest. Let's say you invest half of it in Fund A
with an expense ratio of 1.3%, and you put the other half in Fund B with an
expense ratio of only 0.3%. This example assumes an 8% rate of return. Click the
buttons below to see what can happen to your investment in 20 years.
Investing in Fund A could cost you $19,751!
Here are
some of the mutual fund costs you should watch out for:
Expense ratio. Every fund has an expense ratio, so you can’t avoid this one. The
expense ratio is money deducted from fund assets to cover operating costs that
include investment advisory fees, legal and accounting services, postage,
printing, and other administrative costs. Most funds have an expense ratio of
between 0.2% and 2.5%. A lower ratio means you get to keep more of the fund’s
earnings.
Sales charges. Some funds make you pay a sales fee up front when you buy shares
(a front-end load) or when you sell shares (a back-end load). A fund charging a
level load imposes an annual fee—in addition to operating expenses. These
charges can be avoided entirely: No-load funds don't impose any of these sales
charges.
12b-1 fees. Some funds charge a 12b-1 fee to pay the marketing and distribution
costs of the fund, which can include a sales charge to compensate sales people.
When this fee is charged, it's included in the expense ratio.
Trading costs. Still another expense is the cost of trading securities,
including brokerage commissions. These costs aren't included in the expense
ratio, but they reduce the returns you receive. Watch out for funds with high
turnover ratios: Their trading costs can cut into your total return, and the
frequent trading may generate a lot of taxable capital gains.
Return to top
Know how your funds are managed:
Mutual funds are managed either passively or actively. Passively managed funds
are commonly called index funds because they seek to track a given market index.
Actively managed funds are run by hands-on advisers who try to beat the market
through market timing or superior security selection.
Low-cost index funds that track broad stock or bond indexes provide efficient
ways for investors to achieve wide diversification.
Understand fund basics:
It’s often hard to tell from the name of a fund what securities it invests in
and whether it’s right for you. That’s why you should read a fund's prospectus
and semiannual or annual report before you invest. Some essential information to
look for includes:
Objective. Does the fund seek growth, income, or preservation of capital? Is its
objective in line with your needs?
Strategy. How does the fund seek to accomplish its objective? For example, will
a fund emphasize stocks believed to have above-average growth potential (a
growth fund), or stocks of companies whose share prices are low compared with
their past or projected earnings (a value fund)? If a diverse stock portfolio is
your goal, you'd want to know if you have a balance of growth and value stocks
since growth stocks shine in some periods and value stocks in others.
Performance. What's the fund’s long-term performance—over 5 years or more? It’s
the long term that’s most meaningful, not performance over shorter time frames.
How does its performance compare with the appropriate benchmark? With funds in
its peer group?
Risks. What risks will a fund take to achieve its performance? Does the fund
emphasize high-risk (junk) bonds, for example? Does the fund deliberately forgo
diversification by concentrating in the stocks or bonds of a specific industry?
A fund's prospectus should clearly point out all the risks an investment in a
fund would entail.
Know When to Change Your Mix
Marriage, birth, an inheritance, the death of a spouse. Life-changing events can
certainly alter your financial situation and give you sound reasons to change
your investment mix.
In addition, as time passes, the time horizon for each of your investment goals
shortens: Long-term goals become intermediate-term goals and then short-term
goals.
Market conditions can also create a need to make a change. For example, if
stocks have been doing particularly well for a long period, you may find you
have a higher percentage of your assets in stocks than you had planned. You may
need to adjust your portfolio to bring it back to your target asset allocation.
To keep your plan on track, set a schedule. Pick a date—perhaps a birthday or an
anniversary—to review your investment plan each year. If you need to make a
change, you can rebalance in 3 ways:
Make an exchange. If your asset allocation is dramatically out of balance, you
can transfer money from one type of fund to another. If you move retirement
money within your employer's plan or an IRA, you won't owe any taxes. Outside a
retirement plan, however, you may incur taxable capital gains by exchanging
shares. If this is the case, you may prefer to rebalance using one of the next 2
methods.
Redirect your new investments. You could simply add new money to the asset class
that's underrepresented in your portfolio.
Redirect dividends and capital gains. Have your fund company invest dividends
and capital gains from funds that have grown out of proportion in the funds that
need a boost.
Watch out for these pitfalls:
Remember, successful investing usually means doing just a few things right—and
avoiding some common mistakes.
Being overly aggressive. Some investors delight in risk and might concentrate
their holdings in one high-flying area. The danger: If the market turns against
you—as it did with technology after the boom of the late 1990s—the drop could be
significant and the recovery might take a long time. The lessons: Make sure your
investments are in line with your overall goals and you're properly diversified.
