Financial Planning
External Links open in new window Savings and Investing
Few things are more important than saving money now to finance your future. Have you heard the expression, “money doesn’t grow on trees”? Money may not grow on trees, but it can certainly grow when you save early and often. Regardless of your income level, if you save regularly and invest wisely, you can be wealthy!
Income is a scarce resource because it’s limited. That’s why we have to make difficult decisions about spending and saving. What you give up to get something else – the next best alternative – is known as opportunity cost. Money you choose to spend today is money that can’t be spent tomorrow. The key to successful saving is a concept called “living below your means” - spending less money than you can afford to spend. Following this principle throughout your life will allow you to designate a greater portion of your income for savings.
Pay Yourself First
In order to become a good saver, you must understand the concept of paying yourself first. This means you identify a portion of your income as a fixed expense specifically for savings. In other words, you set aside that amount each month just as you would set aside money for rent or a student loan payment.
Savings Mix
Focusing less on spending and more on saving can be tricky, especially when there are so many areas in life where we feel our money should go. With so many options, where do you start?
Calculated diversity is the key. The idea is to create a blend of assets that provides the maximum return for your money. Most experts recommend a simple investment mix that can be achieved with the following steps.
1. Start an emergency account to cover unexpected expenses that would otherwise find their way onto a credit card. Experts recommend saving 10% of your income each month until you have enough money to cover 3 to 6 months of expenses. If 10% seems impossible, start at a lower monthly percentage and work your way up. Since an emergency is never planned, put your money somewhere easily accessible, like an interest-bearing savings account or money market account.
2. Whether you’re 25 or 55, retirement should be on your mind. Take advantage of an employer’s 401(k) or other sponsored investment program, especially if they offer matching funds. At minimum, contribute enough to get the full company match - that’s free money!
3. In addition to maximizing your contributions to a matched savings program, make regular contributions to a traditional or Roth IRA and/or mutual fund(s). Learn more about these investment options and access calculators and other planning tools at http://money.cnn.com/pf/retirement/index.html.
4. If you have children, consider making monthly contributions to the Oklahoma College Savings Plan (OCSP), our state’s 529 plan, for each child. Participation in the OCSP offers several savings perks, including an Oklahoma income tax deduction on contributions and tax-free growth and withdrawals. Visit www.ok4saving.org for more information. Use these online calculators to estimate the cost of college and design a savings plan to meet your student's needs.
Building Wealth
Several factors affect how much your savings will grow. The most important elements are:
- Time. The earlier you begin to save regularly, the more your money will grow.
- Amount invested. The more income you set aside for savings each year, the more your money will grow.
- Rate of return. The more interest you earn on your savings, the more your money will grow.
Compound Interest
Compound interest is interest earned not only on the principal, but also on interest already earned. In other words, it’s money earned on money earned! Let’s say you invest $100 per month at a fixed 8% interest rate. By the end of the first year, you will have earned $96 in interest.
Not impressed? Check out how much money you would have in 30 years!
Compound Interest Chart |
|||
|---|---|---|---|
Year |
Amount Invested |
Interest Earned |
Total |
| 1 | $1,200 | $96 | $1,296 |
| 5 | $6,000 | $1,603.11 | $7,603.11 |
| 10 | $12,000 | $6,774.58 | $18,774.58 |
| 15 | $18,000 | $17,189.14 | $35,189.14 |
| 20 | $24,000 | $35,307.51 | $59,307.51 |
| 25 | $30,000 | $64,745.30 | $94,745.30 |
| 30 | $36,000 | $110,815.04 | $146,815.04 |
Because of compounding interest, the earlier you start saving, the more money you can make. Notice that by year 15, the interest earned has nearly doubled the amount invested!
Key Investment Terms
Learning the language of savings and investing will help you manage your finances and understand your options.- Annual Rate of Return: percentage of money earned on an investment in one year.
- Certificate of Deposit: also called a "CD"; a savings product that requires the investor to leave the money in the bank for a specific time period.
- Individual Retirement Account (IRA) : a tax-deferred retirement account that permits individuals to set aside money each year, with earnings tax-deferred until withdrawls begin at age 59 1/2 or older (or earlier, with a 10% penalty).
- Inflation: a general rise in the cost of goods and services.
- Mutual Fund: a savings product operated by an investment company which raises money from shareholders to invest in assets.
- Net Worth: the value of an individual's total assets minus total liabilities.
- Rate of Return: the money made through an investment, usually presented as a percentage (income earned / amount of the investment = rate of return).
- Real Estate: residential and commercial land and any structures on it; if you purchase a home, you’re a real estate investor.
- Roth IRA: a type of IRA that allows taxpayers, subject to certain income limits, to save for retirement while allowing the savings to grow tax-free.
- Rule of 72: a formula used to figure out how long it takes money to double at a particular rate of return.
- Stocks: an investor's shares of a corporation, entitling the holder to dividends and other rights of ownership.
- U.S. Savings Bond: a non-transferable savings product issued by the U.S. government that matures in a set period of time.
Understanding Risk
Risk is the possibility that you may not receive the expected return on your investment. Generally, the greater the risk, the greater the potential reward; this is called the risk/reward ratio. To feel comfortable with your financial decisions, you must recognize your tolerance for different types of investment risk.
- Market Price Risk is the chance that an investment's value will decrease due to fluctuations in supply and demand.
- Inflation Risk is the possibility that an investment's value will decrease due to a rise in the cost of goods and services.
- Liquidity Risk is the chance that an investment will be hard to convert to cash.
- Fraud Risk is the possibility that an investor has been deceived or misled.
Want to know more?
A glossary of over 6,000 investment terms can be accessed at www.investorwords.com. Additional information and resources are available online through a variety of websites, including:
- InvestEd - Investor Education Program
- Federal Reserve Education
- Women’s Institute for Financial Education
- Financial Literacy and Education Commission
