Making Money Grow
Once you have a financial plan and have paid off any high interest debts, it’s time to consider how to make your money grow.
There are basically two ways to make money:
1. You work for money. Someone pays you to work for them or you have your own business.
2. Your money works for you. You take your money and you save or invest it.
The Differences Between Saving and Investing
Savings is the money you earn, but don’t spend. This money is usually put into the safest places, or products, that allow you access to your money at any time. Savings products include savings accounts, checking accounts, and certificates of deposit. Some deposits in these products may be insured by the Federal Deposit Insurance Corporation or the National Credit Union Administration. But there’s a tradeoff for security and ready availability. Your money is paid a low wage as it works for you—and it may not even keep up with inflation.
When you invest, you try to make the money you earn grow. When you invest, you have a greater chance of losing your money than when you save. The money you invest in securities, mutual funds, and other similar investments typically is not federally insured. You could lose your principal—the amount you’ve invested. But you also have the opportunity to earn more money.
Some people get into the habit of saving and investing by following this advice: always pay yourself or your family first. Many people find it easier to save or invest first if they allow their bank to automatically remove money from their paycheck and deposit it into a savings or investment account.
For money you want to invest, one of your best options for making automatic contributions is to participate in the Thrift Savings Plan (TSP). The TSP is the federal government’s version of a 401(k). Contributions can be automatically deducted from your pay and provide tax advantages either today (traditional) or in the future (Roth). The TSP is discussed in more detail under the Planning for Retirement section.
Any time you have automatic deductions made from your paycheck or bank account, you’ll increase the chances of being able to stick to your plan and to realize your goals.
What about risk?
All investments involve taking on risk. It’s important that you go into any investment in stocks, bonds, ETFs or mutual funds with a full understanding that you could lose some or all of your money in any one investment.
Diversification, or spreading money among various investments, is the best way investors protect themselves against risk. This strategy can be neatly summed up as, “Don’t put all your eggs in one basket.” Diversification can’t guarantee that all of your investments won’t suffer if the market drops. But it can improve the chances that you won’t lose money, or that if you do, it won’t be as much as if you weren’t diversified.
What are the best investments for me?
The answer depends on factors like:
- when you will need the money
- your goals
- your ability and willingness to take risk
If you are saving for retirement, and you have 35 years before you retire, you may want to consider investment products that may grow faster over the long run, knowing that if you stick to only the “savings” products or to less risky investment products, your money will grow too slowly—or, given inflation and taxes, you may lose the purchasing power of your money. A common mistake people make is putting money they will not need for a very long time in investments that pay a low amount of interest. However, with the possibility of growing faster comes exposure to more risk and the possibility of losing money.
On the other hand, if you are saving for a short-term goal, five years or less, you don’t want to choose high-risk investments because when it’s time to sell, you may have to take a loss. Since investments often move up and down in value rapidly, you don’t want to be vulnerable to market shifts when you need your money.
Stocks and Bonds
To invest in individual companies, you can buy either stocks or bonds. When you invest in a stock or bond, you are hoping that the company will be successful and your investment will grow as a result.
A stock is an instrument that signifies an ownership position (called an equity security) in a company, and a claim on a proportional share in its assets and profits. Generally, you can buy and sell stock that’s listed on a stock exchange through a broker.
A bond is a debt security, similar to an IOU. When you buy a bond, you are lending money to the company. In return for the loan, the company promises to pay you a specified rate of interest during the life of the bond and to repay the principal when it matures, or comes due. You can buy or sell bonds through a broker.
Savings Deposit Program (SDP)
If you are serving in a designated combat zone, you may be eligible for the Savings Deposit Program (www.DFAS.mil). The SDP offers a guaranteed annual return of 10 percent on up to $10,000 in savings— a rate that far exceeds traditional savings accounts. The program was designed to provide members of the uniformed services in designated combat zones an opportunity to build their financial savings.
Mutual Funds and Exchange-Traded Funds (ETFs)
Because it is sometimes hard for investors to become experts on various businesses—for example, what are the best telecommunications, pharmaceutical, or computer companies—investors often depend on professionals who are trained to research companies and recommend companies that are likely to succeed. Since it takes work to pick the stocks or bonds of the companies that have the best chance to do well in the future, many investors choose to invest in mutual funds and ETFs.
What are mutual funds and ETFs?
