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Money Basics: Investing

This article was written by in Financial Literacy, Investing. 6 comments.


April is National Financial Literacy Month in the United States. This brings attention to the lack of a financial education young people receive in this country, both from their parents and from the education system. I disagree with most people about how to solve this issue. Many call for mandatory high school courses in personal finances, but there are many reasons why this has not been and will not be generally successful.

In the spirit of National Financial Literacy Month, I occasionally take some time to focus on some of the financial basics. This is information I would have liked to have had or to have thought about earlier in my life. It’s not necessarily the information that’s important, but having a role model — someone to emulate — who is proficient with money, to guide a young individual on a path towards financial independence. I’ve covered the basics of savings accounts, checking accounts, budgets, and interest previously, and today’s I’ll attempt to tackle the topic of investing.

Money investingInvesting is a massive topic. It can get quite complicated when you look at the types of investments available, each having their own quirks, rules, and purpose. Investing means different things to different people: you can invest in stocks, invest in an industry, invest in a business, and invest in your future. You can invest your money, your effort, or your time. All of these concepts can be radically different.

There is a general theme to all investing, however. While the purpose of saving is to have a foundation or short-term financial safety, investing is the choice people make when they want to build long-term financial stability or independence. When you create a plan for investing — and it’s better to start with a plan in mind even if you don’t really know what you want to do in the future — you think about the future. The expectation when you invest is that your wealth will grow. Compare this to savings, where your expectation is that your wealth is safe.

What do people invest in?

The most common investments are stocks. Stocks are shares of a business. When business owners want to raise money to help their businesses grow, they sell to investors pieces of ownership in that business. Most of the time the pieces are very small. For example, if you invest in one share of a company like Google, you’ll become an owner of the business — but you’ll own only about 0.0000003 percent of the company. And almost always, when you buy stocks, you don’t buy them from the company. Once a company decides to sell shares, the stocks are traded on exchanges like the New York Stock Exchange. When you buy stocks, you’re buying them from another investor who happens to be selling.

Overall, stocks perform well over long periods of time. If you buy a varied collection of stocks and hold them for several decades, your investments have a great chance of increasing in value. The best way to buy stocks, especially for someone new to investing, is to invest in a pre-determined package of stocks designed to match your investing goals and needs. That’s where mutual funds come in. Mutual funds are packages of stocks (or other investments) managed by a professional investor, and these packages often have a goal or style that the manager follows.

With any investment, stocks, mutual funds, or otherwise, there is a chance that you will lose money. This is the risk that’s associated with investing. While there’s a chance of your investment increasing in value over time, increasing your wealth, the opposite might happen. You could buy shares of a company that fails one month later, losing all your money. Investing in shares, therefore, requires lots of research to protect yourself from bad investments, but even lots of research can’t help you accurately predict whether your investment will be successful. That’s why mutual funds are more attractive investments. With mutual funds, you can use the same money to spread out among many investments, so if one company fails, it doesn’t affect your investment as much.

Bonds

Besides stocks and mutual funds consisting of stocks, the next most popular investments are bonds. Companies and governments issue bonds to raise money. Sometimes a government is looking to raise money for a specific project, like building a bridge, and will seek investors, promising to pay the investors back their contribution plus interest. Like stocks, bonds are designed to raise money, but for the investor bonds are safer, meaning they’re less likely to lose value than stocks.

In exchange for that safety, the possibility of growing your wealth with bonds is less than the possibility for doing the same with stocks or mutual funds consisting of stocks. Bonds have a maturity, though. You can buy and sell most stocks whenever you’d like, but when you buy bonds, you are committing to a relationship. When you buy a five-year bond, you will receive some income from the investment over the course of five years, but you won’t get all of your money back until the five year term is complete.

Mutual funds come in handy once again; if you like the relative safety of bonds, you can buy a mutual fund consisting of bonds. These can, with some exceptions, be purchased and sold at any time. Investing is a long-term activity, though, and investors shouldn’t be too concerned about frequent buying and selling.

The best type of mutual funds

I mentioned above that mutual funds are managed by a professional investor. This is an individual who makes decisions for you about which stocks or bonds to buy and sell. All of these professional investors cannot consistently pick the best investments, however. Index mutual funds are designed to take some of the human errors out of investing.

When the financial media talk about the Dow being up or the S&P being down, they’re talking about an index. Indexes (or indices if you prefer) track the overall progress of a representative sample of investments. Most investors can’t pick investments that outperform the indexes, so you’re better off just copying the indexes. You can do that easily by investing in an index mutual fund.