Chasing performance. A related mistake is jumping into last year's
top-performing fund. If you invest after a terrific run-up, you may be arriving
just in time for the fall.
Timing the market. Which area of the market will perform best is anybody's
guess. Yet many investors are “market-timers.” They try to predict where the
best returns will be and move their money there. Inevitably, marketing-timing
leads to more bad decisions than good ones.
Overlapping holdings. Don't spread your money among too many funds. You'll
probably have a good deal of overlap among holdings. You can put together a
widely diversified portfolio with just a few well-chosen funds—or even one
balanced index fund, if that's your preference.
3 - How To Invest For Retirement
If you’re like most people, you have several investment goals—paying tuition,
buying a first or second home, or even taking a special vacation. Whatever your
goals, your top investment priority should almost certainly be retirement. You
can borrow to help finance a house or a child’s education, but no one is going
to lend you money to finance your retirement.
How to Invest for Retirement is designed to make your planning process fast and
painless. In less than an hour, you can determine how much money you need to
save for retirement, what kinds of accounts you should use, and how to allocate
your assets.
Picture Your Retirement:
What kind of life do you imagine for yourself in retirement? Certainly, you'll
want to enjoy financial security. Maybe you'll want more. Perhaps you'd like to
travel or take up some hobbies that might be expensive.
Even if you're picturing a very simple life, it won't come cheap. One reason:
The average retirement is getting longer because people are retiring younger and
living to older ages. A 65-year-old man can expect to live until his early 80s,
and a 65-year-old woman can expect to live a few years longer. More people are
reaching the 100-year mark. By 2050, about 1 million Americans will be at least
100 years old. (Source: National Center for Health Statistics). That's a lot of
years of living to pay for.
Everyday expenses during retirement:
Think about how your financial landscape might change in retirement. On the
positive side, when you're no longer getting a paycheck, you'll no longer pay
Social Security or other payroll taxes. Perhaps your mortgage and other debts
will be paid. However, if you own a home, property taxes and the cost of
maintenance and insurance will undoubtedly increase. After you reach age 70½,
even your income taxes could rise if your required minimum distributions from
all your retirement plans (except Roth IRAs) push you into a higher tax bracket.
Your health care costs could rise significantly. In fact, you may have to begin
paying for health benefits your employer previously provided. As you age, your
costs could soar as you need more prescriptions, medical devices, and even
long-term care—not all covered by Medicare.
How inflation erodes savings:
As if all these things aren’t overwhelming enough, don’t overlook the effects of
inflation on your retirement income. Since 1960, the Consumer Price Index (CPI)
has risen an average of 4.4% a year—a total of 493% through the end of 2001.
That means as each year goes by, every dollar in your pocket buys fewer goods
and services.
In the example below, see how inflation—a general rise in the price of goods and
services—can erode the buying power of the hypothetical retirement account. The
illustration assumes a $2,000 investment each year over a 40-year period, a 4%
inflation rate, and an 8% annual return.
The total before inflation would be $518,113 (nominal dollars). After taking
inflation into account, the investment would only be worth $112,234 (real
dollars) in today's dollars.
The information shown is hypothetical. It does not represent returns from any
particular investment.
Your cost of living will continue to rise throughout your retirement. That means
you’ll probably need to increase the amount you withdraw from your investments
each year you're retired just to maintain the same standard of living.
Yes, retirement will be expensive. But don't despair. Reaching your goal may be
easier than you think.
Set Your Savings Goals
One of the most important steps you can take as a retirement saver is to figure
out how much money you’ll need. By setting a goal—and calculating how much you
should be saving now—you can establish a realistic plan to help you achieve it.
One useful rule of thumb says retirees need to replace at least 75% to 80% of
the income they were receiving just before they retired. Keep in mind this
amount may come from several sources.
For example, you'll probably receive Social Security benefits, but for most
people, these will cover only a portion of their needs. In addition, Social
Security has raised the age at which people qualify for full retirement
benefits; it's now 67 for people born in 1960 or later. While estimates say the
Social Security system is adequately financed until about 2038, tax increases,
benefit reductions, or other measures will be needed to maintain the system
beyond that. You can order a statement estimating your benefits from the Social
Security Administration or by calling 1-800-772-1213.
