Saving and Investing
As you switch your focus from finishing your education to achieving the goals you’ve set for yourself, it’s time to get started on saving and investing.
When you save and invest, you take different approaches to having your money work for you. But you benefit from both saving and investing because they complement each other:
- You save by putting money into insured bank or credit union accounts that typically grow slowly but are government insured.
- You invest by buying things of value, like stocks, bonds, and mutual funds, that have more growth potential — sometimes much more — but aren’t insured. So, you could lose money, especially in the short term.
Savings work best for your short-term goals because you want to be sure the money is available when you need it. Investments are essential for your long-term goals, which tend to have larger price tags. To cover their costs, your assets have to grow.
The Value of Savings
The difference between what you earn and what you spend each month is the amount you have available to save. The more you can increase that difference, by earning more and spending less, the more you can save.
Saving has some very practical advantages:
- Keeping three to six months of living expenses in a savings account means you’re prepared for unexpected expenses — whether your car breaks down, your computer fries, or you’re temporarily between jobs.
- Having savings also means you can afford important extras without straining your regular budget.
Where to Save
Bank and credit union savings accounts are simple and convenient ways to save. You earn interest on your balance in these basic accounts, typically at a low but guaranteed rate.
Once you get started, you might also open other savings accounts where you can earn a slightly higher return but where your principal is still safe:
- Money market accounts tend to pay interest at a somewhat higher rate than basic savings accounts, but they may charge fees if your balance falls below a set minimum.
- Certificates of deposit (CDs) are term deposits with maturities from six months to five years that pay interest at rates at least as high, and sometimes higher, than money market accounts.
- US Treasury bills (T-bills), which you buy online with an easy-to-open TreasuryDirect account (www.treasurydirect.gov), pay a fixed rate of interest that’s set when you buy. They’re available with terms of 4,13, 26, or 52 weeks.
Liquidity describes how easily an investment can be converted to cash without loss in value. Cash itself is totally liquid, whether it’s in your checking or savings account — or in your hand.
CDs and T-bills are a little less liquid because they have maturity dates at which the full value of the interest they pay is due. You have access to your money before the maturity date, but there’s a cost. You usually lose some or all of the interest you expected. With T-bills, you could potentially lose some of the principal, or purchase price.
Liquidity is appealing. But if you keep all your money in liquid accounts for the long term, you actually risk losing buying power. That’s because liquid investments tend to pay interest at a lower rate than the rate of inflation.
The result is that it’s more difficult to reach your goals within a reasonable time frame. So in addition to saving, you need to invest to make your money grow.
The Ups and Downs of Investing
You don’t have to work on Wall Street to be an investor. But you have to be willing to spend some time choosing investments, and you have to stay tuned and be patient. Generally speaking, the longer your money is invested, the larger your account value will be — thanks to the power of compounding.
While your money is invested, your account value changes regularly. One month you could see a gain in value, and another month a loss. Some investments might even be worth less than you paid for them at various times. These price changes reflect what’s happening overall in the investment markets, what’s happening with an individual company, and sometimes what’s happening with both.
You can’t predict the timing of this up and down cycle, so your best strategy is to sit tight when values are down and focus on the long-term results.
Catching the Snowball Effect
When your savings earn interest, you’re paid a percentage of your total balance each time that interest is added to the account. As the balance grows, each interest payment is larger than the one before because the base has increased. Of course, you could withdraw the interest and spend it, but then you’d lose the effect of compounding.
With investing, compounding can be even more powerful. Since the rate of return is typically higher on investments than on savings, you have much more to gain by reinvesting your earnings to increase your account balance.
One of the easiest ways to reinvest is to sign up for an automatic reinvestment plans when one is available, as it is with many stocks and most mutual funds. A word of caution: You won’t have a positive investment return every year, so your account value may not grow even if you reinvest. But don’t let that discourage you.
Balancing Risk and Return
When you invest, you’re looking for a stronger return than saving provides. But the potential for a greater return goes hand in hand with taking more risk. In fact, the larger the potential return, the greater the risk. Just to clarify:
- Return is what you get back in relation to the amount you invest.
