Sunday, August 5, 2007

Investing Made Simple Part IV - Getting Started

When people want to jump into investing, they often are overwhelmed by the amount of different options available to them. This "information overload" can result in "information paralysis". The endless possibilities are enough to render the most intelligent investor numb with inaction. Fear washes over you as you become afraid to take that first step - afraid that the first step will be a misstep. Never fear - your humble host is here to provide you with some advice of things that you MUST do to get started investing.

1. If you are eligible to contribute to a 401(k) plan that offers a company match, contribute at least enough to get the FULL match.

A 401(k) plan is a employer sponsored investment plan. In a nutshell, you can have some percentage of each paycheck deducted and put aside for your retirement. There are rules and restrictions, but the main things to know are:

A. You do not pay tax on the money that is deducted. Taxes are postponed until you withdraw the money.
B. You cannot use this money until you are 59 1/2 years old (although there are some circumstances where you can access this money sooner). The money is intended to be used for one's retirement.

Some companies offer to "match" your contribution as an incentive to get its employees to save for their retirement. For instance, the company that I work for has a 3% match. What that means is that they will match your contribution up to 3% of your salary. So if you have a paycheck of $3000 and you have 3% deducted to go into your 401(k) plan ($90), the company will also contribute $90. If you only contributed 2%,the company would also contribute 2%. If you decided to contribute 4%, the company will contribute 3%, since your contribute goes beyond the maximum that they will contribute.

Basically, you want to be contributing AT LEAST enough so that your company contributes its maximum. So in the case of my company, you want to be contributing at least 3% to your 401(k) plan.

The reason why is simple: this is the one of the only investments where you can IMMEDIATELY get a 100% return on your money. In my example above, if you are contributing $90 and your company is contributing $90, you will immediately double your money. You have invested $90, but $180 shows up in your account! That is a rate of return of 100%.

Not all companies match your contributions dollar for dollar. Some will only match 50%. That's okay. A 50% return is still a great return. Other companies don't match anything. In that case, a 401(k) might still be a good investment for you, but then it isn't the "no brainer" that it would be if your company did have a match.

401(k) plans offer a variety of "funds" in which you can invest your money. How you should invest your 401(k) money probably the subject of another posting, so stay tuned for that! However, I'll give you a little preview....

If your retirement is many years away, you want to invest most of your money in a stock index fund (S&P 500 index fund is a good one to start with if you aren't sure). As you get closer to retirement, you will want to shift money out of stocks and into some sort of a fixed income option.

2. Get a checking account and a savings account with a bank.

If you have any sort of job, chances are that you already have a checking account. A checking account provides a way to have easy access to your money when you need it for your day-to- day bill paying. Checking accounts are not investments, per se, since you usually MAKE money from having a checking account (Yes there are checking accounts that pay interest, but they usually have a very low rate of interest, so they is hardly investments). However, a checking account is a convienent place to park money that you will need for your daily needs.

When you are looking for a checking account, here are some things to consider:

A. Get an account that is federally insured (FDIC or the credit union equivalent). FDIC is a government insurance program which protects your money that is deposited at the bank if the bank goes out of business. If that happens, the government guarantees that you will get your money back, up to $100,000.

B. Get an account that has as low a minimum balance as possible. Many checking accounts have a minimum balance requirement. Unless you keep X dollars in the account at all times, you get charged some fees. Some banks will waive this fee if you have some other relationship with the bank (ex: you have money in some other account, you have a mortgage with the bank, etc). Your goal is to get an account that has as low a minimum as possible, and of course you want to make sure you keep that amount in the account so that you avoid any fees. Fees are BAD and should be avoided at all costs.

C. Get overdraft protection. If you write a check for more money than what you have in your account, you get hit with even more fees. These fees can eat away your hard earned money. To avoid this possibility, you want to get some sort of overdraft protection. This can take the form of a "line of credit" (sort of like a credit card where the bank lets you write the check but then charges you interest until your account is "in the black" again - the interest is sort of a fee, but it is usually cheaper than the overdraft fee), or the form of a transfer from a "linked" savings account that you have with the bank.

Other things that you might look for are ATM locations, online banking capabilities, friendliness of the bank staff, etc. I didn't list those are "musts" since those are personal preferences.

In addition to a checking account, you should also get a savings account where you can park extra money. A savings account is different from a checking account in that you can't write checks to access your money, but you earn a higher rate of interest than you would in a checking account. This account serves two purposes:

A. You can stash your emergency fund in this account. An emergency fund is money for those unplanned, unbudgeted expenses from time to time. Normally, you won't be touching this account except in an emergency (hence the name emergency fund), but if you DO need this money, you want to be able to access it at a moment's notice.

B. You can park extra money here that you will be investing at some point in the near future.

You want the money to earn interest so that at least the money is "working" for you, but you also want the money to be easily accessible for when you need it.

Since your savings account will be at the same bank as your checking account, the bank is already chosen for you. Most banks will have a variety of savings account choices. Usually the difference in accounts boils down to the following characteristics: minimum balance and interest rate. Accounts that have a lower minimun balance usually have the lowest interest rate. Choose the savings account that has the highest interest rate for the amount of money that you will be keeping in the account. You want to avoid going below the minimum balance at all costs.

There are various "online banks" that offer money market funds, which are essentially savings accounts. In many cases, the online banks offer higher interest rates than the interest rates at your local bank. Because they can be linked to any checking account, some people will have a checking account with a local bank and a savings account with one of these online banks. However, I prefer having my checking and savings account with the same, local bank for the following reasons:

A. Having accounts at the same bank allow me to transfer funds between checking and savings accounts, and have the funds available immediately. Transfers between institutions often take a day or two to clear.

B. Banks often use the total of all accounts with the institution to see if you meet the minimum balance requirements.

C. You can get perks when you have a ongoing relationship with one bank. For instance, my bank offers services for "preferred" customers, such a free travellers checks, notary services, discounts on safety deposit boxes, etc.

D. As mentioned above, you can use your savings account for overdraft protection to save you from paying fees or interest.

E. Call me old fashioned, but I like to be able to have someplace where I can talk to someone, face-to-face, when I have a problem.

So in closing, if you want to get started investing, make sure you get your company's full 401(k) match, and make sure that you have a checking account for your day-to-day spending along with a savings account where you can park your emergency money.

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