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Make The Move From Saving To Investing
By John M. Gannon
Summer 2006
Life in the military means a life of change, including changes in duty stations and deployments around the world. This life of moves can be a positive experience for you and your family. Of course, such a life also can prove stressful - and expensive. The difference between a positive move and a painful one often depends on your family's level of readiness - especially financial readiness.
Numerous elements can help you achieve a high degree of financial preparedness. For starters, you should build a moving fund - a savings nest egg to use when you relocate. As you save for deployment or other goals, you also will want to manage additional aspects of your financial household, such as reigning in credit card debt and avoiding costly loans.
Once you have established a routine of saving, you can begin to make another big move - to investing.
Unlike savings in a bank or credit union account, which carry no risk to your principal, investing always carries risk. You can lose some or all of your initial investment. But investing enables you to pay for longer-term goals such as the down payment on a home or a child's college education. Investing can grow your money more than traditional saving options, but it is riskier.
The "big three" investment choices are stocks, bonds and mutual funds. These choices usually are best for people just starting to invest.
Stocks
When you buy a stock, you are buying a small piece - a "share" - of the company that issued the stock. You become a part owner of the company, along with all other individuals and institutions that have bought stock. As a part owner, you have equity in the company, which is why stocks sometimes are called equities. You can invest in any of thousands of individual stocks from the United States and around the world, and they may be broadly classified as growth, income or value stocks.
Growth stocks are companies whose earnings or revenues are growing faster than other companies. As company earnings and revenues increase, the price of the stock and the value of your investment usually increase. But if growth stops or the market stalls, stock prices can drop substantially - and so does the value of your investment.
Income stocks are companies that pay high dividends to investors. Your money can grow through dividend income or stock price increases. But watch out for stocks that pay extra high dividends because this may be a sign of problems in the company. And, of course, the stock price can go down as well as up.
Value stocks are companies whose stock is selling at a low price or is considered undervalued compared to competitors. The low price of these stocks usually is because of some perceived bad news, such as a poor earnings announcement, legal problems or that the industry is out of favor with investors. Value stock buyers, however, believe these companies are sound and that the stock price will recover. If these companies report better-than-expected performance, their stock prices can increase substantially. But if performance does not improve, the stock price could stay the same or decline.
Stock Tip: You can buy stocks with little or no commissions or fees. Many military families believe they can't start investing in stocks because they don't have enough money. However, you can invest in stocks inexpensively through direct stock purchase plans (DSPs) and dividend reinvestment plans (DRIPs) offered by hundreds of companies. Talk with an investment professional about companies that offer DSPs and DRIPs.
Bonds
When you buy a bond, you lend your money for a specific length of time to the government agency or company that issues the bond. In return, the agency or company promises to pay you interest on your money during that time period until the bond matures. You may hear bonds called fixed-income investments, because they pay a fixed rate of interest over the life of the bond. The amount you loaned the bond issuer is returned to you at the date of maturity.
Many different types of bonds are available, including U.S. Savings Bonds, Treasury bonds, municipal bonds and corporate bonds. For more information about bonds, see the Winter 2005-06 issue of Military Money ("Basics Of Bonds," pages 12-13) or go online to read NASD's Bond Learning Center (go to www.nasd.com and click on the Investor Information tab).
Bond Tip: It is best to hold bonds until they mature. That's because the value of bonds is affected by interest rates. If interest rates are higher when you want to sell a bond than when you bought it, you likely will have to sell your bond for less than you paid for it. If interest rates are lower, however, you may be able to sell your bond for more than its face value.
Mutual Funds
When you buy a mutual fund, you pool your money with other people's money and become part owner of a portfolio of stocks, bonds or other assets held by the fund. Minimum initial purchases usually are about $2,000, and minimum additional investments generally are about $250. Some funds will waive the initial deposit and allow you to invest as little as $50 a month.
Mutual funds can own hundreds or thousands of different assets, providing an easy and inexpensive way to diversify investments so you don't have "all your eggs in one basket." Many funds also give you the benefit of professional management of your investment. The downside of mutual funds is that share prices change daily and you can lose money.
Load funds charge a sales commission; no-load funds do not. When you pay an up-front sales commission, it is called a front-end load. A commission paid when you sell is known as a back-end load. In a load fund, an investment professional usually is available to explain the fund and advise you when to buy or sell shares. With most no-load funds, you are fully responsible for understanding your investment.
Thousands of mutual funds are available, but here are some broad categories to consider as an investor.
Equity (stock) funds invest primarily in individual stocks. These funds seek to increase the value of your investment. They are considered riskier than other types of funds.
Fixed-income (bond) funds invest primarily in individual bonds. These funds seek to protect your investment and generate income. They are considered a more conservative choice than stock funds. Bond fund prices go down when interest rates go up. Earnings are treated as ordinary income on your income taxes.
Balanced funds invest in both stocks and bonds. For example, one fund may have 60 percent of assets invested in stocks and 40 percent in bonds. These funds seek to provide the capital appreciation (growth) potential of stocks and the income generation of bonds.
Index funds invest in assets that match those held in a common market index, or benchmark, such as the Standard & Poor's 500. These funds seek to match the performance of the index.
Life-cycle funds invest in pre-mixed percentages of stocks, bonds and other assets so investors can match a fund to their age and risk tolerance. For example, a fund for younger, more aggressive investors may invest 80 percent in stocks and 20 percent in bonds. A more conservative fund might invest in 50 percent stocks, 50 percent bonds. They seek to save investors time and effort in selecting funds.
Mutual Fund Tip: Generally, the higher the risk, the higher the potential return. However, an investment that is "too aggressive" means you could lose some or all of your money. "Too safe" means you may not accumulate enough money for your goals. Talk with an investment professional about levels of risk and how they relate to your financial situation and goals. Once you know how comfortable you are with varying levels of risk, check out investment strategies that can help you balance risk with the rewards of higher earnings.
With this basic introduction to the most common types of investments - and the understanding that all investments carry some degree of risk - you should be better prepared to make a successful move from saving to investing.
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John Gannon leads investor education initiatives for NASD, the world's leading private-sector provider of financial regulatory services. Please visit www.saveandinvest.org, a comprehensive website recently launched by the NASD Investor Education Foundation to help servicemembers manage their money with confidence. This article was adapted from the recently expanded publication, "Money and Mobility," a joint project of the Foundation, the National Endowment for Financial Education and the National Military Family Association.
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