Four key things to learn and know on your way to financial literacy.
- The difference between saving and investing: Some people think these are one and the same, but they’re not. The focus in saving is on preserving money that you accumulate over time. Money that is saved is typically “stored” in low-risk vehicles, such as fixed annuities, bank savings accounts, CDs and money market accounts, which guarantee the principal and interest. A savings approach is appropriate for shorter-term needs that generally require a higher degree of liquidity, but is generally not the best approach for accomplishing your longer-term financial objectives. Investing, on the other hand, emphasizes accumulation through growth. Investment vehicles, such as stocks, bonds and mutual funds, involve a greater risk to principal than do savings vehicles, but also offer a higher return potential and may better guard against inflation. Most financial plans reflect a combination of savings and investments.
- Risk and reward: First off, let’s understand that there is risk in saving and investing…it can’t be avoided. You could keep your savings in a mattress and the mattress could catch on fire! The key is to understand the different types of risk and the relationship of risk and reward. For example, savings vehicles typically have no risk of loss of principal (market risk) or lack of a ready market when you need the money (liquidity risk). Without these risks, however, they produce a relatively low return, which means that they may not grow at a rate to keep pace with inflation (purchasing power risk). Investment vehicles, however, do come with both market risk and liquidity risk, including the risk of losing your principal investment. With these risks, however, investment vehicles offer the potential to produce a higher return and greater accumulation over time. The objective is not to eliminate risk. Rather, the objective is to balance risk and return in a way that is consistent with your temperament and financial goals.
- Understand saving and investment vehicles: Take the time to understand what you’re saving and investing in…the potential risks and rewards, the fees and expenses, the advantages and disadvantages.
- Investment resources: Know where you can turn for advice. Decide whether you want to actively manage your investment portfolio or whether you’d prefer to pay an advisor to recommend specific investments, as well as make market timing and asset reallocation decisions.