You may also receive a pension, although guaranteed-for-life pensions are
becoming endangered species. Your employer can estimate any pension benefits for
you. You may also be able to keep working to avoid spending down your retirement
fund—but you'd better not count on it. Today, 45% of retirees left work before
they planned to, often because of poor health, layoffs, or other problems
outside their control. (Source: Employee Benefit Research Institute, 2001
Retirement Confidence Survey™)
If you're like most people, your primary source of retirement income will be
your own savings. Make this your savings goal.
Why it pays to start early
The sooner you begin setting aside money for your retirement, the better off
you'll be. That's because time is a powerful ally to retirement investors.
Every day you delay represents a missed opportunity for your money to grow, as
the following example illustrates.
Consider 2 investors of the same age, with the same annual income, and with
similar investment goals. The only difference is one starts investing earlier
than the other.
Investor 1 begins at age 25 and contributes $2,000 each year for 10 years and
then stops adding money to the account. Investor 2 invests $2,000 each year for
30 years, starting at age 35. Assuming both earn a hypothetical investment
return of 8% per year after expenses, can you predict which investor comes out
ahead?
Where to find the money
As you can see, the power of compounding can provide an amazing boost for those
who invest over the long term. The lesson: Don't wait until you can “afford it”
to save for retirement. Start now, even if you can only set aside small amounts.
Your savings will add up faster than you think—and what a feeling of
accomplishment!
Bonuses and other windfalls can provide painless sources of retirement savings.
Carefully shopping for houses, cars, and appliances enables you to save even
more. But one of the most effective ways to jump-start your savings is watching
small, everyday expenses.
Make a list of everything you spend in a month and look for “hidden” sources of
extra money. Perhaps you can make coffee at home rather than paying for a cup at
the coffee shop. Or maybe you can take your lunch to work instead of dining out.
If you can save just $8.22 a day (that's $57.54 a week, or about $250 a month),
you'll have saved $3,000 over the course of a year—enough to make the maximum
contribution to an IRA.
Establish Your Retirement Accounts
Now that you’ve set your investment goal for retirement, you can decide what
kinds of accounts to establish. Several offer tax advantages for retirement
investors. When you use tax-advantaged accounts, your investments will grow
faster.
The long-term benefits of tax-advantaged
investing
Let's say 2 people invested in the same mutual fund, but one invested through a
Roth IRA (where returns grew tax-free*) and the other used a taxable account.
Each investor contributed $2,000 annually to the hypothetical account and had an
8% return after expenses. A combined state and federal income tax rate of 30%
was imposed on the total return of the taxable account each year. Both investors
reinvested interest, dividend, and capital gains distributions. What were the
results after 40 years?
Despite identical investment returns, the Roth IRA grew to $559,562—$263,800
more than had accumulated in the taxable account.
*Most retirement plans are tax-deferred, not tax-free. Withdrawals of earnings
from a tax-deferred account such as a traditional IRA or an employer-sponsored
plan would be subject to tax as ordinary income.
Choose Your Investments
You're almost finished! Whether you're investing in your employer-sponsored plan
or an IRA—or both—you need to decide how to allocate your assets among stocks,
bonds, and cash investments. The asset mix you choose will depend on how much
time you have until retirement, your risk tolerance, and your financial
situation.
Which IRA is best for you?
The answer depends on your financial situation now and what you expect it to be
in the future. For example, if you're a participant in an employer-sponsored
retirement plan and you have a relatively high income (up to certain limits), a
Roth IRA is likely the appropriate choice because a contribution to a
traditional IRA wouldn't be deductible on your tax return. If you exceed the
income limits for a Roth IRA, the only choice you'll have is to make after-tax
contributions to a traditional IRA—which still allows your investments to grow
tax-deferred.
When deciding on a type of IRA, it also helps to think about how your tax
situation might change following retirement. If you expect to be in a lower
income tax bracket when you retire, a traditional IRA may be more suitable. Why?
Because contributions may be tax-deductible now (depending on your income), and
you'll probably pay taxes at a lower rate when you make withdrawals.
Finally - you must plan your estate.
4- How To Plan Your Estate
Size Up Your Situation
Two key elements provide the basis of your estate planning: the nature of
the assets in your estate and the characteristics of your intended
beneficiaries.
Two key elements provide the basis of your estate planning: the
nature of the assets in your estate and the characteristics of your intended
beneficiaries. Some assets, such as a family business, require a major
commitment from the recipient; other assets, such as a portfolio of mutual
funds, don't. Some assets can be left by will or personal trust, while others,
including retirement accounts and insurance proceeds, are usually left to the
beneficiaries designated on the accounts or policies. (Making sure the right
beneficiaries are named is an essential part of estate planning.)
