Saving and Investing
The CT Department of Higher Education, in partnership with UConn and CPTV, has created a new online program, "Who Wants to Be Financially Responsible?" to educate students about money management in an interactive game format. Check out Episode #2: Cash Management and Episode #6: Investments for more information on saving and investing.
Why Save?
Taking control of your financial situation helps reduce the anxiety of not knowing whether you have the money to pay your bills when they are due. It is important to have a sense of control over money, rather than letting money have control over you.
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1. to purchase planned goods or services in the future;
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2. to buy goods or services that people suddenly see and want;
- 3. to deal with emergencies and unexpected events.
How To Get Started
- Make a Plan
- Pay Yourself First
- Start Small but Start Now
- Make Saving Automatic
- Decide Where to Keep Your Savings
Make a Plan
In order to have money to save or invest, it is important to have a plan or budget the money you have coming in. The Personal Financial Plans and Goal Setting sections of this site can help get you started. All financial decisions involve trade-offs – gaining something and giving something up. When you spend, you give up the opportunity to save. If you want to achieve a financial goal, you need to give up some of your spending. Once you decide what you're saving for—and when you'd like to have it—you can decide how you should save and invest.
Pay Yourself First
To pay yourself first means simply this: Before you pay your bills, before you buy groceries, before you do anything else, set aside a portion of your income to save. The first bill you pay each month should be to yourself. This habit, developed early, can help a person build tremendous wealth. You might think it’s impossible to save money, while you’re in college. Think again! Here are a few ideas to try:
- If you get money from home, put part of it into your savings account and the rest into your checking account.
- If you have a job, put $10 or $20 from each paycheck into your savings before you pay other bills.
- Put $1 a day plus your loose change in a cup or jar. By the end of the month, you may have $50 or more to deposit into your savings account.
Start Small but Start Now
Don't feel that saving has to be "all or nothing!" Saving even small amounts while you're paying your obligations can put compounding to work for you. Pay yourself first! Have money deducted automatically from your paycheck or set up automatic savings from your checking account, so you save before you can spend. Additionally, it may never be easy to begin saving a larger percentage of your earnings all at once. Starting small and building your savings over time can be a good step toward reaching your goal.
By setting money aside every month, your savings will grow even faster. According to the "Cool Million" calculator at http://www.dinkytown.net/, if at age 21 you began saving $100 a month at 8 percent interest, by 65 your account would be worth over $450,000. Increasing the monthly contribution to $200 would double that to more than $900,000. And, by saving $300 a month, you'd reach $1 million by age 61.
Postponing savings can hurt. The longer you delay saving, the harder it is to catch up. According to the "Don't Delay Your Savings" calculator at http://www.dinkytown.net, if you saved $100 a month at 8 percent interest, after 20 years your account would be worth $57,266. But wait only two years to begin saving and that balance would shrink to only $46,865 – over $10,000 less. A five-year delay would reduce the balance to only $33,978. Why? Because of the magic of compounding.
The Magic of Compounding
- What is compounding? Basically, it's putting aside money – whether in savings, a retirement account or the stock market – and then essentially leaving it alone. As your account earns interest or dividends, you continually reinvest those profits, generating (compounding) additional earnings at an accelerated rate.
For example, the value of $1000 compounded at various rates of return over time is shown in the following chart:
| Years | 4% | 6% | 8% | 10% |
|---|---|---|---|---|
| 10 | $1,481 | $1,791 | $2,159 | $2,994 |
| 20 | $2,191 | $3,207 | $4,661 | $6,728 |
| 30 | $3,243 | $5,743 | $10,063 | $17,449 |
Start Saving Early
- For every 10 years you delay before starting to save for retirement, you will need to save three times as much each month to catch up.
- Starting at 20 - If you put $1,000 a year into an IRA every year from age 20 through age 30 (for 11 years) and stop - and the account earns seven percent annually - your savings will equal $168,514 at age 65.
- Starting at age 30 - If you don't start until age 30, but save the same $1,000 amount annually but for 35 years straight at the same seven percent rate, you will have saved three times as much money but your account will grow to only $147,913 at age 65.
Make Saving Automatic
- With so many bills, expenses, and day-to-day expenses to take care of, saving money can seem nearly impossible. The best way to develop a saving habit is to make the process as painless as possible. Make it automatic. Make it invisible. If you arrange to have the money taken from your paycheck before you receive it, you’ll never know it’s missing.
Decide Where to Keep Your Savings
At some point you will need to decide what you will do with your savings. You will want the savings you have to earn money. Investing is putting your money to work to earn more money. Interest rates matter. The higher interest rate your investment returns, the more money you can make. However, there is a direct correlation between interest rates and risk. The riskier the investment, the greater your potential gains – and losses. For example, regular savings accounts typically offer very low interest rates in exchange for very low risk of loss. On the other hand, investing in the stock market can potentially earn double-digit investment rates over long periods of time. Of course, stocks can be a risky short-term investment, as we've seen this past year.
