2.4.4.

F1

AdvancedLevel

Savingmoneyforfutureconsump onisanimportantfactorofyourfinancialplan.Youcansavemoneyinasavingstool
(savingsaccountatyourdepositoryins tu on)orinaninvestment.Investmentsareassetspurchasedwiththegoalof
providingaddi onalincomefromtheassetitselfbutwiththeriskofloss.Yourfinancialplanwouldnotbecompletewithout
bothsavingsandinvestments.

Savingvs.Inves ng
Youshouldntuseinvestmentsforsavingsorshorttermgoals/expensesbecauseoftwoprimaryreasons:
1. Unlikeinsuredsavingstools,investmentsarenotsecure.Thereisachancethatsomeorallofyourmoneyinvestedcould
belost.
2. Investmentsarelessliquidthansavingstools.Thatis,investmentsmaynotbeeasilyconverted
Invesng helps you
tocashoryoumayhavetopayapenaltytoaccessthemoney.Infact,withsomeinvestments
cope with risk and
youmayhavetowaitalong me,evenyears,toaccessthefunds.
uncertainty.
Investmentshelpbuildyournetworthbecausetheyhavethepoten altoearnhigherreturnsthan
savingstools.Areturnistheprofitorincomegeneratedbysavingandinves ng.Yourtradeoto
earninghigherreturnsishigherinvestmentrisk.Riskisthechanceoflossfromaneventthatcannot
been relycontrolled.Unlikesavingstools,allinvestmentscarryinvestmentrisk,whichisthe
possibilitythataninvestmentwillfailtopaytheexpectedreturnorfailtopayareturnatall.Asthe
poten alreturnrises,generally,sodoestheinvestmentriskinvolved.

Knowledgeofthe
generalrisklevelfor
investmentreturns
helpsyoumanage
yourrisk.

Investmentsareassetsbecausetheyhavemonetaryvalue.OnyourStatementofFinancialPosi on,investmentsarelistedas
investmentassets.Savingtoolsarelistedasmonetaryassets,assetsthatcanbequicklyandeasilyconvertedintocash.
Asaresultofthepoten alforhigher
returnsandlowliquidity,moneyinvestedis
usuallyusedtopayforlongterm(more
thanfiveyears)goalsandexpensessuchas
adownpaymentforahouseintenyears,a
youngchildshighereduca oninfi een
years,orre rementincomeinthirtyyears.
Asaguidetospending,itisrecommended
thatyoudedicateatleast10%ofnet
incometosavingsandinvestmentseach
meincomeisreceived.

Saving

Emergencies

More
Liquid

Limited
Risk

Lower
Returns
(04%)

Financial
Security

Long
term
goals

Less
Liquid

Higher
Risk

Higher
Returns
(812%)

Net
Worth

Inves ng

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2.4.4.F1

RateofReturn
Theamountofreturnyouearnonasavingstoolorinvestment
isdeterminedbycalcula ngtherateofreturn,thetotalreturn
expressedasapercentageoftheamountofmoneysaved.

Total
Return

Amountof
Money
Invested

Rateof
Return

Example:Mandysaved$2,200inamoneymarketdeposit
account.A eroneyear,shehasareturnof$110.Whatis
Mandysrateofreturn?

$110

$2,200

MostCommonTypesofInvestments
Bond

.05=
5%

Youshouldstrivetohavetherateofreturnearnedonan
investmentbehigherthantherateofinfla on.Infla on
istheriseinthegenerallevelofprices.Ifyouinvest
moneyata2%interestrate,andtheinfla onrateis2%,
thenyourpurchasingpowerwillnotbeincreased.Infact,
a eryoupaytaxesonyourinvestmentincome,youwill
actuallybelosingmoney.Infla onriskisthedangerthat
moneywontbeworthasmuchinthefutureasitis
today.Infla onriskisaconcernwithinvestments
becauseitdefeatstheobjec veofprovidingforfuture
financialsecuritybybuildingnetworth.

Bondexample:
A$1,000fiveyearbondwitha5%
annualinterestrate.
Youshouldreceive:$50in
interesteachyearforfiveyears
andattheendoffiveyears,your
$1000principalinvestment.

