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.
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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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