- Risk is another way of saying “uncertainty.”
One investment risk you face is the possibility of losing money, which happens if an investment drops significantly in value and you sell at a loss. Another risk is not realizing a strong enough return to meet your goals. This happens if an investment doesn’t gain as much as you anticipated.
The good news is that the more you learn about the way investments work, the better you’ll be at estimating the level of risk you’re taking with each investment you make — though there’s no guarantee that the past performance of any individual investment will be equaled or surpassed in the future.
Types of Investments
The sheer number of investments can seem overwhelming, but most of them can be grouped into three big categories: cash, debt, and equity.
- Cash investments are savings. When you buy an insured CD or a T-bill, you know you’ll get your principal plus interest back at the end of the term. The trade-off is that cash investments don’t offer much return.
- Debt investments are bonds. When you buy a bond, you’re actually loaning money to a company or government that issued the bond and promises to repay you the amount of the loan plus interest. Because the market price of a bond can drop, or a bond issuer can default and not repay, bonds are usually more risky than cash. But they’re less risky than stocks.
- Stocks are equity investments. When you buy stock you have a share of ownership in the issuing company. Stock returns are tied to the fortunes of the company and what’s happening in the overall stock market.
While individual stocks pose different risks and returns, all stocks have similar characteristics. The same is true of all bonds.
Mutual Funds and ETFs
Researching bonds and stocks can be fun if you’re confident about what you’re doing. But if you’re new to investing, making these choices can be intimidating. Mutual funds and exchange-traded funds (ETFs) make your task a lot easier.
Funds are pooled investments. They combine the money they raise from selling shares to investors to buy portfolios of stocks (if they’re stock funds), bonds (if they’re bond funds), or sometimes a combination of stocks and bonds. Professional managers choose the investments, decide when to buy, and when to sell.
Each fund has an investment objective, which may be something broad, like growth or income, or something specific, like tracking a particular index. With some research, you can find funds with objectives that fit your investment goals.
Index mutual funds and ETFs may be a particularly good choice because they aren’t expensive to buy, and you can get started with just a small minimum investment.
Allocating Your Assets
Asset allocation describes the way you divide the money you have to invest, on a percentage basis, among cash investments, bonds, and stocks. Asset allocation is also a quick indicator of the level of risk your portfolio carries:
- When you emphasize stocks, you focus on long-term growth, not current income. Stocks carry more risk and are typically more volatile than bonds or cash because their prices typically change more quickly. Portfolios with heavy stock allocations are described as aggressive.
- When you emphasize cash and bonds, you concentrate on current income rather than long-term growth. They carry less risk because the investments are more liquid. Portfolios allocated largely to cash and bonds are described as conservative.
There’s no “right” way to allocate. What’s right for you depends on the:
- Goals you want to meet
- Time you have to reach those goals, which is another way of saying how old you are
- Amount of risk you’re comfortable taking
Diversification means buying a variety of investments of each type rather than just one or two. That might include:
- Stock in companies of different sizes, in different businesses, or based in different countries
- Bonds from different types of issuers, with different terms, and different credit ratings
It’s smart to diversify because no single investment or type of investment produces strong returns all the time. When some are having a bad year, others may be doing better. So by owning a variety, you increase the potential for keeping your average return positive. In that way, a broadly diversified portfolio limits the risk you have to take to achieve your goals.
Mutual funds and ETFs can be a convenient way to diversify, since each fund portfolio is already diversified. For example, buying shares of a fund that tracks the S&P 500 is more convenient and much more cost effective than buying shares in each of the 500 companies in the index.
What’s in Your Portfolio?
Your investment portfolio isn’t a briefcase that you carry around or some documents you lock in a fireproof box. It’s the combination of investments that you own.
To start a portfolio that will help you meet your goals, you need to understand how each investment you’re considering works, how much risk it carries, and how it fits in with the rest of what you own. It’s not as hard as you might think.
- Link the investments you buy to the goals you want to reach. Don’t emphasize safety and liquidity for long-term goals or growth potential for short-term goals.
- Avoid complex investments or any investments that nobody can explain in a way you understand.