Abondisaformoflendingtoacompanyorthegovernment(city,state,or
federal).Whenyoupurchaseabond,youarelendingmoneytoanorganiza oninreturnforafixedinterestrate.The
organiza on(usuallyacompanyorthegovernment)paysinterest(usuallybiannuallyorannually)toyouun lthematurity
dateisreached.Thematuritydateisthespecified meinthefuturewhentheprincipalamountofthebondisrepaidtothe
bondholder.Ingeneral,bondshavetheleastamountofinvestmentrisk.Bondsarethemostpredictableinvestmentsince
bondsarepurchasedwithafixedinterestrate.However,thereisariskthatinterestwontbepaidand/ortheprincipal
amountofthebondwontberepaid.Thespecificinvestmentriskleveldependsonthetypeofbond;higherriskbondstend
tohavehigherinterestrates.

Stock
Stockisashareofownershipinacompany,andtheownerofthestockiscalledthestockholderorshareholder.Theamount
ofstockyoupurchasedetermineshowmuchofthecompanyyouown(usuallyasmallpercentage).Ifthecompanymakesa
profit,thenyoumayreceivepartofthatprofitasareturn.Thisiscalledadividend,whichistheshareofprofitsdistributed
incash.Whenyouownastock,youexpectthatthemarketprice(thecurrentpricethatabuyeriswillingtopay)ofthestock
willincrease.Therefore,ifyouareabletosellstocksforamarketpricehigherthanwhatwaspaid,youwillreceiveareturn,
knownasacapitalgain(unearnedincomereceivedfromthesaleofanassetaboveitspurchaseprice).Ingeneral,capital
gainshavethehighestinvestmentriskofallreturns,butalsohavethepoten alforthehighestamountofreturn.For
example,ifthecompanyperformspoorlyorgoesoutofbusiness,youcouldlosepartorallofyourprincipalinvestment,
dependingonthemarketpriceatwhichyouwereabletosellthestocks.

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2.4.4.F1

MoreTypesofInvestments
RealEstate
Realestatecanincludeownershipofresiden alorcommercialpropertyorlandas
Manyexpertsrecommendthata
wellastherightsaccompanyingthatland.Whenyouinvestinrealestate,youmay
primaryresidencenotbe
earnreturnsintheformofcapitalgainsandrents.Capitalgainscomefromsellingthe
consideredaninvestmentasset.
realestateformorethanwhatyoupaid.Rentischargedfortheuseoftheproperty
However,thisdependsonseveral
orland.Forexample,ifyouownaresiden alrealestatepropertyyoucanrentittoa
factorsincludingwhereyoulive
familyinexchangeforthemlivingthere.Realestatecanbemore meconsuming
andyourpersonalfinancial
thanotherformsofinves ng.
situa on.

Specula veInvestments
Specula veinvestmentshaveveryhighlevelsofinvestmentrisk.Specula veinvestmentshavethepoten alfor
significantfluctua onsinreturnoverashortperiodof me.Someexamplesofspecula veinvestmentsarefutures,
op ons,andcollec bles.Thesearerecommendedforpeoplewithanaggressiveinvestmentphilosophyandahighlevel
offinancialsecurity.
MutualFunds
Amutualfundiscreatedwhenacompanycombinesthefundsofmanydierentinvestorsandtheninveststhatmoneyin
adiversifiedpor olioofinvestments.Mutualfundsmayincludestocks,bonds,realestate,and/orspecula ve
investments.Thereturnfromamutualfundmayincludeinterest,dividends,rents,and/orcapitalgains.Whenyouinvest
inamutualfundyoureceiveapercentageofthetotalreturnbasedupontheamountofmutualfundowned.Mutual
fundsreduceyourinvestmentriskbyspreadingriskamongavarietyofinvestments.Ifoneinvestmentwithinthemutual
fundfailstopayareturn,chancesarehighthatanotherinvestmentwithinthefundwills llpayareturn.Mutualfunds
saveyou me,because meisnotspentchoosingindividualinvestments.Instead,agroupofmutualfundmanagers
constantlyevaluatewhichinvestmentstobuyandsell.Therefore,mutualfundmanagerschargefeeswhichcanbehigher
thanifyoupurchasedindividualinvestments.However,feeschargedvarydependinguponthetypeofmutualfundand
thecompanythatoersit.
IndexFunds
Anindexfundisatypeofmutualfundthatwasdesignedtoreducefeesbyinves nginthestocksandbondsthatmake
up an index. An index is a group of similar stocks and bonds. For example, the Standard and Poor 500 is an index that
includesthe500largestcompaniesthatsellstock.Bybuyingandholdingaspecificsetofstocksandbonds,indexfunds
requireveryli lemanagementcomparedtomutualfundsandcanchargelowerfees.