An additional benefit of index mutual funds is the low fee. Whenever you invest — whether you buy or sell — you pay fees. People invest with the intent of growing their wealth, and the best investors do that by reducing these fees. The worst investors buy and sell frequently and, for the most part, make the professionals who collect the fees rich rather than building wealth for themselves over the long-term. If you choose wisely, index mutual funds are often the best investments for reaching your long-term goals while saving money. It’s a great value.

Other investments

ETFs have increased in popularity in recent years. ETFs are exchange-traded funds. The financial industry loves these investments because they have the appeal of mutual funds with the added benefit of being able to be bought and sold during the day, unlike mutual funds which trade only at the end of the day. Of course the industry loves ETFs; they encourage investors to trade investments frequently, thus increasing fees from trading. There’s no need for long-term investors to invest in ETFs. You can avoid these rather than playing into they hype.

The menu of investments is lengthy, particularly once you start looking at derivatives, stock options, and other complicated investments not particularly relevant to a beginning investor. Stick with stocks (broadly invested), bonds, and mutual funds unless you have a large sum of money you don’t mind losing. Most people don’t.

Retirement-specific investing

The government offers tax benefits for people who invest for the future. Many people working in a career look forward to the day they can leave their jobs behind and relax with the remaining decades of their lives. The government help subsidize people who no longer work, so you can be sure those in political power are interested in encouraging people to fed for themselves.

The 401(k) investment, named for the section of the tax code that contains its definition, is one of the most popular ways to invest for your retirement and receive a tax benefit for doing so. You may be automatically enrolled in a 401(k) when you start a new job, or you may need to sign up for yourself. You can reserve a portion of each paycheck for your retirement. All that you reserve must be left invested in order to receive the tax benefit (and avoid a penalty) except in certain circumstances. As a result, you’re putting some money away, untouchable, for many years.

An IRA (Individual Retirement Account or Agreement) is similar to the 401(k) in that respect, but you can also sign up for an IRA as an individual rather than as an employee of a business by contacting a broker directly.

Neither an IRA nor a 401(k) are investment types. They are not like stocks, bonds, or mutual funds. Instead, they are packages that can contain a varied array of investments. Most 401(k) plans contains mutual funds, but you can invest in almost anything within your IRA.

Points to keep in mind

  • When you invest, keep in mind that the idea is not to guess which investments will make you rich in a short period of time. Investing is a long-term endeavor, and you need diversity and patience in order to succeed.
  • Risk and reward are correlated. The riskier investment types like stocks can grow your wealth more, but they can also devastate your finances. Finding the right balance is a personal decision.
  • Studies have shown that the best predictions of long-term performance are the fees. Always research the fees involved with any investment type or activity so you understand completely where your money is going and how much you get to keep.

Photo: Images_of_Money

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More Fees for Bank of America Customers

This article was written by in Banking. 9 comments.

Just when you thought it was safe, Bank of America and other large, national banks, are still finding ways to charge customers new fees. Only a few months ago, word of a new $5 monthly fee for debit card users sent Bank of America customers into a frenzy, threatening to move money away from the financial giant. Bank Transfer Day was largely a success, despite the complicated process of switching banks in today’s automated banking environment.

Hundreds of thousands of customers enrolled in credit unions, smaller organizations that are generally more consumer- and community-friendly than national institutions. Fees like Bank of America’s $5 debit card fee hit mainstream news outlets, bringing personal finance into the consciousness of the public once again. Bank of America eventually dropped its proposal for the new fee, but the bank didn’t stop looking for more methods of extracting funds out of its customers.

Bank of AmericaFor the last generation, customers have grown accustomed to free or mostly-free checking and savings. These are considered deposit accounts. Depositing your money with a bank is more beneficial for the bank than for the customer. Doing business with a bank does the company a favor. The institutions should be paying customers for the banks’ benefit of holding the customers’ money. Sometimes banks do pay consumers, through interest on savings accounts, which as most people know have been at pathetic rates for the last few years.

With money on deposit, banks can go out and offer loans to businesses and individuals, earning money on the interest charged on those loans. That’s where banks should make money from their customers. Savings and checking customers are doing banks a favor.

Lately, the problem has been that banks aren’t making as much money from lending as they had previously, and shareholders demand consistently growing profits. That pressure results in even more fees. And banks are now counting on the fact that last year’s outrage has subsided, and the public is now willing to live with the idea that basic banking is not free. Additionally, it’s fair to say that the cost for a bank to manage checking and savings accounts may have increased, due to research and development into technology to provide all the banking conveniences (online access, mobile apps, person-to-person payments, etc.) that consumers have come to expect, although one could argue the lowered reliance on tellers and live customer services representatives should offset that cost.