- Avoid investments with too many restrictions, conditions, or fees.
To expand to the next level, you don’t want to buy randomly. You need a strategy, or plan, that involves asset allocation and diversification. For example, you’ll want to be sure new investments make sense in relation to your portfolio as a whole. If you already own lots of technology stocks, an index fund that owns large, established companies might be a more suitable choice than another Internet start-up.
Don’t Get Scammed
When you invest you have to negotiate a number of hurdles. But one you can avoid is falling victim to a scam designed to separate you from your money. Here are some tips that will help you do that:
- Remember there are no shortcuts. Whether you’re investing for income or for growth, remember that investing is a long-term strategy.
- Look out for scams. Hot tips — even from your best friend — and get-rich-quick deals are almost always scams. So is any investment you’re told you have to buy right away and can’t tell anyone about.
- Know that higher potential return comes with greater risk. If an investment guarantees otherwise, the only thing you can be sure of is that you’ll lose your money.
- Avoid unregistered investments.
- Be skeptical. If an investment sounds too good to be true, it probably is.
- Check the credentials of any salespeople or advisors that want to work with you with your state securities regulator or the BrokerCheck link at www.finra.org.
Reallocating and Rebalancing
As your life and your goals change, your portfolio needs to change to keep up.
Reallocation is the process of adjusting your portfolio to fit a new set of goals. If you’re thinking about going to grad school in a year or two, you might want to switch to a more conservative asset allocation to be sure you have the money you need for tuition. You could reallocate by selling stocks and emphasizing cash investments.
Sometimes, even when your goals stay the same, you have to respond to what’s happening in the investment markets.
Rebalancing is a way of tweaking your portfolio in response to market ups and downs. If you have an aggressive asset allocation but your bond holdings have a great year, your asset allocation could end up more conservative than you intended. You could rebalance by selling off some bond investments and purchasing stocks.
You don’t have to reallocate or rebalance often. But you’ll want to give your portfolio a yearly checkup to be sure you’re still on track.
Ready, Set, Invest
When you’re ready to save and invest — and there’s no better time than right now — there are some useful guidelines. They don’t guarantee you’ll get rich. But they will make the difference between making progress toward your goals and feeling as if opportunity is getting away from you:
- Learn more. Good places to start are well-known financial publications, online and in print. Check the library or a professor for references or ask a friend or relative who invests.
- Find out about investment presentations on campus. If what you hear interests you, seek out the presenter for more information.
- Contact your bank or credit union about investment services and information they provide.
- Investigate an online brokerage or mutual fund account. Many of them provide reliable investor education as well as a way to get started investing at a reasonable cost.
- Be honest with yourself about how much risk you’re comfortable taking. That’s called risk tolerance. To help you find out, check out this money risk quiz. It never pays to invest too aggressively and then sell in panic if the markets drop.
Money Saving Tips
- Cook with friends and split grocery costs.
- Eat at home instead of going out. Try packing your lunch everyday.
- Plan for a menu that incorporates similar ingredients in different ways.
- Make a shopping list and stick to it.
- Put the amount you are budgeting for groceries on a gift card, and make a commitment to only spend that amount.
- Take classes that work towards your degree; See an academic advisor!
- Buy used textbooks or use library copies.
- Consider sharing a book with a classmate you know and trust. Utilize free scanning at the Knight Library (KIC stations).
- Apply for scholarships every year.
- Go to free concerts, activities and speakers on campus.
- Read the Eugene Weekly to find free activities around town.
- Host game nights with friends.
- Join an intramural sports team.
- Give handmade gifts.
- Take advantage of student coupons and promotions.
- You can ride the bus for free with your UO ID card.
- Ride a bike or walk to campus.
- Choose a lower-cost residence hall.
- Live with roommates once you decide to live off-campus.
- Compare housing costs in different areas of Eugene and Springfield.
- Use your utilities wisely!
- Turn off the lights and unplug electronics when you leave a room.
- Wear a sweater or snuggle up under a blanket rather than turning up the heat.
- Use WiFi on campus to reduce phone data usage.