Practical investing

Concepts: Impractical investing is the riskiest, often expensive, way of saving money for future use. Practical investing is the safest way to save money. The most practical investments are savings accounts, bonds, and brokerage accounts.

Practical investing is the long, slow process of saving money for future use. Not by stashing it at home, but by giving it to a trustworthy person outside of home who will protect it, and better yet, put it to work earning extra money on your behalf. ‘Protected money’ helps defend against future emergencies. ‘Extra money’ helps pay for expensive things, caring for family members, and retiring from work. The most practical investments are savings accounts, bonds, and brokerage accounts.

Savings accounts are available in banks and credit unions. Shop around to find the best deal for you and when you apply for an account, be sure it is FDIC insured (FDIC stands for the Federal Deposit Insurance Corporation). The FDIC insures against accidental or criminal loss of all the money held in your account up to the limit of $250,000 per account holder, per bank.

ADVANTAGE- Money is easily deposited and withdrawn.
DISADVANTAGE- The interest rate is very low, usually below our national rate of inflation.
RECOMMENDATION- Use your savings account as an emergency fund to pay for catastrophes such as job loss, medical bills, and other overwhelming events. Try to save 3-9 months of wages in your emergency fund for the rest of your life.

Bonds and CDs (CDs are certificates of deposit) usually pay more interest (interest is ‘extra money’) than savings accounts. Bonds sold by the U.S. Government are guaranteed to be fully repaid with interest after a specific period of time. Bonds sold by companies are fully repaid with interest unless the company is unable to make the payment. CDs are sold by banks and credit unions, and insured by the FDIC.

ADVANTAGE- The seller promises to repay you the full amount of the bond plus interest.
DISADVANTAGES- The full amount plus interest is not repaid until the maturity date. “Investment grade” bonds are usually repaid, but “junk bonds” may not be repaid.
RECOMMENDATION- Purchase bonds and CDs with maturity dates at or below 5 years in order to save for startup projects such as buying a car, new business, or new house.

Brokerage accounts sell securities such as stocks and stock-index funds. The accounts are “SIPC insured” if the broker is a member of the SIPC (SIPC stands for the Securities Investor Protection Corporation). The SIPC insures against financial failure of the broker and unusual loss of securities by the broker. The SIPC insurance limit is $500,000 per customer, including no more than $250,000 cash, for all of the customer’s accounts combined. SIPC insurance does not protect against investment losses.

‘Extra money’ from stocks and stock-index funds might exceed the interest rates of bonds and CDs, and also exceed the rate of inflation. But stocks and stock-index funds are riskier investments than bonds and CDs because you could lose money in the stock market.

Three good ways of earning money in the stock market are 1) buying shares of a reputable stock-index fund, 2) holding the shares for a long time, and 3) reinvesting stock dividends. All three ways are illustrated in the following graph:

dividend reinvestment

The graph shows 33 years of growth-in-value of a stock-index fund that was invested in a group of stocks measured by the Standard & Poors 500 Index (the “S&P 500″). The stock-index fund earned ‘extra income’ in 2 ways: 1) from stock dividends and 2) from growth-in-value of the fund. When all dividends were reinvested by buying additional shares of the fund (blue line), the final fund value of $6,000 was twice what it would be, $3,000, when the original number of shares were held without reinvestments (red line) for the entire time. The blue line represents compounded growth.

Impractical investing is a very risky, often expensive way to save money. The very risky investments include junk bonds, initial public offerings, partnerships, leveraged funds, commodities, currencies, collectibles, options, derivatives, hedge funds, and property ownership. The possible expenses are high commissions, high tax rates, tax accountant fees, illiquidity (tied-up money), and costly mistakes.

Useful references

FDIC. https://www.fdic.gov

SIPC. https://www.sipc.org

Introduction to Treasury Securities. https://www.investopedia.com/articles/investing/073113/introduction-treasury-securities.asp

TreasuryDirect®. https://www.treasurydirect.gov/

The Index Card. Why Personal Finance Doesn’t Have to be Complicated. {http://wp.me/p1LlDo-KQ} Helaine Olen, Harold Pollack. Penguin Publishing, New York, 2013.

roadmap to investing. https://www.sec.gov/reportspubs/investor-publications/investorpubsroadmaphtm.html

Questions from a friend

Questions: I was wondering if you have some favorite web sites to get information about investing for a thirty something person. And also for a teenager that has a part time or full time job. In both cases, to save for retirement or even to save up for a down payment on a condo or house.

Thanks for your questions. My advice to teens and young adults is to start an emergency fund before investing in securities. They should gradually build a large emergency fund of dollars in the bank to use for job-loss and other big financial emergencies (see book called the Index Card in the Young Adults section of the link below).

Teens who declare earned income to the IRS can deposit an equal amount of earnings in a custodial Roth account (see video on Hannah’s Roth account in the teens section of the link below). It’s important for teens to learn how to open and manage an investment account such as the Roth. In the Roth, I recommend holding a broad index stock fund for life; it will weather the ups and downs of the stock market over time (several good internet sites for teens in the link below).