So why not simply park your money in a safe haven? Simple: inflation. If your money is earning 2 percent interest but the inflation rate is 3 percent, you'll actually net a 1 percent loss.
Savings Accounts
- If you save your money in a savings account, the bank or credit union will pay you interest, and you can easily get your money whenever you want it. At most banks, your savings account will be insured by the Federal Deposit Insurance Corporation (FDIC). With these products, your money tends to be very safe because it's federally insured, and you can easily get to your money if you need it for any reason. But there's a tradeoff for security and ready availability. Your money earns a low interest rate compared with investments. In other words, it gets a low return.
Insured Bank Money Market Accounts
- These accounts tend to offer higher interest rates than savings accounts and often give you check-writing privileges. Like savings accounts, many money market accounts will be insured by the FDIC. Note that bank money market accounts are not the same as money market mutual funds, which are not insured by the FDIC. Again, the easy access to funds and safety of this type of account are balanced by a low return.
Certificates of Deposit
- You can earn an even higher interest if you put your money in a certificate of deposit, or CD, which is also protected by the FDIC. When you buy a CD, you promise that you're going to keep your money in the bank for a certain amount of time.
Stocks
- Have you ever thought that you'd like to own part of a famous restaurant, or the company that makes the shoes on your feet? That's what happens when you buy stock in a company-you become one of the owners. Your share of the company depends on how many shares of the company's stock you own.
- Over the past 60 years, the investment that has provided the highest average rate of return has been stocks. But there are no guarantees of profits when you buy stock, which makes stock one of the most risky investments. If the company doesn't do well or falls out of favor with investors, your stock can fall in price, and you could lose your money.
- You can make money in two ways from stock. First, the price of the stock can rise if the company does well and other investors want to buy the company's stock. If a stock rises from $10 to $12, the $2 increase is called a capital gain or appreciation. Second, a company sometimes pays out a part of its profits to stock holders-that's called a dividend. Sometimes a company will decide not to pay out dividends, choosing instead to keep its profits and use them to expand the business, build new factories, design better products, or hire more workers.
- One of the riskiest investments you can make is buying stock in a new company. New companies go out of business more frequently than companies that have been in business for decades or longer. If you buy stock in a small, new company, you could lose it all. Or the company could turn out to be a success. You'll have to do your homework and learn as much as you can about the company before you invest. And only invest money that you can afford to lose.
Bonds
- Many companies borrow money so they can become even bigger and more successful. One way they borrow money is by selling bonds. When you buy a bond, you're lending your money to the company so it can grow. The company promises to pay you interest and to return your money on a date in the future.
- The company's "promise to repay" your principal generally makes bonds less risky than stocks. But bonds can be risky. To assess how risky a bond is you can check the bond's credit rating. Unlike stockholders, bond holders know how much money they will make, unless the company goes out of business. If the company goes out of business or declares bankruptcy, bondholders may lose money. But if there is any money left in the company, they will get it before stockholders. Bonds generally provide higher returns (with higher risk) than savings accounts, but lower returns (with lower risk) than stocks.
Mutual Funds
- Stocks and bonds can be purchased individually, or you can buy them by buying shares of a mutual fund. A mutual fund is a pool of money run by a professional or group of professionals who have experience in picking investments. After researching many companies, these professionals select 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.
- Mutual fund risk is determined by the stocks and bonds in the fund. No mutual fund can guarantee its returns, and no mutual fund is risk-free.
What is Right for You?
- When it comes to savings, there isn’t a right or wrong answer. It ultimately depends on your needs. If you are using your savings for overdraft protection and want to have it available instantly in the event you need it, a savings account might be the most appropriate. If you are saving for a large purchase or something predictable a few months or years down the road, you can probably find better rates with a CD or possibly a money market fund.
- For many people, it comes down to having a mix of multiple savings vehicles. There will be part of an emergency fund in a savings account at the bank, possibly some cash in a money market fund in an investment account, and some CDs or bonds stashed away for longer-term savings. Always remember: the greater the potential return, the greater the risk. Whatever the case may be, you want to make sure your money is working as hard as it can.
- There are hundreds of excellent finance, investing, economics, accounting, business and management books in the world. A few hours of well-directed reading each week can have a fattening effect on your pocketbook as well as give you something to talk about at your next cocktail party.
Other Resources
- Numerous interactive calculators are available online to help you estimate potential savings under different scenarios. Try the various calculators located at http://www.dinkytown.net
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66 Ways to Save: http://www.pueblo.gsa.gov/cic_text/money/66ways/index.html
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What's Insured and What's Not: http://www.frbsf.org/publications/consumer/products.html
