For Nest Eggs and Rainy Days

Now that we’ve learned a little about debt and credit, it’s time to look at the happier side of finances: savings! It just feels better to know you have money saved for a rainy day. And that’s what we’re going for as we build our financial literacy…greater peace of mind!


There are many reasons for saving money. Some are more short-term, others quite long-term. We’re not going to look at retirement savings right now (that’s next week), but there are so many other purposes for saved money. First and foremost, it’s part of an emergency preparedness plan. Having money put away will help us through job losses, financial troubles, unexpected medical expenses, and the more common (albeit BIG!) challenges of life. For example, how many months could you live off your savings if you lost your income? That's an important thing to consider!

In addition to emergency savings, there are other items to consider for long-term (non-retirement) goals. Education, replacing cars, going on missions. These are all important and worthy expenses that, if planned for, can keep us out of debt.

But where do you put that money while you're saving it? An excellent question! I am not qualified to give you financial advice, but in this week's post, we’re going to learn about the mechanics of some of the options out there.

But first, two general principles. Some investments are considered safe: they are zero or low-risk options. Others have high risk. Generally, the lower the risk, the lower the potential return. Investments also vary in terms of their “liquidity” – how fast you can get your money back in your pocket when you need it. If the money you are putting away is for emergencies, you’ll want to keep it fairly liquid. If you won’t need it for a while, you can stick it somewhere longer (and that generally gives you the potential for higher returns as well).

Still reading? Good job! Keeping those two principles in mind, let’s take a look at some of the options out there:


• Savings Accounts (very liquid, low risk): This is probably better than putting it under your mattress! Interest rates are not terrific right now, but it's better than nothing! And you can access your money at pretty much any time. The other advantage of using a bank is its being FDIC-insured (double-check that your bank is!). Being FDIC-insured means that even if the bank fails, you are guaranteed to get back your money up to a certain amount (currently for each depositor, $250,000 per insured bank). Check out the FDIC's website here (and read your FDIC Bill of Rights here!). Depending on how much money you have, you may want to spread your accounts over different banks to maximize how much you're insured for. And don't rule out Internet banks either (think something like ING)! They often offer slightly higher interest rates than your typical brick-and-mortar establishment.

• CDs (semi-liquid, low risk): CDs earn a little more interest because you're letting your money go for a little longer. Usually, the longer the period, the higher the interest you’ll be earning. Unfortunately, there are penalties for taking the money out early. Typically, the shortest period is going to be for six months, so if you need to keep your savings accessible (for example, to live off of in case of job loss), but you can set up a "ladder" of CDs so that one is coming due each month with the amount you think you'll need. Shop around with local banks (and online banks, too!) to get the best rates. And the good news? These are also FDIC-insured!

• Bank Money Market Accounts (fairly liquid, low risk): These are also available through your local banks and generally earn higher interest rates while still being very low-risk (and also FDIC-insured). They are very much like checking accounts, though usually have tighter restrictions on minimum balances and frequency of withdrawals. (Note: There are also some mutual funds known as money market mutual funds. See below.)

• Bonds (less liquid, lower risk): A bond is like an IOU from a government or a company. When you buy a bond, you’re essentially loaning them some of your money, and they are promising to pay a specified amount back to you at a specified future date. Bond terms can range from a few months to 30 years. Refer to independent bond-rating agencies to check the chance that a bond will default. FYI, there are many types of bonds. See below for additional links.

• Stocks (can be highly liquid, but higher risk): Owning stock basically means you own part of a company. If the company does well, the value of the stock goes up. The opposite is also true: if the company does poorly, you will lose some or all of the value. You may receive periodic dividends on stock you own. These are a higher risk than the above options because the company has no obligation to give you a payout. If they do poorly, you just lose your money (as opposed to a bond where they still have to pay you back).

• Mutual Funds (less liquid, medium risk): A mutual fund is a collection of stocks and bonds. When you buy into a mutual fund, you are pooling your money with other investors, and a professional manager is choosing the stocks and bonds to invest in. The advantage of mutual funds is that you don’t have to have as much expertise to choose which stocks you want to invest in. Another advantage is that you are automatically more diversified because your money has been spread over several different investments. Mutual funds charge some kind of management fee (ask about “load”), but they are also known for generating decent returns. There are many, many different kinds depending on what you want to achieve.

Want to learn more? There are SO MANY websites out there. Each of them have different opinions on how to use these instruments, so first concentrate on the basics and mechanics of each type of investment (and ignore the sidebar ads!). As you do, you will get a feel for your preferences and opinions, and that’s the best place to start. If you want to go further, explore more of the content on these sites or contact a financial planner you trust. You CAN do this!

GENERAL INFO:
http://www.investopedia.com/university/beginner/beginner5.asp

STOCKS:
http://money.howstuffworks.com/personal-finance/financial-planning/stock.htm
http://beginnersinvest.about.com/od/stocksoptionswarrants/a/what-is-stock.htm

BONDS: 
http://www.investopedia.com/university/bonds/bonds4.asp
http://bonds.about.com/od/bonds101/a/whatisabond.htm
http://www.investinginbonds.com/learnmore.asp?catid=46&id=7 (glossary)
http://www.fool.com/bonds/bonds02.htm

MUTUAL FUNDS:
http://money.cnn.com/magazines/moneymag/money101/lesson6/index2.htm
http://mutualfunds.about.com/od/mutualfundbasics/a/mutualfund.htm

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Here's our trivia question for the week: What's the full name for a CD? (Hint: It's not compact disc!) Stay tuned for the answer later this week!