Whatisanexampleofaninvestmentgoalyouhave?
Whattypesofinvestmenttoolswouldyouusetoachievethatgoalandwhy?

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2.4.4.F1

Lendingvs.Owning
Youarelendingmoneywithsomeinvestments,suchasbonds.Yourreturnsareintheformof
interest.Youownsomethingwithotherinvestments,suchasstocks,realestate,andspecula ve.
Whenyouownaninvestment,yourreturnsareintheformofdividends,rents,andcapitalgains.
Typically,whenyoulend,
bothyourreturnsandlevel
ofinvestmentriskarelower.
Ontheotherhand,when
youownyouhavegreater
investmentrisk,butalsothe
poten altoearnhigher
returnsandexperiencethe
leastinfla onrisk.

Owning

Lending
Interest

Dividends

Rents

Capital
Gains

Increasingpoten alforhigherreturnsIncreasinginvestmentriskDecreasinginfla onrisk

InvestmentPhilosophy
Thepoten alforhigherreturnscanbewhatmo vatesyoutoaccepthigheramountsofinvestment
risk.Everyonehasapersonaltolerancelevelfortheamountofinvestmentrisktheyarewillingto
assume.Thisisknownasaninvestmentphilosophy,oranindividualsgeneralapproachtoinvestment
risk.Investmentphilosophiesaregenerallydividedintothreemaincategories:conserva ve,moderate,
andaggressive.Ifyouhaveanaggressivephilosophyyouarewillingtotakeonmoreinvestmentrisk
forthepoten alofhigherreturns.Theamountof meyouhavemayalsoinfluenceyourinvestment
philosophy.Yourphilosophymaybedierentwithafi eenyearinvestmentthanathirtyyear
investment.

Whattypeof
investment
philosophywould
youhave?

Por oliodiversifica onisamethodtoassistyouwithriskreduc on.Por oliodiversifica onreduces

your risk by spreading money among a wide array of investments. Chances are if one investment is
losingmoney,anotherwillbeearningareturn.Thegoalofdiversifica onistocreateacollec onof
investmentsthatwillprovideyouwithbothanacceptablereturnandanacceptableexposuretorisk.
Mostpeoplediversifytheirpor olioaccordingtotheirinvestmentphilosophy.Forexample,aperson
withanaggressiveinvestmentphilosophywillmostlikelyincludealargeramountofhighinvestment
riskinhis/herpor olio.

HowDoYouPurchaseInvestments?
Whenyoupurchaseaninvestment(exceptforrealestateandsomespecula veinvestments)youaredoingsofromastock
exchange.Astockexchangeprovidesanorganized,centralservicetobuyandsellstocks,bonds,andotherinvestmentsthat
aretraded.Worldwide,therearemanydierentstockexchangesandalimitednumberofpeopleareallowedtobuyandsell
directlyfromeachstockexchange.Therefore,ifyouwanttopurchaseaninvestment,abrokeragefirmmustbeu lized.A
brokeragefirmfacilitatesthebuyingandsellingofinvestmentsfromastockexchange.Brokeragefirmsactasanintermediary
betweenthestockexchangeandtheinvestor.Youwillpayabrokeragefirmafeefortheirservices.Therearetwotypesof
brokeragefirmsthatdierinthefeeschargedandservicesprovided:
Discountbrokeragefirmprovideslimitedservices.Adiscountbrokeragefirmonlycompletesordersyougivethemtobuy
andsellinvestments;theydonotprovideyouwithadviceastowhichinvestmentstobuyandsell.Becauseofthis,discount
brokeragefirmsusuallychargelowerfeesand/orcommissionsthanfullservicebrokeragefirms.
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2.4.4.F1

Fullservicebrokeragefirm(alsoknownastradi onal

EdwardJonesandMerrillLynchare
examplesoffullservicebrokeragefirms.
E*TRADEisanexampleofanonline
discountbrokeragefirm.Manydiscount
brokeragefirmsareonlineonly.

brokeragefirms)oeryouinvestmenttransac ons
aswellasinvestmentadviceandafinancialadvisor.A
financialadvisorisatrainedprofessionalthathelps
peoplemakeinves ngdecisions.

