At credit.org, we’re mostly concerned with helping people get educated and on their feet financially. Our clients are typically trying to eliminate revolving debt, or become homeowners. We don’t provide investment advice.
But we are concerned with financial success. We want all of our clients and everyone we educate to have a bright future and a secure retirement. Our Basics of Financial Planning booklet is available as a free .pdf download.
When it comes to saving for retirement, investments are usually part of the picture. There are many ways to put your retirement savings to work for you while you continue to save over the years. With persistent saving and careful investing, everyone with an income can financially prepare for their retirement.
Different Kinds of Investments
- Stocks are shares of a company. If you buy stock (or equity) in a company, you are a part owner of the company. If the company grows and performs well, your stock’s value can go up over time. If the company does poorly, declares bankruptcy, or goes out of business, your stock holdings can become worthless.
- Bonds are a form of debt. A company or municipality issues a bond to raise money from investors. If you purchase a bond, you are lending money in return for a promise to repay at a specified interest rate during a set period of time. When the bond has “matured”, the principal value of the bond is repaid. Corporate bonds may be subject to default in bankruptcy. “High-Yield” corporate bonds are at a higher risk of default—because the company involved cannot entice bond-holders or investors, they must offer a higher rate of interest to sell their bonds. High-yield corporate bonds are also known as “junk bonds.”
- Mutual funds take money from investors and put them into a variety of products, including stocks, bonds and loans. This combination of holdings is their portfolio. Buy buying into a mutual fund, you are entitled to a portion of the income generated by the portfolio.
- Money Market accounts are a type of mutual fund that let investors pool their money in a savings vehicle that earns better interest than a bank savings account. Money market funds may have minimum balances and limits on accessing the money in the account.
- Annuities are an insurance product. You purchase an annuity with regular payments or in one lump sum, and in exchange the insurer disburses payments back to you on a set schedule. This is a way of buying insurance for your retirement, but you also name a beneficiary who collects if you die.
- CDs or certificates of deposit were discussed in our Basics of Saving and Basics of Banking They are a form of savings account that hold your money for a set period of time and earn interest paid by the bank.
- Commodities involve buying futures on a particular good. This might be something like currency, metals, or agricultural products. If the value of the commodity goes up, the investment pays higher returns.
- Hedge Funds combine money from investors into higher-risk securities. These funds tend to be large and exclusive, so only people with a lot of money to invest can afford to get into a hedge fund. They are riskier than mutual funds, but may offer a much higher return. Often large institutional funds, like pension funds, will be invested in a hedge fund.
- 529 Plans are savings plans designed to pay for educational expenses. They are tax-exempt, but limited in how they can be used.
- myRA is a retirement plan sold by the US Treasury department. Workers who can’t get a retirement plan through their employer can set up a myRA account with automatic payroll deductions and no minimum contribution. These accounts can be rolled over to a Roth IRA. Learn more about myRA here.
- Savings Bonds are issued by the Treasury Department. Because they are government issued, these bonds are considered very safe investments. There are tax benefits to these bonds as well.
The stock market involves public companies selling equity to investors. A public company is one that is traded on the open market and provides public information about their business regularly.
A privately held company can have an IPO, or initial public offering, where they sell securities openly for the first time, and thereby become a public company.
Shareholders have a vote on company matters, like electing a board of directors or setting compensation for the company’s executives. If you have a retirement account, you probably get a lot of paperwork related to your investments. Among these are many of the required disclosures that come with being a public company, and proxy statements that talk about what is being voted on at shareholder meetings.
When you issue an order to trade stock, it may not be executed immediately. The price may change a little bit from when you made the order. Brokerage firms may advertise their speed of execution so you will know how quickly they can execute your trade orders.
Long and Short Positions
Taking a long position on a stock or commodity means you expect its value to go up. You purchase ownership of the asset and intend to hold it for a long time.
Taking a short position means you expect the stock’s value will go down. You borrow shares of stock and sell them at today’s price. Then you use those funds to buy the same amount of stock later after the price goes down. You return the shares to the brokerage you borrowed from initially, and keep the difference. If the price doesn’t go down, you owe even more money to the brokerage.