A mutual fund or ETF is a pool of money run by a professional or group of professionals called the investment adviser. In a managed fund, after researching the prospects of many companies, the fund’s investment adviser will pick the stocks or bonds of companies and put them into a fund.
Investors can buy shares of the fund, and their shares rise or fall in value as the values of the stocks and bonds in the fund rise and fall. Investors may typically pay a fee when they buy or sell their shares in the fund, and those fees in part pay the salaries and expenses of the professionals who manage the fund.
A Note About Fees and Expenses
Fees and expenses vary from fund to fund and the amount you pay may depend on the fund’s investment strategy. A fund with high costs must perform better than a low-cost fund to generate the same returns for you. Even small differences in fees from one fund to another can add up to substantial differences in your investment returns over time.
For more information about mutual fund and ETF fees and expenses, be sure to read our online brochure entitled Mutual Funds and ETFs—A Guide for Investors.
How can I keep fund fees and expenses low?
One way that investors can obtain for themselves nearly the same returns as the market is to invest in an index fund or index ETF. This is a fund that does not attempt to pick and choose stocks of individual companies based upon the research of the fund managers. An index fund seeks to equal the returns of a major stock market index, such as the S&P 500, the Wilshire 5000, or the Russell 3000. Through computer programmed buying and selling, an index fund tracks the holdings of a chosen index, and so generates the same returns as an index minus, of course, the annual fees involved in running the fund. The fees for index funds and ETFs generally are lower than the fees for managed funds.
Historical data shows that index funds have, primarily because of their lower fees, enjoyed higher returns than the average managed fund. But, like any investment, index funds involve risk and historical data is no guarantee of future returns.
Working with an Investment Professional
Do I need an investment professional?
Are you the type of person who will read as much as possible about potential investments and ask questions about them? If so, maybe you don’t need investment advice. But if you’re busy with your job, your children, or other responsibilities, or feel you don’t know enough about investing on your own, then you may want professional investment advice.
Investment professionals offer a variety of services at a variety of prices. It pays to comparison shop. You can get investment advice from most financial institutions that sell investments, including brokerages, banks, mutual funds and insurance companies. You can also hire a broker, an investment adviser, an accountant, a financial planner or other professional to help you make investment decisions. Some financial planners and investment advisers offer a complete financial plan, assessing every aspect of your financial life and developing a detailed strategy for meeting your financial goals.
Remember, there is no such thing as a free lunch. If professional financial advisers are working for you, they are getting paid for their efforts. Some of their fees are easier to see immediately than are others. But, in all cases, you should always feel free to ask questions about how and how much your adviser is being paid. And if the fee is quoted to you as a percentage, make sure that you understand what that translates to in dollars.
How do I choose the right investment professional?
Ask questions! You can never ask a dumb question about your investments and the people who help you choose them, especially when it comes to how much you will be paying for any investment, both in upfront costs and ongoing management fees.
Here are some questions you should ask when choosing an investment professional or someone to help you:
- Are you licensed and registered with the SEC, FINRA or a state regulator?
- What training and experience do you have? How long have you been in business?
- What is your investment philosophy? Do you take a lot of risks or are you more concerned about the safety of my money?
- Describe your typical client. What experience do you have working with people like me?
- How do you get paid? A “commission” that is based on certain transactions in my account? A percentage of assets you manage? Another method? Do you get paid more for selling your own firm’s products?
- How much will it cost me in total to do business with you?
An investment professional has a duty to make sure that he or she only recommends investments that are suitable for you. The best investment professional is one who fully understands your objectives and matches investment recommendations to your goals.
“Robo-advisers” offer automated digital investment advisory programs. They allow individual investors to input information through a web portal or mobile application, and they use that information to create and manage those individuals’ investment accounts. Robo-advisers are typically registered investment advisers. In some cases robo-advisers may offer advisory services at a lower cost than traditional advisers, but your ability to interact with a human may be very limited or non-existent. You should carefully consider whether a robo-adviser is right for you before making a decision to invest through one.
Before you Invest, Investor.gov
Investor.gov has a free and simple search tool that allows you to find out if your investment professional is licensed and registered, and if he or she has a disciplinary history or customer complaints. ALWAYS check the background of any investment professional before hiring him or her to manage your money.
The Office of Investor Education and Advocacy has provided this information as a service to investors. It is neither a legal interpretation nor a statement of SEC policy. If you have questions concerning the meaning or application of a particular law or rule, please consult with an attorney who specializes in securities law.