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Start out and stay financially sound
Andrew K. Thompson
Personal Finance 8th
Article Assignment
Things That Could Help Your Financial
Planning
First, remember to set your investment goals.
This means you've got to (1) write your goals down and prioritize
them, (2) attach costs to them, (3) figure out when the money for
those goals will be needed, and (4) periodically reevaluate your
goals. By keeping your goals as specific as possible it will help
you from wandering away from what you really want.
Before
saving make sure you are living within your means, having adequate
insurance, and keeping emergency funds. If you don't live within you
financial means you'll never be able to achieve any of your
financial goals. Keep control of your expenses--this includes credit
card use. Use commonsense buying. Life, property and liability, and
medical insurance should be in place before you begin an investment
program--they not only protect you but your family. Remember that no
budget is solid. An emergency fund should be immediately available
to you.
Invest as soon as possible. Time is your best ally
when it comes to investing. The sooner you invest, the more you
earn. Pay yourself first--this proves that your long-term goals have
precedence over all else. Even if you only have a few bucks to
invest, make a start. If your employer offers any matching
investments, don't pass them up. (Also, keep an eye to any
investments that are tax favored, like IRAs). If money happens to
fall in your lap--from inheritance, salary bonus, gift, tax refund,
or a lottery winning--invest it. Another approach is to use two
months a year as your investing months, where you cut back on cost
to save more. Invest rather than speculate. Investing is less risky,
and the value is based on the return it earns.
Investment
choices are split into two categories: Lending investments and
Ownership investments.
*Lending investments include savings
accounts and bonds. Savings accounts pay you interest on the balance
you hold in your account. With a bond, your return is generally
fixed and known ahead of time with the maturity date. Bonds hold a
face value, which is the amount you receive when the bond matures
(also referred to as the par value or principal). The coupon
interest rate refers to the actual rate of interest the bond pays,
with these payments generally being made on a semiannual basis. Most
bonds have fixed interest rates, but some have variable or floating
rates, meaning that the bond's interest rate changes periodically to
reflect the current level of interest rates.
*Ownership
investments have two major forms, real estate and stocks. The most
popular ownership investment is stocks because real estate has the
downside of being illiquid. With stocks you are buying a small
fraction or ownership in a company. If the company earns a profit,
you receive some of that profit through dividends. As profits and
dividends continue to increase, investors see the stock as more
valuable and are thus willing to pay more to purchase it and
visa-versa. With preferred stock the dividends are generally fixed
and are issued before common stock. Preferred stock holders receive
their dividends first, and common stockholders receive their
dividends from the remains. Risk is involved. There is interest rate
risk, inflation risk, business risk, liquidity risk, market risk,
political and regulatory risk, exchange rate risk, and call risk.
Investments can go up or down in value resulting in a capital gain
of loss. The longer you plan on leaving an investment in the market
the less risky it is. Remember that taxes must fit into your
investment layout. Borrowing money for investment gives you leverage
however, it can act as a two-edged sword. It can either help you or
hurt you. It's risky.
Understand the interest rates.
Interest rates play an important role in determine the value of an
investment and they are closely related to the inflation rate.
Nominal rate of return is the rate of return earned on an investment
without any adjustment for lost purchasing power. The real rate of
return is nominal minus inflation rate.
Diversify your
financial portfolio. By diversifying your portfolio the good and bad
returns cancel each other out. Diversification leads to two types of
risk: systematic risk and unsystematic risk. Systematic risk, is
risk that can't be eliminated through diversification, it affects
all stocks. Unsystematic risk can be eliminated through investor
diversification and usually results from factors unique to a
particular firm. With asset allocation the investor invests in
several different classes of investments. Domestic common stocks,
international common stocks, and bonds. The concept of time brings
to factor the risk in the allocation process.
Efficient
markets concern the speed in which information is reflected in
security prices. The more efficient the market is, the faster prices
react to new information. Remember that systems don't beat the
market--long-term investing works best. Stick to your plan and don't
try to time the market. Focus on the asset allocation process. Keep
the commissions down. Diversify your stocks. If you need help, turn
to a financial advisor. Keep it simple and you'll do great.
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