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Investing Basics

After you have successfully established a personal budget, eliminated or reduced your debts, and begun saving, the next step is to grow your savings and put your money to work for you through investing. Investing long-term savings allows you to take advantage of compounding, which happens when you earn interest, and to beat inflation, which is the tendency of the value of money to decrease over time.

If you simply leave your money at home, in a checking account, or in a savings account you probably will not beat the rate of inflation, meaning that your savings may actually be worth less over time. Investing, on the other hand, offers a means to equal or exceed the rate of inflation, protecting and growing your savings.

When do I start?

It is never too late to start investing, but the earlier you can begin, the better. This is due to the power of compounding.

For example, if you invest $2,000 when you turn 20 years old, and continue investing $250/month at a 10% interest rate, your investments will be worth about $1,022,346 by the time you turn 55 years old.

If, however, you wait to invest that same $2,000 until you turn 30 years old, and invest at the same rate of $250/month at a 10% interest rate, your investments will be worth only about $358,586 by the time you turn 55 years old. Big difference!

Investment Planning

Before you begin investing, give some thought to your expenses and goals – both short and long term. Do you need money for a house, car or vacation? What about retirement? What do you intend to do with your time after you retire, and how much will it cost? Thinking through these questions in advance of investing will help you choose the correct investment vehicles to meet your goals.

It is also a good decision to engage the services of a financial advisor before you begin investing. A good financial advisor will help you identify what your personal goals are, what your resources are, and how to align your resources in a way that positions you to achieve your goals.

There are many different financial advising certifications and credentials. To help you make sound decisions about which type of advisor to engage, we have described the differences between some common certifications briefly below. Whatever choice you make, it is important for you to understand how the advisor gets paid (commission for selling you a specific product, hourly, etc.) so you know what their motivations might be in advance of starting a relationship with them. It is also important to know whether your advisor has fiduciary duties – or, in other words, whether he or she is legally obligated to act in your best interest.

Certified Financial Planner (“CFP”). To obtain certification as a CFP, advisors must have real world experience in advising clients on investments, including 3 years in the field or a 2-year apprenticeship under another CFP. Every CFP has completed courses on topics like insurance, estate planning, retirement, taxes, and investing. CFPs also must pass an ethics exam, and a 10-hour, 285-question certification test. CFPs are usually generalists, and can advise you on almost all financial planning questions, like budgeting, insurance coverage needs, estate planning, and matching investments to long term goals. This is widely considered the most prestigious financial planning designation in America.

Certified Public Accountant (“CPA”). The CPA credential is the oldest financial credential in America, and applies specifically to accountants. The CPA exam covers topics like accounting, auditing, bookkeeping, taxes, and ethics. This designation does not include any training in areas of personal finance outside accounting. CPAs often seek other credentials to broaden their areas of expertise.

Personal Financial Specialist (“PFS”). The PFS designation is available only to CPAs, and is the most common additional credential CPAs seek in order to expand their proficiency in financial planning. PFSs must have 2 years of full-time experience in financial planning and take coursework in estate planning, tax law, retirement, risk management and investment planning for individuals, families, and businesses. The designation also requires a comprehensive exam.

Enrolled Agent (“EA”). This designation means that an advisor has completed an exam overseen by the Internal Revenue Service specific to tax preparation. The test touches on personal, corporate, and estate taxes, as well as IRS rules in each of these areas. EAs are generally limited to tax preparation.

Chartered Financial Analyst (“CFA”). CFAs are investment specialists. Designation as a CFA requires 3 years of coursework, a difficult board exam, and at least 4 years of professional experience in the financial planning field. Many CFAs work as money managers. The knowledge CFAs have relative to investments is often too specific for the sorts of personal investing questions most people have.

Chartered Life Underwriter (CLU) and Chartered Financial Consultant (ChFC). CLUs and ChFCs specialize in life insurance and estate planning. The main difference between the two is that CLUs focus their work on life insurance specifically, whereas ChFCs work with more general financial planning principles. Both designations overlap to some degree with the CFP designation, but do not require a board exam.

Certified Employee Benefit Specialist (CEBS). CEBSs focus their work on selling and administering employee benefits plans. To be certified, CEBSs complete a curriculum of 8 courses on insurance, retirement, pension, regulatory issues and other related topics. There is no comprehensive exam for this designation, though it too overlaps to some degree with the CFP program. Advice from advisors of this type typically focuses on 401(k) plans, pensions, and health insurance.

Certified Fund Specialist (CFS) and Chartered Mutual Fund Counselor (CMFC). Holders of both of these designations specialize in mutual funds, and may offer advice as to which mutual funds to invest in. CFSs receive training on dollar-cost averaging, annuities, and other related topics, and must complete continuing education requirements to remain current with their designation. Initial certification requires completion of 60 hours of self-study and a final exam. CMFCs must complete a 12-month course in similar topics, and pass a proctored exam.

A last word of caution on advisors: the term “financial planner” can be used by anyone, and does not necessarily mean a service provider is certified. Take the time to talk with prospective partners before committing to make sure you have a complete understanding of what they bring to the table, and what other options are available to you.

How do I invest?

There are many varieties of investment products available on the market, a few of which are described below. Ultimately, no investment vehicle is without risk, and we encourage you to investigate the options available to you before making a final decision. It is also generally a good idea to diversify your investments to avoid risking too much in any one place.

Professional planners are invaluable in helping you navigate these areas:

Short-term options. Short-term investments are typically used for money you want to have access to relatively quickly. For that reason, the rates of return on these types of investments generally fall below those of other options on the market.

The two most common short-term investment vehicles are money market funds and certificates of deposit. With a money market fund, the investor’s money is directed to a type of mutual fund that buys low-risk government securities, certificates of deposit, commercial paper, and other highly liquid, low-risk securities. Certificates of deposit are issued by banks and other financial institutions, and are an agreement between the institution and the investor that a certain amount of money will be deposited for a set period of time in return for a set rate of interest.

Long-term options. The most common forms of long-term investments are bonds, stocks, mutual funds, and individual retirement accounts (or “IRAs”). Bonds are certificates of debt issued by governments and corporations to raise money. Investors in bonds lend money to these institutions, and in exchange the institutions agree to return the money to the investor after a set period of time, with accrued interest.

Stocks and mutual funds are what most people think of when they think about investing. When a buyer purchases stock, he or she is buying a stake in the company issuing the stock. Often, these investments return dividends when the company does well, but also bear the risk of losing all of their value if the company ceases operations. To guard against some of this risk, mutual funds purchase stock in multiple companies across multiple sectors of the economy, as well as bonds and other securities.

IRAs are the most common form of retirement investment plan. These investment vehicles receive preferential tax treatment, in exchange for the participant’s agreement not to access funds until retirement.

Resources

The foregoing is a very brief, incomplete description of the various investment options available in the market, and is meant primarily to give basic information to those starting out with investing. Financial advisors are very helpful in guiding potential investors through the ins and outs of various options, and often offer free consultations prior to actively taking on money management for clients.

In addition to speaking with an advisor, we encourage you to take advantage of the following primers for more information: