Investment Options in Today’s Financial Market
Each year you should make it a goal to save at least ten (10%) percent of your net income for retirement. One of the best ways to ensure that you save ten (10%) percent of your net income is to open up a retirement account and have ten (10%) percent of each one of your paychecks automatically deposited into it. This idea is what is often referred to as “paying yourself first.” In order to make this happen, you will have to learn to live on less.
There are many different ways individuals can invest their hard earned money for retirement. The following is a list of some of the most common types of investments where individuals place their money when saving for retirement.
• 401 K
• Roth Individual Retirement Account
• Certificates of Deposit
• Mutual Funds
• Individual Stocks
The following is a brief overview of each one of the aforementioned types of investments
A 401 (k) plan is an employer sponsored plan to assist individuals in saving for retirement. If you enroll in a 40l (k) plan with your employer, you must choose a percentage of your income to contribute to the plan. Each paycheck, money will be automatically deducted and deposited into your 410 (k) account. All contributions you make to the plan will be done so on a pre-tax basis.
If you invest in a 401 (k) plan, it will contain several different types of mutual funds to invest your contributions in. The mutual funds within your 401 (k) plan will invest in stocks, bonds and money market investments. You must allocate your resources as you see fit.
The money you invest in your 401 (k) plan for a given year will not be taxed at the federal level for that specific year.
For example, lets assume you earn $40,000.00 per year. Over the course of the year you contributed $4,000.00 into your 401 (k) plan. Assuming you are in the 25 percent tax bracket, you would have saved $1,000.00 in taxes ($4,000.00 multiplied by 25 percent) since you do not have to pay federal taxes on the $4,000.00 you contributed to your 401(k).
In any event, you will still be responsible for paying taxes on your 401 (k) contributions and any gains, as you withdraw the money during retirement. This money will be taxed as ordinary income.
Many employers that have 401 (k) plans will match, up to a certain percentage of the money, dollar for dollar, that their employees contribute into their 401 (k) accounts. Employers do this to entice their employees to save more for retirement. You should make every attempt possible to contribute at least the percentage of your income that your employer is willing to match.
Let’s assume your employer matches your contributions, dollar for dollar, up to five (5%) percent of your contributions. Given the foregoing, you should contribute at least five (5%) percent of your income into your 401 (k) plan. By not doing this you are giving away free money.
There are limitations with regards to how much money you can contribute to your 401 (k) each year. As of 2011, employees 49 and younger can contribute up to $16,500.00 into their 401 (k) accounts. For employees 50 and older, the contribution limit is $22,000.00.
If an employee leaves the job where he or she had a 401 (k) account, the employee can keep the account with the ex-employer, but may have to pay a fee to do so. Alternatively, the employee that left a job where he or she had a 401 (k) account, can roll the account over into his or her new employer’s 401 (k) plan. Another option for an employee who left a job where he or she had a 401 (k) account is to roll over the account into an Individual Retirement Account.
Typically, you have to wait until you are 59 ½ years old before you can begin withdrawing money in your 401 (k), without incurring a penalty. In most circumstances, if you withdraw money from your 401 (k) account before you are 59 ½, you will incur a penalty. Once you turn 70 ½ years old, you are required to begin withdrawing money from your 401 (k) account. The Internal Revenue Service has requirements with regard to how much money you have to withdraw each year, once you turn 70 ½ years old.
Roth Individual Retirement Account (Roth IRA):
All contributions made into a Roth IRA are made with after tax dollars. Since contributions into a Roth IRA are after tax dollars, you typically will not be taxed on any earnings. This is one of the best advantages of a Roth IRA. In addition, you will typically not be taxed on the money you contributed to your Roth IRA once you begin to withdraw it.
As of 2011, if you meet certain income requirements and are 49 or younger, you can contribute up to $5,000.00 each year into a Roth IRA. If you are at least 50, you can contribute up to $6,000.00 per year.
If you open a Roth IRA and keep it open for at least five (5) years, you are allowed to withdraw your contributions without penalty. You have to wait until you are at least 59 ½ before you can withdraw the earnings portion of your Roth IRA, without incurring a penalty or paying taxes on any earnings.
Let’s assume you are 62 years old and over the past eight (8) years you contributed a total of $15,000.00 to your Roth IRA. Your Roth IRA is now worth $25,000.00. When you go to withdraw the money, you will not be taxed on any of the $25,000.00 in the account.
If you contribute money to a 401 (k) plan, you can still contribute money to a Roth IRA, if you meet certain income requirments.
If you want to open a Roth IRA account, you can go to a bank, full service stock broker, discount broker, or online broker to get started. Each of the aforementioned will be able to assist in you in the process.
Traditional Individual Retirement Account (Traditional IRA):
As opposed to a Roth IRA, Traditional IRA contributions are tax deductible if your income is below a certain amount. Furthermore, all transactions made within a Traditional IRA are not taxed.
Unlike a Roth IRA, once you retire and begin to withdraw money from your Traditional IRA, all of the money in the account is subject to federal income tax and will be taxed as ordinary income.
If you are considering opening either a Traditional IRA or a Roth IRA and are not sure which to open, you should probably consult a financial professional to see what is the best option is for you.
As of 2011, you are allowed to contribute up to $5,000.00 into a Traditional IRA if you are 49 or younger. If you are 50 or older, you can contribute up to $6,000.00.
If you contribute money into a 401 (k), you can still contribute money into a Traditional IRA, assuming you meet certain income requirements.
If you want to open a Traditional IRA, you can go to a bank, full service stock broker, discount broker or online broker to get started. Each of the aforementioned will be able to assist in you in the process.
