Investing starts with saving. Before making your first substantial investment, you need to have enough money saved up for it. This is why a recent graduate has different priorities than someone who’s been part of the work force for a few years.
To clarify, investing and saving are two separate things, serving different purposes. Investing is putting money aside in order to make it grow, to provide for long-term goals such as your retirement, your children’s college expenses, or something like a wedding. You invest in what you think will increase in value over time, which can be anything ranging from stocks, property, and artwork to shares in a fund.
Short-Term and Long-Term Investments
You are saving for short term needs, often by putting aside a small amount of money every month into a savings account in a bank or building society for easy access. Short term goals can be a holiday, a new car, or coverage for emergencies that might pop up. While the opinions of exactly how much you should have saved for emergencies may differ, the minimum is usually considered enough money to cover three months worth of living expenses such as rent, phone, gas, food and utilities in case you’d lose your job. Medical expenses can quickly accumulate too, should something happen, and need be taken into consideration as well.
A recent graduate with an entry-level position may not have too much money available to save, especially those struggling with large student debts, which the majority of graduates have. Start saving by having a small amount transferred to your savings account every month when you get paid. You won’t notice it, but it will quickly grow. You can also keep only the amount you need to live on from your salary into your checking account, and put the rest into your saving account.
If your whole paycheck is available in your checking account, you are likely to spend it. Thirdly, in the beginning of your career you are likely to advance quickly. When time comes for a raise, you can allocate a portion, such as half the amount of your new raise, into your savings account. You won’t notice it at all, since you still have more spending money than before the raise. If you continue to save this way, you’ll be able to save larger and larger amounts as your income increases. It won’t take long to build an emergency fund, along with short-term goals, and you can soon save up for larger investments.
Save and Invest
On a smaller scale, you can and should both save and invest at the same time. A great option for young employees is an employer’s 401(k) retirement plan. Often the employer will match a percentage of the employee’s contributions, which essentially is free money. There is another reason to start saving young, and it’s called compounding. For example, if you start saving for your retirement at age 25, and you put aside $3,000 a year in a tax-deferred retirement account for 10 years, your $30,000 investment will have grown to more than $338,000 by the time you reach 65.
On the other hand, if you start saving the same amount at age 35, and continue for 30 years until you are 65 years old, you will have only set aside only about $303,000 despite having invested three times as much over the course of the 30 years. Keep in mind that even though you’re likely to have a larger income in your 30’s, you’re also likely to have more expenses such as mortgage, childcare, car payments and such, making it more difficult to put money aside.
Still, $3,000 a year can be a stretch when also struggling with student debts and savings, but starting with as little as $25 weekly in an IRA and continuing for 40 years, assuming an average return on your investment dollars of 8 percent, will also result in an impressive growth over time, with investments worth about $350,000 when it’s time to retire. Keep in mind that funds such as IRA’s have yearly tax-deductible limits, and the more years of savings, the more years of tax benefits.
These are affordable options that will give you a substantial return of investment. However, later in your career you are likely to have accumulated enough savings for more substantial investments. When looking at stocks and bonds, a popular idea is that a person’s age should correlate to the percentage of their portfolio that should be in bonds. A 35-year old should have a portfolio with 35% bonds, while a 60-year old should have 60% bonds.
However, others warn against this since the real return of bonds is only about 1-2% which is too little for people in their twenties, thirties or forties. Therefore, they should generally keep their allocation to bonds much lower than their age. But also the elderly investor at the beginning of retirement, may find two-thirds allocation to bonds too high.
Bonds may be sufficient for preserving wealth, but retirees need to see ongoing growth in their portfolio too, in order to continue to provide for their continued retirement needs. Therefore, to try to keep pace with inflation, enough stocks remain important for the portfolio also later in life. With Americans living longer and longer, financial planners are recommending and adjustment to the age rule, so that it should be 110 or 120 minus your age. This will make your money last longer.
Gryfin Test Prep is dedicated to making the learning process efficient and enjoyable for those looking to acquire advanced professional certifications. They specialize in preparing individuals for the CIA, CISA, EA, CMA and CPA exams and actively write about industry trends in the world of finance and accounting.
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