Furthermore, the latest round of fees are designed to hurt lower income households more than those with higher net worth amounts. It’s been true in investing for a while that the better rates and lower fees are available to those with higher balances. This is due to the attempt to convince customers to invest as much money as possible with any one particular institution or brokerage. The same is true with fees; the more money you have, the more leverage you have to demand lower costs for the services you buy.

This leaves low-income families in a tough spot. If you can’t maintain a minimum balance in your checking account, a monthly fee will reduce that low balance even further, possibly even below zero, so you end up owing money to the bank or the bank decides to close your account. While the balance minimums encourage customers to leave more of their money with one institution, not all customers have more money to deposit.

Here are a few recent examples of how the latest round of new fees from big banks penalize those without the means to deposit more.

  • Some Wells Fargo customers have been subject to a new $15 monthly fee if unable to maintain a $7,500 balance. And they’ve recently changed policies to prevent customers from suing the bank or being part of a class-action lawsuit.
  • Citibank increased its minimum balance to avoid a $20 monthly fee from $6,000 to $15,000.
  • Bank of America is testing new monthly fees of $6 to $25 in three states (Arizona, Georgia and Massachusetts).

At the same time, an informal poll of fans of Consumerism Commentary on Facebook and followers on Twitter indicates most engaged Consumerism Commentary readers, who generally earn more than the average internet user according to basic demographic research, pay nothing for their checking account, though some are still subject to a minimum balance or enrolling in direct deposit to avoid a fee. Finding free checking is still possible, especially with credit unions, but non-students still need to occasionally jump through hoops with major banks.

New regulations are often cited by the financial industry as the trigger for punishing low-income customers for handing their money to banks for safekeeping and lending. Others see these new fees as a way for banks to increase profits while using regulation as a convenient scapegoat. Of course, opinions on the matter are generally divided along political party lines as well as between industry lobbyists and consumer advocacy groups.

Low-income families might continue to avoid the banking industry, which may be the unstated goal of financial institutions in the first place. Unfortunately, that leaves little choice for low socio-economic status communities other than turning to non-bank financial products, like expensive payday loans and check cashing services. Not only do these communities need better financial role models (education alone will never solve the financial literacy problem), but they need to be guided toward better products and services.

There’s a real market opportunity for better products and services, for smart entrepreneurs who are looking to make a difference. In the mean time, here’s how to close your Bank of America savings or checking account when walking into the branch won’t work for you.

Photo: MoneyBlogNewz
KVAL / AP

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Improve Your Finances By Modifying Your Behavior

This article was written by in Featured, Personal Finance. 10 comments.

Improving your financial situation requires more than just trying harder. People who write financial websites offering advice often think or imply that the reason for financial misfortune is ignorance of the basics. Recently, there was one website that claimed that the only thing people need to know was spend less than you earn, as if taking this to heart is the single solution to getting your finances on the right track.

There is no switch that you can just turn on, for the most part. In some cases, particularly where someone experiences a major emotional setback — “hits rock bottom” — changing your direction in place works, but that could mean losing a house or destroying a family relationship. A devastating situation isn’t guaranteed for everyone and you may not want to wait until you reach such a low point.

MoneyIf you’ve been living in debt for the entirety of your adult life, you may have an epiphany of some sort and turn yourself around with just the knowledge that your net worth needs to increase at the end of each month in order to become financially independent, but for most people, changing behavior takes much more than desire.

There are certain things you can do to help yourself — and your brain — accept that you need to start improving your financial situations for the sake of your future self and family.

Replace old habits with new habits

Much behavior can be reduced to patterns and habits. Breaking a habit, like emotional spending, can be incredibly difficult because of the comfort that has developed through years of participating in the activity. Shoppers who derive pleasure from spending money may be in uncontrollable debt, and use shopping in difficult times to feel better. Of course, with more shopping and spending more money than is available, this person could experience emotionally difficult situations due to the lack of finances, yet still seek to cure those negative feelings by shopping.

Replace the reaction of shopping with something that makes you feel better without damaging your personal finances. Exercising releases chemicals in the brain that, for many people, enable happy feelings, so one of the best options for replacing a bad financial habit is exercise. Whenever you feel the urge to do something that you know is harmful to your finances, choose to run around the block or work out in a gym.

It might be difficult to make this change at first, but the goal is to make a new habit that can be triggered in place of your old habit. For some time, you may want to overlap both reactions, but after several weeks of consciously using your new habit, you should be able to successfully replace the old.