Theprocessofinves ngiscomplex.Choosinginvestmentsandcrea nga

personalinves ngplanrequiresknowledgeofthemarket/economy,
Whataretwoadvantagesand
knowledgeofthespecificinvestment, metomonitortheinvestment,etc. disadvantagestoadiscountbrokerandfull
Anadvantagetoafullservicebrokeragefirmisthatyouhaveaccessto
servicebrokeragefirm?
financialadvisorswhousetheirexper setohelpyouwiththeinves ng
Discount
Fullservice
processaswellasensureyouaremee ngpersonalfinancialgoals.Financial
Broker
BrokerageFirm
advisorsmayalsoinformyouofinvestmentop onsthatyoumayhavenot
knownaboutotherwise.Formany,theadviceand meofafinancial

advisorareworththefeespaid.
Justaswithsaving,inves ngmoneyismostsuccessfulwhenyoumakeit
automa c.Brokeragefirmsprovideautoma ctransfers/depositstomake
inves ngautoma c.Youmayfindthatdevelopingarela onshipwitha
financialadvisoralsohelpsyoustayontrackwithapersonalfinancialplan
becauseitcreatesaccountabilityandaddsdiscipline.

ChoosingaBrokerageFirm
Whenchoosingabrokeragefirm,youshouldunderstandhowthatfirmchargesfees.Fullserviceanddiscountbrokerage
firmschargefeesindierentways:

DiscountbrokeragefirmWillusuallychargeafeeforcomple ngabuy/selltransac onforyou(o enreferredtoasan

order).Otherfeeswillvarybutmayinclude:

ServicefeeThisisusuallyaquarterlyorannualfeechargedtotheconsumertousetheservice.
MaintenancefeeThisfeeisusuallychargedifthevalueofaninvestment(s)isbelowaspecificminimum
balancerequirement.

Inac vityfeeIfyouhaventcompletedanorderwithinacertainperiodof me.

FeesspecifictoaninvestmentDiscountbrokersmaychargefeesspecifictothetypeofinvestmentyouare
trading(stock,bond,mutualfund,etc.).

FullservicebrokeragefirmFinancialadvisorsforfullservicebrokeragefirmsarecompensated
forthe meandknowledgeprovidedtoinvestors.Therefore,feesarechargedinadierent
mannerthandiscountbrokeragefirms:

ApercentageoftheinvestmentvalueFinancialadvisorsreceiveapercentageofthe
totalvalueofaninvestment.Forexample,aninvestorsmutualfundisworth$1,000.00.
Afinancialadvisorcharginga2%valuefeewouldearn$20($1,000.00*.02).

Apercentageoftheamountdepositedfinancialadvisorsreceiveapercentageofthe

Most financial
advisors charge a
percentage on
either the value of
the investment or
amount deposited
not both.

amountinvested.Forexample,aninvestorcontributes$1,000.00toaninvestmentworth
$5,000.00.Afinancialadvisorcharginga4%depositfeewouldearn$40.00($1,000.00*.02=4).

HourlyrateandflatfeeAbrokeragefirmwillchargetheconsumeranhourlyrateorflatfeetogiveadviceor
completeaproject.
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2.4.4.F1

ChoosingaBrokerageFirmcon nued
Inaddi ontofees,financialadvisorsmayearncommissions.Theinvestordoesnotpaycommissions;companiespay
commissions.Forexample,ifyoudecidetoinvestinaspecificcompanysmutualfundthroughafinancialadvisor,the
companywillpaythefinancialadvisoracommission.Eventhoughcommissionsarentadirectcosttoyouitiss ll
importanttoknowwhetherornotafinancialadvisoriscompensatedviacommissions.Afinancialadvisorthatearns
commissionsmaybebiasedtowardsaspecificproductratherthanoeringinves ngadvicethatisbestforyourfinancial
goals.
Howfinancialadvisorsarecompensated(feesand/orcommissions)dependsonthebrokeragefirmthefinancialadvisor
worksfor.Therefore,whenchoosingafinancialadvisor,beginbyresearchingbrokeragefirms.
Itisveryimportanttoresearchafinancialadvisorandthefirmhe/sheworksfor.TheFINRABrokerCheck
(h p://www.finra.org/Investors/ToolsCalculators/BrokerCheck/index.htm)isafreetooltohelpinvestorsresearchthe
professionalbackgroundsofbrokeragefirmsandfinancialadvisors.

Ques ons Howarethefirmsfinancialadvisors

Toask:
compensated?

Howlonghasthefirmbeeninbusiness?

Doesthefirmhaveahistoryofposi ve
reviewsandsuccess?

Howdoesthefirmrankincomparisonto
otherbrokeragefirms?

Alwaysaskfinancial
advisorsforaclear
explana onofhowtheywill
becompensated.