Certificate of deposits (CDs):
A certificate of deposit is a financial product offered to individuals by banks and credit unions. When an individual purchases a CD from a bank or credit union, he or she agrees to deposit a certain amount of money with that financial institution for a certain amount of time. In return for agreeing to keep the money in the bank or credit union for a certain amount of time, the individual is typically paid a fixed interest rate on the purchase price of the CD.
Typically, you have the option to either receive a monthly interest check or you can let the interest payments accumulate until the CD matures.
Let’s assume you go to your local bank and purchase a three (3) year CD for $5,000.00 that pays three (3) percent interest. Since you purchased a three (3) year CD, you agree to keep the CD for three (3) years from the date of purchase. Since th CD pays three (3) percent interest, you should be able to receive a monthly interest check in the amount of $12.50. Alternatively, you can let the interest accrue and be paid all of it, along with the purchase price of the CD, once the CD matures.
The majority of individuals that purchase CDs typically purchase ones that have a duration of three (3) months to five (5) years.
CDs typically pay a higher interest rate than money that is kept in a savings account. The reason being is that by purchasing a CD, you commit your money for an agreed-to amount of time. This differs from a savings account where you can withdrawal money at any time you choose.
If you purchase a CD and withdraw the money earlier than the maturity date, you will be assessed a substantial penalty. Therefore, you should probably not cash out a CD before the maturity date.
You are not limited to owning only one (1) CD during any given time period. For instance, if you purchased a five (5) year CD last year for $3,000.00, you can still purchase as many more CDs as you desire.
Banks and credit unions typically have a minimum purchase price for their CDs.
A mutual fund is a type of company where money is pooled together from many individuals to invest in stocks, bonds, short-term money market instruments, and other securities. In the United States alone, there are thousands of different mutual funds. Mutual funds vary in what types of securities they own. For example one mutual fund may only invest in the stock of small size energy companies while another mutual fund may only invest in junk bonds.
Mutual funds enable small individual investors to invest in a diversified portfolio as opposed to investing in individual stocks or bonds, which can be more risky. Each mutual fund employs a manager who is responsible for buying and selling the securities within the mutual fund.
Once you invest in a mutual fund, you will own shares in the mutual fund, which represent the holdings of the mutual fund.
When investing money with a mutual fund, it may be wise to research the mutual fund you are considering to invest with to ensure that it has a history of producing solid returns. Furthermore, you may want research its average annual return over a ten (10) year period.
There are many sources such as Money Magazine, Forbes, The Wall Street Journal, etc., that publish information regarding mutual fund performance. Also, you can order the prospectus of the mutual fund you are considering to invest with, directly from the mutual fund. The prospectus will give you material information about the mutual fund.
Another factor to consider when investing money in a mutual fund is the commissions and fees that you will incur. You can purchase shares in a mutual fund through brokers, insurance agents, financial planners, banks, and the mutual fund directly. There will usually be commissions that you will have to pay when buying or selling shares in a mutual fund. In addition, the mutual fund will charge management fees for costs associated with managing the mutual fund.
When investing in a mutual fund, you may want to consider one that has a relatively inexpensive commission and/or fee structure as compared to its peers.
If you do not feel comfortable selecting a mutual fund to invest in on your own, you may want to seek the assistance of an investment professional to help you in your selection.
If you own one (1) share of stock in a public company, you are a partial owner of that company. Examples of public companies that you have probably heard of that issue stock include Microsoft, General Electric, McDonald’s, Nike, etc. If you own at least one (1) share of a public company, you will be considered a shareholder of that company.
When you purchase stock, you typically buy it through a stock broker. The stock broker will charge you a commission. There are full service stock brokers and discount stock brokers. Full service brokers typically charge more commission for purchasing and selling stock than discount brokers do. However, full service brokers may provide more investment advice and personal service than a discount broker.
Another way to purchase stock in a public company is by purchasing it directly from the corporation. Many public companies allow you to purchase stock directly from them and will charge you a nominal fee (if any), for doing so. If you want to purchase stock in a public company directly from them, go to the company’s website to get the contact information for the investor relations department. Next, call the investor relations department to see if this option is available and if so, inquire about what steps you need to take to do so.
Many companies that issue stock distribute a portion of their income to the shareholders in the form of dividends. If a company pays a dividend, it will typically pay it on a quarterly basis.
When purchasing stocks, you want to buy low and sell high. Hence, you want to have the stock rise in value from the time you bought it until the time you sell it.
As mentioned earlier, owing individual stocks may be more risky than owning shares in a mutual fund.
A bond is a debt security that is created when the debt issuer (borrower) issues debt to the bondholder (lender). To put it another way, the debt issuer borrows money from the bondholder. In return for borrowing money, the debt issuer will pay the bondholder interest, usually on a semi-annual basis. The interest rate that the bondholder is paid is called the coupon rate. In addition, the debt issuer will repay the bondholder the original amount of money loaned once the bond matures.
Typically, when bonds are issued, they are for specific periods of time. Once that specific period of time is up, the bondholder will be repaid the original amount of money lent to the debt issuer.
Bonds can be issued by entities such as corporations and municipalities in order to finance long-term investments. In addition, bonds can be issued by the government to finance spending.
There is a chance that the debt issuer will go bankrupt. In the event this occurs, the bondholders may not be repaid the money they loaned. Bonds are rated by credit agencies. The higher the bond rating, the higher probability the bondholder has in getting paid back. Bonds that have been issued low ratings typically pay higher interest rates than bonds that have been issued higher ratings. This is because the debt issuer of these bonds has a higher probability of filing for bankruptcy.
If you consider investing in bonds, you may want to consult an investment professional to assist you in your selection.
In order to make your short-term and long-term financial goals a reality, you need to have an income.