The Balanced Spreadsheet-Financial News, Budget Advice, Debt help, Financial Tips, and other advice

January 28, 2010

The Financial How to series Part IV. How to start investing for retirement

Part I-How to start a budget

Part II-How to get out of debt

Part III-How to start and maintain an emergency fund

Today we are going to wrap up our “Financial how to . . . . .” series on the topic of how to start investing for retirement.  For some this can be a scary topic as it brings up many questions such as “How much do I need to save now for retirement”, “How much will I need to retire”, and “What types of investments do I put my money into.”  These are all good questions that need to be answered before you start to invest.  With that being said I am going to focus on how to get started and not give any advice on certain funds or stocks as I am far from an expert. 

What is investing?

There are three kinds of investment lengths, although as I will discuss later I think only one is truly investing.  There is short-term investing which is less than one year, intermediate investing which is between 1-5 years, while long-term investing is greater than 5 years.  I consider long-term investing the only true investing as the stock market has usually made money over any 5 year period compared to only about 60% of the time over a 3 year period which is more like speculating and as we saw as recently as 2008, investing for only 12 months is essentially gambling. 

Types of Investing

For me there are two kinds of investing, retirement and non-retirement.  Non-retirement includes investments such as a child’s college fund, saving for a down payment on a house, or investing in real estate.  Retirement investing includes vehicles such as 401(K) and IRA’s.  They have special tax advantages to them, but there is a catch as they have penalties for early withdraws, therefore the decision needs to be made ahead of time that any retirement investing is truly for retirement only.  Most of the time when people talk about investing, they are referring to retirement investing which is the main focus of this post.

Common investments

When investing in retirement accounts, there are three common investments: stocks, bonds, and cash.

Stocks are the most common investment as well as the most discussed.  That is because they have the most day-to-day volatility.  Stocks have traditionally offered the greatest reward but also the most risk.  Stocks have been way down after their highs in late 2007.  But in 2009 they have started to make a recovery.  The key to stocks is to diversify by selecting mutual funds that contain many stocks in one fund. 

Bonds have done well recently with the drop in interest rates.  They have less day-to-day change in price than stocks; however they have historically underperformed the return of stocks.

Cash is invested in things such as savings, money market, and certificates of deposit (CD).  They are “safe” investments, as you do not risk losing any principle with the return being a fixed rate.  Investing in cash to me though is an oxymoron because you are parking your money as you might be gaining 4-5% every year but you will lose most of your gain due to 4% inflation so you gain nothing. 

Commodities include things like oil, natural gas, corn, wheat, and precious metals. Commodities are historically very volatile with huge upswings and downswings. 

Things to look for when investing

Whatever you decide to invest in I would recommend you look into the following three things before investing

Diversification You need a balance portfolio and not have all your eggs in one basket no matter how great of a return you are getting.  Diversification protects against losing all of your savings on just one bad investment.  For that reason when I invest in stocks I do not investing in single stocks but rather mutual funds which are made up of various stocks.

Invest in things with long track records You do not want to start investing in something that has only been around for years.  By seeking out funds with at least a 10-15 year track record you can see how returns have been over both good and bad periods and see if they have been able to weather the storm.

Know where you money is going! Invest in things you are comfortable with.  Never put money into something you do not understand as you do not want to be pressured into something that you do not agree with.  Investing in X because “my co-worker said it was a good idea” or because “My brother-in law invests in it” does not mean it is a good idea.

As mentioned in the opening, investing can be trick and overwhelming for a lot of us.  What you need to do though is to take some time and learn about investing.  Finally, building wealth takes time; it is not an overnight process.  But you need to start soon and invest in good solid investments and not some get rich quick scheme.  The key to building a big nest egg is investing now instead of later.  You might be in your 20’s or 30’s and think you have plenty of time which you do, so use your time as an asset and not a liability.  Also if you are in the later years of your life, do not worry, you can still start today.  It is never too late.

That is the conclusion to The Balanced Spreadsheet’s January 2010 “Financial how to . . . . . .” series.  I hope you enjoyed it and we will be back soon with another series in February.

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