Resist temptation by making it difficult or inconvenient

Some financial advisers and gurus suggest freezing your credit card in ice or keeping your emergency fund at a bank that’s difficult to access. The more barriers you can place between yourself and your bad financial behaviors (in this case, using your credit card or dipping into your emergency fund), the more success you’ll have in avoiding these temptations.

Combining barriers with habits can be successful, too. Rather than purchasing items from Amazon on impulse, create a habit of waiting 24 hours between your desire and your action. This barrier of time gives you the opportunity to re-evaluate your decision. Twenty-four hours later, you may be in a different mood and decide that you don’t need the item you intended to purchase as bad as you thought you did.

Remove barriers to good financial behavior

While you’re adding barriers to prevent bad financial behavior, you may want to think about whether you already have barriers preventing you from making good financial decisions. Although the stock market has been on a rally lately, medium-term performance has not been great, and the investing industry has attracted a bad reputation through and following the recession and credit crunch. The fear of losing money may be preventing young people from investing in the stock market.

Many investment advisers say that you should evaluate your risk and only invest in a way that makes you comfortable with your possible losses, but an investor’s level of risk aversion could be tied to his or her feelings about the stock market. Risk profile measured this way would then fluctuate. One possible outcome from feeling good about the stock market and willing to take on risk during times of confidence about Wall Street while feeling nervous when the media is taking the financial industry to task is the unprofitable accidental strategy of buying high and selling low.

If you’re young and would like to save for retirement, with a goal of leaving your work behind one day with enough money to pay your expenses, you can’t ignore the stock market. A diversified portfolio may not make you rich over time, but there’s a good chance you’ll be able to retire.

Change your words

The words you choose to describe your financial behaviors will have an effect on your approach to your money. For example, take “investment” and “expense.” I mentioned this phenomenon in my editor’s note after Jennifer Calonia’s article about wedding planning and spending.

One way people often justify or rationalize expenses is by calling them “investments.” For example, one might say, “Spending a large amount of money for a wedding is an investment in your relationship.” Someone else might say, “Going to a private university is an investment in your future.” You should only invest in something when you receive an asset in return, and you are planning for the value of that asset to increase over time.

You may be able to argue that the asset you receive in return for a wedding is a partner who stays with you for the rest of your life. You may receive an emotional asset in return. But in order to be truthful with yourself, consider whether you’re using the term “investment” to justify paying more for a ceremony than you need to. As I’ve written previously, spending money for once-in-a-lifetime event is not a bad way to spend money if you can afford it, but calling it an investment is just a way for you to feel better about your resulting lack of money.

In return for your expense for your college-level education, you may receive assets: your ability to earn an increased income over time when compared with someone with just a high school diploma, possibly, cognitive skills that help you succeed in the world regardless of your job, career, or income, and, possibly, connections that you retain for the rest of your life, helping you with career moves and friendships. The values of these things may increase over time, making the term “investment” more legitimate. The trouble appears when you pay a higher price for education than necessary, calling it an investment.

If you ask anyone who has any experience with finance, a house is an asset and a mortgage is a liability. Yet, some financial gurus continue to insist that a house is a liability. This doesn’t make any sense from a purely financial perspective, but if you look at the connotations of the words instead of the meanings — or if you look at the broader sense of “liability” rather than its financial sense — these gurus might have an argument. A house that does not create cash flow for you (that is, a house that is not an investment with rental income) should be avoided as much as possible. Anything that costs you money is a liability in the sense that is drags your finances down. Although it’s not financially accurate, considering bad assets “liabilities” encourages you to eliminate as many of these as possible and to replace them with income-producing assets.

Politicians and activists use word choice to influence their constituents’ opinions all the time. That’s why we have terms like “pro-life” and “American Recovery and Reinvestment Act.” It’s a form of manipulation, but if you’re using this technique to benefit your financial situation, no one can blame you for misdirection.

Using these tricks — replacing old habits with new habits, adding barriers to bad behaviors, removing barriers to good choices, and changing the words to describe what you do — can help you overcome the difficulty of putting what you know about “spending less than you earn” into effect. There’s a bridge between knowledge and action, and unfortunately, many people mistakenly think that the reason so many people in the United States are suffering financially is due to lack of knowledge. The prescribe solutions like money management class in high school and other financial literacy initiatives. Having more information is not going to solve financial illiteracy. On an individual or family level, taking steps to modify behavior will certainly move finances in the right direction.

khrawlings

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Are You Concerned About the Very Poor?

This article was written by in Society. 74 comments.

Whether you agree with it or not, the reason this country has supported programs like welfare, Social Security, the GI Bill, food stamps, Medicare, government-backed mortgages, FEMA insurance, and other social programs is because a modern society benefits when as many citizens as possible have opportunities to succeed financially. Social programs aren’t perfect and don’t always provide what they promise, and there’s always a small percentage who take advantage of the system.

