Wednesday, June 10, 2009

Tools for Saving & Investing

Tools for Saving

The simplest way to begin earning money on your savings is to open a savings account at a financial institution. You can take advantage of compound interest, with no risk.

Financial institutions offer a variety of savings accounts, each of which pays a different interest rate. You can choose to use these typical accounts to save for the near future or for years down the road.

Types of Savings Accounts

Savings account (in general)

  • Access your money at any time
  • Earn interest
  • Move money easily from one account to another.
  • Have your savings insured by the FDIC or NCUA up to $250,000.

Money market savings account

  • Earn interest.
  • Pay no fees if you maintain a minimum balance.
  • May offer check-writing services.
  • Have your savings insured by the FDIC or NCUA up to $250,000

Certificate of deposit (CD)

  • Earn interest during the term (three months, six months, etc.).
  • Must leave the deposit in the account for the entire term to avoid an early-withdrawal penalty
  • Receive the principal and interest at the end of the term.
  • Have your savings insured by the FDIC or NCUA up to $250,000.

Tools for Investing

Investing is not a get-rich-quick scheme. Smart investors take a long-term view, putting money into investments regularly and keeping it invested for five, 10, 15, 20 or more years.

Stocks—Owning Part of a Company

Stocks. Shares of stock may be acquired on an organized exchange such as the Nasdaq or New York Stock Exchange, through a stock-broker, over the counter or by direct purchase in some cases. When you buy stock, you become a part owner of the company and are known as a stockholder, or shareholder. Stockholders can make money in two ways—receiving dividend payments and selling stock that has appreciated. A dividend is an income distribution by a corporation to its shareholders, usually made quarterly. Stock appreciation is an increase in the value of stock in the company, generally based on its ability to make money and pay a dividend. However, if the company doesn't perform as expected, the stock's value may go down.

There is no guarantee you will make money as a stockholder. In purchasing shares of stock, you take a risk on the company making a profit and paying a dividend or seeing the value of its stock go up. Before investing in a company, learn about its past financial performance, management, products and how the stock has been valued in the past. Learn what the experts say about the company and the relationship of its financial performance and stock price. Successful investors are well informed.

Stock options. Some companies offer employees stock options, which they can use to buy stock in the company at a fixed price. For example, your employer, Wally's Widgets, offers a stock-option plan, and its stock is valued at $30 a share. The stock-option price is set at $40 a share. As part of your compensation for meeting company goals and contributing to increased profits, you receive options to purchase 100 shares. Over time the value of the Wally's Widgets shares appreciates to $50 a share. You may now want to exercise your stock options and purchase the shares valued at $50 for $40.

Bonds—Lending Your Money

Bonds. When you buy bonds, you are lending money to a federal or state agency, municipality or other issuer, such as a corporation. A bond is like an IOU. The issuer promises to pay a stated rate of interest during the life of the bond and repay the entire face value when the bond comes due, or reaches maturity. The interest a bond pays is based primarily on the credit quality of the issuer and current interest rates. Firms like Moody's Investor Service and Standard & Poor's rate bonds. With corporate bonds, the company's bond rating is based on its financial picture. The rating for municipal bonds is based on the creditworthiness of the governmental or other public entity that issues it. Issuers with the greatest likelihood of paying back the money have the highest ratings, and their bonds will pay an investor a lower interest rate. Remember, the lower the risk, the lower the expected return.

A bond may be sold at face value (called par) or at a premium or discount. For example, when prevailing interest rates are lower than the bond's stated rate, the selling price of the bond rises above its face value. It is sold at a premium. Conversely, when prevailing interest rates are higher than the bond's stated rate, the selling price of the bond is discounted below face value. When bonds are purchased, they may be held to maturity or traded.

Treasury bonds, bills and notes. The bonds the U.S. Treasury issues are sold to pay for an array of government activities and are backed by the full faith and credit of the federal government. Treasury bonds are securities with terms of more than 10 years. Interest is paid semiannually. The U.S. government also issues securities known as Treasury bills and notes. Treasury bills are short-term securities with maturities of three months, six months or one year. They are sold at a discount from their face value, and the difference between the cost and what you are paid at maturity is the interest you earn. Treasury notes are interest-bearing securities with maturities ranging from two to 10 years. Interest payments are made every six months. Inflation-indexed securities offer investors a chance to buy a security that keeps pace with inflation. Interest is paid on the inflation-adjusted principal.

Bonds, bills and notes are sold in increments of $1,000.

Savings bonds. U.S. savings bonds are government-issued and government-backed. There are different types of savings bonds, each with slightly different features and advantages. Series I bonds are indexed for inflation. The earnings rate on this type of bond combines a fixed rate of return with the annualized rate of inflation. Savings bonds can be purchased in denominations ranging from $50 to $10,000.

Some government-issued bonds offer special tax advantages. There is no state or local income tax on the interest earned from Treasury and savings bonds. And in most cases, interest earned from municipal bonds is exempt from federal and state income tax. Typically, higher income investors buy these bonds for their tax benefits.

Mutual Funds—Investing in Many Companies

Mutual funds are established to invest many people's money in many firms. When you buy mutual fund shares, you become a shareholder of a fund that has invested in many other companies. By diversifying, a mutual fund spreads risk across numerous companies rather than relying on just one to perform well. Mutual funds have varying degrees of risk. They also have costs associated with owning them, such as management fees, that will vary depending on the type of investments the fund makes.

Before investing in a mutual fund, learn about its past performance, the companies it invests in, how it is managed and the fees investors are charged. Learn what the experts say about the fund and its competitors.

Remember, when investing in stocks, bonds and mutual funds:

  • Find good information to help you make informed decisions.
  • Make sure you know and understand all the costs associated with buying, selling and managing your investments.
  • Beware of investments that seem too good to be true; they probably are

How Much Extra Savings Is a Tax-Deferred Investment Worth?

If you pay taxes, which most of us do, a tax-deferred investment will be worth the amount you invest multiplied by the tax rate you pay. For example, if your federal tax rate is 15 percent and you invest $3,000 in an IRA, you'll save $450 in taxes. So in effect, you will have spent only $2,550 for a $3,000 investment on which you will earn money. A good wealth-creation plan maximizes tax-deferred investments.

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