Your life partner handled your finances for 35 years. Suddenly, he’s gone. No matter how much you trust your financial advisor, the ultimate responsibility is now yours. You need to know the rules and tools of the game.
9 INVESTMENT TERMS YOU NEED TO KNOW
NINE COMMON INVESTMENT TERMS
1. 401(k): This is a retirement savings plan offered by many for-profit companies. A portion of each paycheck can taken out before taxes and invested so that it grows tax-free, over time, until you withdraw the money in retirement.
Tax-free growth makes a huge difference in the amount of money you can accumulate. Some companies will match part of the money that you contribute, helping your savings grow even faster. Not-for-profit employer-sponsored retirement savings plans include: 403(b) plans for employees of tax-exempt organizations; 407 plans for state and local government employees; Thrift Savings Plans (TSP) for federal employees.
2. IRA stands for Individual Retirement Account. It’s another type of retirement savings account but, unlike 401(k)s, IRAs are not sponsored by employers, and can be opened by individuals. You can contribute income up to a set maximum amount for a traditional IRA, Roth IRA, Simple IRA, or a SEP IRA.
3. Compound interest. Say you make a $100 investment that goes up 10% (or $10) in one year. Its now worth $110. The next year, it goes up another 10%, but this time that 10% equals $11, because its base value was higher. Bottom line: With compound interest, an investment growing at the same yearly rate (say, 10%) in effect grows faster each year simply because each year its base keeps getting higher. (By the same token, compound interest that you owe can drown you in debt.)
4. Diversification in the investment field means, don’t put all your money in one kind of investment. No one can predict the future, so it’s better to have many kinds of investments to reduce the risk of losing a lot of money in any one part of the investment market.
5. Asset allocation is a kind of diversification in which you spread your money (or assets) across three different asset classes:
• Cash means physical money (dollars and cents). It also means your savings account, a money market account, and/or government bonds that can easily and quickly be cashed.
• Bonds. Buying a bond means that you are lending money to an organization (corporate bond),
or government entity (U.S. government or municipal bond), with a right to receive interest. Some bonds are considered safe investments, but they generally return less money. So-called junk bonds provide a higher return for the loan, but they are riskier.
• Stocks are shares of ownership in a public or private company. When the company does well, your investment may be worth more money. When it does poorly, your investment may be worth less.
6. Capital gains and losses. When you sell something for more than you paid for it, that’s a profit, or capital gain. If you sell something for less than you paid for it, that’s a capital loss. The IRS taxes capital gains, but it lets you deduct your losses from your taxes. Capital gains can occur with any kind of property—stocks and bonds, real estate, jewelry, art, and more.
7. A mutual fund is an investment program funded by shareholders that trades in diversified holdings (stocks, bonds, etc.) and is professionally managed by an investment company, such as Vanguard or Fidelity Investments.
• Expense ratio is the annual fee a mutual fund charges for operating costs, management fees, and administrative fees. This cost usually averages between 0.25% and 2% of assets under management.
8. An index fund is a mutual fund that tracks a particular market index, such as the Standard & Poor’s 500 Index, which is based on the market value of 500 large, publicly traded U.S. companies. You can also buy an index fund of the total market of U.S. stocks, the total market of international bonds, etc. Note: Index funds charge much lower fees than do other types of mutual funds, because they include all the funds in a given market, which means you’re not hiring someone to choose among individual securities. Historically, index funds have generally been a superior way to invest if you buy and hold. This has been true mainly because of their lower costs.
9. Tax efficiency. This is a measure of how much of an investment return (income or capital gains) is left after taxes are paid. In general, the more an investment relies on income (usually interest payments and dividends), rather than capital gains, the less tax-efficient it is.
RETIREMENT PLANNING RESOURCES
There are several helpful sources of detailed information on retirement planning. One such is Investopedia. Others are listed below, and still more may be found through your search engine. Be wary, however, of advice and information coming from investment business sources who are competing for your business. Their information may be biassed.
For more information:
• en.wikipedia.org - Compound interest
• investopedia.com - Planning for retirement
• lifehacker.com - Definitions of financial terms
• asaging.org - Financial knowledge and decision-making of older adults
• twocents.lifehacker.com - Opening an IRA
• investopedia.com - Mutual funds
• investopedia.com - Investment tax efficiency