Short-selling example: Le Chiffre orders a short sale of 100 shares of Skyfleet Airlines. He borrows these shares through a brokerage and sells them immediately. The current price is $1 per share, so he has $100.
What he expects is that the airline will decline significantly in value. Say the price of the airline stock drops to 50 cents per share; he would then buy 100 shares for $50. He gives those shares back to the brokerage he initially borrowed from, leaving him with $50 profit.
Unfortunately, things do not go as Le Chiffre expected, and the stock value doesn’t go down at all. It goes up! When the stock rises to $2 per share, it now takes $200 to buy back the 100 shares he borrowed.
When buying and selling on the stock market, an investor can make orders:
- Market orders mean the stock or bond is purchased or sold right away. The price may fluctuate during the process, but it’s typically very close to when the order is issued.
- Stop-loss orders are orders to buy or sell when the stock or bond reaches a certain price. If you are in a long position, you might issue a stop-loss order to make sure you don’t lose if the price drops too low. It’s good to have a stop-loss order on a long-term investment if you are not going to be monitoring it regularly.
- Buy-stop orders that purchase a when a certain price level is reached. If you are in a short position on a stock, you might issue a buy-stop order to purchase stock before the value goes up too high. When the target prices are reached, both kinds of stop orders are converted to market orders and executed.
- Limit orders mean the stock or bond is only sold at a specific price or price range. You might issue an order to buy if the stock reaches a certain price or lower, or sell if the price reaches a certain price or higher. They are different from stop orders in that they are limited. They will never become market orders as they are only executed at the limit price range.
- Stop loss orders mean the trade will definitely be made if triggered, but the price isn’t guaranteed. Stop-limit orders guarantee the trading price, but the order isn’t guaranteed to be triggered.
An employee stock option is when a company grants an employee the option to buy stock at a specified price. They are typically offered over a set time period. The price is usually set at the time the stock option is given, and may be discounted from the actual price.
Employee stock options typically have a vesting period. So a company might offer a worker an option on 100 shares of stock that vest over four years. The first year, the worker may buy 25 shares, and the next year 25 more, then 25 the third year, and the last 25 shares the fourth year. The worker is then fully vested.
These purchases are all made at the original offered price. So if the original option was offered at $1 per share, but the price goes up by $1 every year, the worker still pays $1 per share for the last 25 shares, even though they are now worth $4 per share. Once the option has been exercised, the worker can sell them immediately, or hold on to them and hope the value keeps going up.
The idea behind these options is to entice workers to stay with a company, and to become invested in the company’s success. If the employee leaves the company, they no longer have the ability to exercise the stock option.
The option will also have a time limit, so if it is not exercised in time, the opportunity is lost. A worker would sensibly decline the option if the stock price drops.
In order to lower the risk of investing, it is wise to diversify. That means spreading investments out and not focusing too much on any one stock or investment. If you have all of your retirement in one company’s stock and it goes under, you will be wiped out. But if you have your retirement spread out over 30 different companies, then the consequences are not so dire if one of them goes under.
Some investment products diversify for you. A good mutual fund is already a combination of different investments. This is called portfolio management—the fund’s manager is typically buying and selling particular investments to keep the fund performing better than the market if possible.
A fund may also be indexed to a particular market index. A fund might be designed to match the Dow Jones Industrial Average, rather than trying to beat the market. If the market as a whole does well, the index fund does well. If the market tanks, then so will the index fund.
An important way to diversify is with international trading. Having investments in multiple countries means if one country’s economy does poorly or if their currency value falls, the entire investment portfolio doesn’t suffer.
Asset allocation means balancing your investments among a set of criteria. Each individual will have different priorities, so it’s good to work with an investment advisor to come up with an asset allocation strategy that works for you.
Some factors you might consider are how long you intend to be invested in the market and how much risk you are willing to take. A young investor might be able to bear much more risk than an investor who is very close to retirement. So the young investor might have their money in a fund that is 70% stocks and 30% bonds, while an older investor would have shifted their allocation to 30% stocks and 70% bonds.
Investing and trading on the market are complicated tasks and have many risks. We don’t offer investment advice, and urge anyone who is interested to consult a Certified Financial Planner. For help with debt, budgeting, or credit, call us today for personal, confidential help.