Thirty something persons need a tax-advantaged retirement account. Employed persons should participate in their employers 401(K) plan [or similar plan] to the fullest extent above all other financial goals, with exception of building an emergency fund and getting out of debt as very top priorities; the condo and house are lower priorities. Unemployed persons should check eligibility for SEPs, other retirement accounts, or IDAs (start with the “money basics” and sec .gov websites in the Young Adults section link)

Link:

Reading list for young people and their families, https://wp.me/p9F6Bd-7v

Saving for Unemployment

An emergency fund is used to pay 3-9 months of living expenses during unemployment. Keep it for retirement.

Protect Yourself

Unemployment means that you aren’t paid for doing work. People who either lose their job or retire from work are unemployed. Could you pay for living expenses during unemployment? If not, you should start building an Emergency Fund. There are two important savings plans during life: the Emergency Fund and Retirement Account (ref. 1).

Emergency Fund

The emergency fund is used to pay living expenses during temporary unemployment and other unusual expenses such as big bills. Workers should save 3-9 months worth of earned income in a secure savings account (ref. 2). That’s a difficult task when also planning to buy expensive items such as cars and houses, or paying-off college loans. Get a headstart in childhood by slowly saving cash in a custodial bank account.

Retirement Account

The retirement account is needed to pay living expenses during permanent unemployment in old age. Contribute to your own retirement accounts as soon and often as possible (ref. 3). Begin by opening a Roth IRA during childhood when you start reporting earned income to the Internal Revenue Service (ref. 4). Employer-sponsored and Self-employed retirement plans should be opened at the first opportunity (ref. 5).

About forty to fifty years of regular investing are needed to build adequate savings for retirement (ref. 3). Plan on investing in quality securities such as stock index funds and government bonds (ref 1,6). Begin with stock index funds early in life and add the bonds late in life, finishing with a 90% investment in stock funds and 10% investment in bonds (ref. 7).

Retirement accounts have special rules for investing money (contributions) and removing money (withdrawals).

Withdrawals before age 59½ years are generally not permitted without paying a fine and taxes [check the rules for exceptions in ref. 5]. There are no fines after age 59½ years.
Roth IRA. You must pay taxes on all contributions and the contribution limits are $5,500 per year [check ref. 5 for changes]. Withdrawals after age 59½ are not taxed and there are no mandatory withdrawals.
Other IRAs and retirement plans. The contribution limits vary from $5,500 to $19,000 depending on the account [check ref. 5 for changes]. You don’t pay taxes on any contribution, but withdrawals are always taxed. The government requires partial withdrawals each year after age 70½ years.

References

1. The Index Card. Why Personal Finance Doesn’t Have to be Complicated. Helaine Olen, Harold Pollack. Penguin Publishing, New York, 2013.

2. Emergency Fund Calculator, MoneyUnder30 . com: https://www.moneyunder30.com/emergency-fund-calculator.

3. Retirement Income Calculator: https://retirementplans.vanguard.com/VGApp/pe/pubeducation/calculators/RetirementIncomeCalc.jsf

4. Video on compound interest in a Roth IRA: https://youtu.be/6dzpNd3megg

5. Retirement plans: https://www.irs.gov/retirement-plans

6. Saving and Investing for Students, SEC resources for youth: https://www.investor.gov/search/node/students

7. Warren E. Buffett, Chairman of the Board. Letter to the shareholders of Berkshire Hathaway, Inc., 2013. Page 20, 2/28/2014.

Advice for young adults on getting started with investing

An excellent article in today’s newspaper (ref. 1) presented clear advice on how to become wealthy without paying hefty fees:

Begin by finding good, free financial advice in the internet. Search for tools and advice on creating a budget, finding affordable housing, building a financial plan, and saving for retirement.
Build the foundations of a budget, rainy-day savings, and retirement savings.
Invest money you won’t need for 5 years.
Begin investing as early as possible and compound your interest.

Numerous writers and seasoned investors offer the same advice. Find more useful information in references 2-6.

References

Ny Anna-Louise-Jackson. Make your money grow before hiring an advisor. The Columbus Dispatch, November 4, 2018, page H7.
Helaine Olen and Harold Pollack. The Index Card. Why Personal Finance Doesn’t Have to Be Complicated. Penguin Random House, New York, 2016.
Do-it-yourself investing- Introduction. Small Trades Journal, 2013.
Warren Buffett’s advice to nonprofessional investors. Small Trades Journal, 2014.
My Money Five. MyMoney.gov.
Overview. RaisingInvestors.blog, 2018.

Story: Saturday morning with the grandchildren

I recently shared stories about grandchildren with one of the partners in our investment club. Her 6 years old grandson and 4 years old granddaughter visit her every Saturday morning. Soon after arrival, the 4 year-old runs to the penny jar and puts a few coins in the piggy bank, counting their value during the process. It’s a play activity without feelings of ownership by the child. The 6 year-old performs chores for which he receives a salary of $2. He originally wanted $5, but agreed to $2 after negotiations with grandmother. In the near-future she will take them to the Dollar Store and let both of them spend a $1 anything they want. They will make the purchase and live with their decision. She wants them to learn shopping skills and the value of money. Later on, their father will open a savings account for them at the local bank. It’s the making of a family tradition.