It’s also important to think about your beneficiaries. Are they people or
organizations? Are they minors or adults? Do you have children from a previous
marriage? Are your intended beneficiaries good at managing money or will they
need help? A number of factors will contribute to your decisions about who will
receive what assets and how they'll receive the assets. A charity might prefer
to receive your money, while your affluent son might prefer to get the family
beach house.
Let’s say you want to name your daughters as 2 of your beneficiaries. One is a
thrifty and successful investor, but the other has no interest in investing and
tends to overspend. You might leave the first daughter money free and clear. To
protect the second daughter, you might leave the money to a trust that would
provide professional financial management and control how the money can be
spent.
If you're married, your spouse needs to be involved in your estate planning from
the start. Some important strategies you’ll want to consider require
coordination between both spouses’ plans. You should also discuss your estate
planning with other family members if possible. Hard feelings can arise when
items that have sentimental value for one relative are unknowingly left to
another.
Start your estate planning by drawing up an inventory of all your property,
along with a realistic estimate of each asset’s value. Give careful
consideration to each of your potential beneficiaries and make note of any
characteristics that might affect how you'd want them to benefit from some
property or assets in your estate. Once you have completed your inventory,
familiarize yourself with the basics of estate planning so you can work
effectively with your estate planning professional.
Minimize Your Taxes
Because the federal estate, gift, and generation-skipping transfer taxes will be
imposed at rates as high as 50% in the coming years, you’ll want to plan based
on the size of your estate.
If you have more than $1 million, you need to consider estate tax planning. The
more assets you have, the more aggressive and complex your plan may become.Most
families don’t have enough assets to make the estate tax a concern. If your
estate (including your spouse’s property) will be under $1 million, you probably
don’t need to worry about estate tax planning—at least not yet.
If you have more than $1 million, you need to consider estate tax planning. The
more assets you have, the more aggressive and complex your plan may become.
Many strategies for reducing estate taxes are complicated and involve giving up
control of some assets during your lifetime or require the filing of additional
income tax returns each year. Some risks can be involved—an innovative estate
tax planning strategy could be challenged in court.
As you think about your estate plan and as you work with an estate planning
attorney, ask yourself these questions:
How important is it for me to control all of my assets
during my lifetime?
How much complexity can I deal with, and how much work am I willing to do to
save on taxes?
How much legal risk am I willing to take by using aggressive strategies in my
estate plan?
You and your adviser or attorney might very reasonably decide that your
answers to those questions will rule out certain estate tax planning strategies.
For some people, the amount of discomfort and hassle caused by these strategies
simply may not be worth the amount of tax they'd save.
Get to Know the Basic Tools
At its most basic level, estate planning starts with determining how the
ownership of your property will pass to your beneficiaries when you die. Some of
your property may be held in a personal trust, some may be owned by you, some by
your spouse, and some by both of you.
Many people rely on a last will and testament—written instructions—to dictate
how their property is to be distributed upon death. Despite its name, a “last
will” isn’t always the last word on how your property will be distributed.
In addition, property can be distributed according to the terms of a partnership
or shareholders’ agreement. State law also may dictate how some property is
distributed to ensure that a spouse and minor children receive a minimum
percentage of the estate.
Pick an Estate Planning Professional
The federal laws affecting estates changed considerably in 2001 and will
continue to change each year through 2011. So an estate plan you created under
the old laws could fail to accomplish your goals. That's why you and your family
need an expertly designed plan that’s flexible enough to fulfill your wishes now
and as the rules change.
Because of changes in the federal laws, many states are also changing their
laws, especially those involving estate and inheritance taxes. State laws vary
greatly. What may work in your state of residence may not work in another state
where you own property.
Worse, seemingly small errors in an estate planning document can make it
invalid—possibly shortchanging your beneficiaries. For these reasons, families
often use a team of experts to develop an estate plan, perhaps including a
financial planner or investment manager, a trust officer, an insurance agent,
and an accountant. Many professionals can help in designing an estate plan, but
eventually you’ll need a lawyer who practices estate law to draft the documents.
How can you find qualified estate planning professionals? Start by asking
trusted friends, financial and legal advisers, and colleagues to recommend
people. Then check their credentials: This is a specialized area, and you want a
bona fide specialist.
Interview candidates before hiring anyone, getting a detailed explanation of
what they can and can't do. They should be able to provide you with a reliable
estimate of the cost of their services based on your family’s situation and the
size and complexity of your estate. Importantly, make sure you and your family
are comfortable with the person you hire because estate planning can involve
some very private and personal issues.
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