The push-and-pull between the focus on the society and the focus on the individual existed even before the founding of the nation, and this particular Weeble that wobbles between left and right without falling down (yet) has allowed the United States to become the biggest economy in the world in a relatively short period of time, and that’s a good thing.

From an individual perspective, it might not be that intuitive that one needs to be concerned about the “very poor.” After all, with social safety nets, one might think that the “very poor” have little to worry about. Regardless of the existence of programs — both public and private — poverty is still an issue in this country, even if you don’t see it in your daily life as you shuffle in an office building from meeting to meeting or shuttle from city to city on business trips. It’s hard to be concerned about something if you aren’t faced with it every day.

If, however, you are concerned about the “very poor,” there are ways to help, even if you don’t believe that handouts are effective. The most popular rationalization for not caring about poverty is the idea that helping another individual teaches complacency rather than responsibility, interdependence rather than independence. The incorrect assumption is that families in destitute situations have no desire to work for their money like those who have built wealth for themselves and have earned the right to let their money do the work for them and receive income from dividends and interest rather than working in the middle-class and working-middle-class sense of the word.

The real problem is tied into that psychology 101 concept I turn to repeatedly, Maslow’s hierarchy of needs. If most waking minutes in your day are spent worrying about your shelter, your food, and having a safe place to sleep, “income mobility” is a fantasy. You’re a victim of “class warfare,” but in your reality, you don’t have time or energy for political arguments about class warfare.

If you are concerned about the very poor, there are options. Helping bring attention to poverty can form provide opportunities to those without them without much sacrifice from those with opportunities.

  • Give money directly to organizations that run programs focusing on providing opportunities. The top-rated charities focusing on poverty according to Charity Navigator are Direct Relief International (although International is in the name, they also work to eliminate domestic poverty, particularly in disaster-stricken areas), SOME (So Others Might Eat, focusing on the D.C. area), and the People’s Resource Center (based in Chicago). If you prefer to give a hand-up rather than a hand-out, focus on organizations that provide job training and placement, programs that expand the reach of educational opportunities, and programs that present positive financial role models.
  • Volunteer with the organizations that run these programs. Build houses. Build schools. Help at a food bank. When you are actively involved, you get to experience the results of your work much more closely than if you were to send a check every month. No, you won’t get a tax deduction for volunteer work, but that’s not the point.
  • Become a community leader. When people from poor communities manage to succeed financially, they often don’t return to be the role model their community needs. This is the reason financial illiteracy is a problem that will continue from generation to generation, keeping low socio-economic status communities from thriving.

Are you concerned about the very poor? Does paying your taxes and being satisfied with existing social safety nets relieve you from any other possible responsibilities for how the country fares as a whole? Do we even have any responsibilities to anyone other than ourselves and our families?

Related: Here’s how you might be able to avoid poverty for your family. Also, could you survive at the poverty line?

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The Power of Customer Outrage

by Flexo

In what almost seemed like a staged publicity stunt, Verizon Wireless quickly rescinded their plans for a new $2 fee for most bill payment options. An employee leaked an internal memo describing the new fee, and within twenty-four hours, the wireless company both confirmed and then rescinded the fee, citing their policy of listening to ... Continue reading this article…

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Podcast 104: Financial Literacy Month

by Flexo

Today’s guest on the Consumerism Commentary Podcast is Kim McGrigg, Manager of Community and Media Relations for Money Management International (MMI), which is sponsoring Financial Literacy Month. MMI is the largest nonprofit, full-service credit counseling agency in the United States. Consumerism Commentary Podcast #104 Financial Literacy Month: S04E26 / 128 Download – RSS – iTunes ... Continue reading this article…

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Podcast 50: Financial Literacy Month, Cate Williams

by Flexo

This week’s guest on the Consumerism Commentary Podcast is Cate Williams, Vice President of Financial Literacy at the credit counseling agency Money Management International. In honor of Financial Literacy Month, Flexo and Tom Dziubek discuss several financial literacy topics with Cate, including at what age children should learn basic money skills, how many kids actually ... Continue reading this article…

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Donations to Rural Classrooms Worth Twice as Much

by Flexo

A few years ago, the personal finance blogging community came together to create the pfblogs.org Financial Literacy Challenge through DonorsChoose.org, a charity that facilitates funding for classroom projects needing money. The challenge was designed for bloggers to encourage their readers to provide tax-deductible donations through DonorsChoose.org to fund classroom projects focusing on increasing financial knowledge. ... Continue reading this article…

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