TaxAdvantagedInvestments
Savingsandinvestmentsareaformofunearnedincomeandarethereforesubjecttoincome
tax.However,thegovernmentencouragesyoutoinvestincertaintypesofinvestmentsby
makingthemtaxadvantaged.Taxadvantagedinvestmentsarestructuredwithtaxbenefitsto
investorsinmind.Taxadvantagedinvestmentsareusuallynottaxfreeandinsteadreduce,
defer,oradjustthecurrentyeartaxliability.Youmostlikelypaytaxestheyearmoneyisputinto
theinvestmentortheyearmoneyistakenout,whereasotherinvestmentsaresubjectto
incometaxeveryyear.Themoneythatyouwouldhavepaidintaxescanremaininthetax
advantagedinvestmenttoearninterestoninterestandincreasevaluefaster.Themostcommon
taxadvantagedinvestmentsareoeredforthosewhowishtoinvestinre rementand
educa on;however,therearetaxadvantagedinvestmentsforotherpurposes.

Taxadvantaged
investments
reduce,deferor
adjustthe
currentyeartax
liability

Mostcommon:
Re rement
Educa on

Whataretworeasons
youwouldwanttouse
ataxadvantaged
investment?

Thereareusuallylimitsto
theamountofmoneyper
yearthatcanbeinvested
inataxadvantaged
investment.

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2.4.4.F1

Inves ngforRe rement

Itisrecommendedtou lize
employersponsored
re rementaccountsasmuch
aspossibleifavailable.

Inves ngforre rementisanimportantfinancialgoalandmustbecarefullyplannedoveralongperiodof me.

Tohelpyouinvestinre rement,thegovernmentandmanyemployershavecreatedinvestmentplansspecificallyfor
re rement.Theinves ngprocessissimilartootherinvestments.Youchooseinvestments,whichareusuallymutualfunds.
Then,themoneycontributedisdepositedintotheinvestment(s)ofyourchoice.Re rementplansaretaxadvantagedto
encourageyoutosaveforre rement.Ifitisanemployersponsoredre rementplan,theemployerhelpsyouinvestby
automa callydeduc ngmoneytoinvestfromwagesearned.Theemployermayalsocontributeapor onofmoneytothe
investment(alsoknownasmatchingfunds)withnoaddi onalcosttoyou.
However,thetradeotothetaxadvantagesisthatmostre rementplanshavepenal esifmoneyiswithdrawnbeforeyou
reachaspecificre rementage(thespecificagedependsonmanyfactors).Themostcommonre rementplansare:

Employersponsoredre rementplans
Themostcommonemployeesponsoredre rementplansarecalleda
401(k)and403(b).Bothplansareverysimilar;thespecificplanyour
employeroerswilldependonwhattypeofemployeryouhave(a
privatebusiness,publicen ty,nonprofitorganiza on,etc.).403(b)
plansaredesignedfortaxexemptorganiza ons.

Whenavailable,useanemployer
sponsoredre rementaccountas
muchaspossible.

Personalre rementaccounts
Therearere rementplansthatoertaxbenefitswithoutemployersponsorship.Themostcommonpersonal
re rementaccountsaretheTradi onalIRA(IndividualRe rementAccount)andtheRothIRA.Thedierence
betweenaTradi onalIRAandRothIRAiswhentaxesarepaidontheinvestment.TaxesarepaidonaTradi onal
IRAintheyearmoneyiswithdrawnfromtheaccount.TaxesarepaidonaRothIRAintheyearmoneyis
depositedintotheaccount.Yourpersonalfinancialsitua onwilldetermineifaTradi onalIRA,RothIRA,ora
mixtureofbothaccountsisbestforyou.
Therearemanyothertypesofre rementplans.Youremploymentstatusaswellasyourpersonalfinancialsitua onwill
determinewhichre rementplan(s)isbestforyou.
Yourpresentselfimpactsyourfutureself!
Investmentshavethepoten altoearnhigherreturnsthansavingstoolsandarethusimportanttobuildingnetworth
(wealth).However,atradeotohigherreturnsislowerliquidityandhigherinvestmentrisk.Thismakesinvestmentsideal
foralongterm meframe(generallymorethanfiveyears).Discussingyourfinancialgoalswithafinancialadvisorisagreat
steptobegininves ng.Takingadvantageofpor oliodiversifica on,taxadvantagedinvestments,andthebenefitsof
employersponsoredre rementplanswillmaximizeyourreturn.
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