If you are wanting to get ahead financially, you can’t just depend on your paycheck to do it. Many people are barely getting by, living paycheck to paycheck. Then there are people who know if they are going to get anywhere, they are going to have to live below their means and start putting that
If you are wanting to get ahead financially, you can’t just depend on your paycheck to do it. Many people are barely getting by, living paycheck to paycheck. Then there are people who know if they are going to get anywhere, they are going to have to live below their means and start putting that money into places that it can work for them.
The problem with that is that many people think they should save that money in their savings accounts, but when savings accounts typically aren’t gaining enough to keep up with inflation, the person is really fooling themselves. In about ten years, that money will have far less buying power than what it has today. So we can hardly call a savings account an investment.
So What Is the Solution?
There is only one way a person can make a stable plan to get ahead. They have to invest their money in something that can grow ahead of inflation. But there are good ways to invest and bad ways. How does one decide on where they should be putting their money to get the best return? A lot of this has to do with time frame and purpose, and there are some general rules that can be used to know best positioning for your finances in terms of keeping them safe.
Diversify, Diversify, Diversify
The first rule for keeping investments safe is diversification. Single stocks and bonds rely heavily on getting in at the right time. Because of this, people generally start with mutual funds.
Investor.gov states, “There are four reasons investors choose mutual funds:
- Professional Management. The fund managers do the research for you. They select the securities and monitor the performance.
- Diversification or “Don’t put all your eggs in one basket.” Mutual funds typically invest in a range of companies and industries. This helps to lower your risk if one company fails.
- Affordability. Most mutual funds set a relatively low dollar amount for initial investment and subsequent purchases.
- Liquidity. Mutual fund investors can easily redeem their shares at any time, for the current net asset value (NAV) plus any redemption fees.”
Mutual funds give much less of the knee jerk reaction for every directional shift the economy takes. Instead, it may slightly move one way or the other. It allows for the managers of those accounts to only make slight corrections rather than ones that are more drastic.
Timing Is Everything
Some may think that picking a conservative investment means it is going to be the safest, but this isn’t necessarily true. Aggressive and conservative just tell us how fast or slow these investments travel. If it has the ability to travel upward quickly, it also has the ability to travel downward just as quickly.
So an aggressive investment is not an investment for short-term goals. This is because if it has a quick downturn, it is uncertain if there will be time to pull back up.
A conservative investment is not going to travel as quickly. If it has a downturn, it should be relatively small and be able to bounce back more quickly. The problem is that its gains will also be small. So where it is a safer investment for the short term, it has issues in the long term. This is because if an investment is only growing at one-third the rate of inflation, over a ten-year period, it has actually lost a considerable amount of buying power. The money is there, but the money isn’t worth as much.
The Basic Rule for Time Frame
- 0-1 year: savings account or money market account
- 1-5 years: very conservative investment, heavy on bonds, very little or no equities
- 5-10 years: moderate account; half bonds, half equities
- 10+ years: aggressive account, mostly or all equities
Kent Thune gives a more detailed breakdown of this in his article “3 Mutual Fund Portfolio Examples for 3 Types of Investors”
Again, some will ask how an aggressive account can be safe. The history of the market has never been in decline more than three years in a row, and our economy has continually seen increase over the long term. Because this is the case, an aggressive mix should be viewed as safer than conservative for a long-term investment.
The Roth IRA
One factor with timing is making sure it is where you can get your hands on it when you need to. If it is strictly for a long way off, having it in a tax-qualified account isn’t a bad idea. But since you can’t touch those accounts without a penalty until you are 59 and 1/2, it may not be the best if you think you will ever need it for any reason. There is, however, one exception.
The Roth IRA is a special tool to use when placing investments. This is because it has the ability to be used for a long-term tax-qualified investment, but if you ever run into a tight spot, you are able to pull out the principle that you put in. So if you have invested $20,000 into your Roth IRA, You are able to pull out that $20,000 without penalty. You just can’t touch the growth. There are also special stipulations that can be used to pull out a percentage to be used for educational or first-time home buyer situations.
Think Mutual Fund, Think Safe
There are no guarantees with investing; it does take some risk. Nobody can time the market, and that is what most people are concerned about. So to take the guess work out and simply rely on the rules of time frame and purpose, mutual funds will be the safest place for you to invest.