Hi. Today we're going to begin our discussion on understanding more about the magic of savings and investing. So let's begin by placing this into the context that we're getting quite familiar with. The role of savings and investing, really focuses on the issue of wealth accumulation. So when we think about that. In other words, when we make the decision to not spend money today. To put it aside for the future, that's really what we think of behaviorally as the act of savings. And that's the beginning, of wealth accumulation. Investing, as we going to say, really has a lot more to do with what we do with the money. But why is this so important? Why do we talk about savings and investing in such a way that makes them of critical importance to family well being? Well, number one is that historically over the last several decades, there's been a major shift. In terms of retirement responsibility. Much of the owners, are being adequately prepared for retirement has really been transferred from employers and the government, to individuals themselves. And a lot of this we saw in the shift from employer provided plans from defined benefit plans, ones that pay the guaranteed pension amount, to defined contribution plans like 401Ks or 403B plans. Where, how much money you have depends on whether or not you contribute and how you invest that money, a few other things to think about too though, is that building well also allows us to stand a lot of temporary shocks to our come as well, so for example if we take time off from eternity or paternity and families. If we're changing jobs, transitioning, maybe even moving across country. And of course, thinking about retirement itself. We refer to this idea of making sure that we can maintain a lifestyle over changes, or over hiccups, if you will, in our financial road, as smooth in consumption. Right? So the idea of smoothing our ability to maintain a lifestyle over time. And in addition we want to think about the goals we have in life. Many of which will also require some form of savings and investing. We want to buy a home, we probably need to save for a down payment. We want to fund education for children, for ourselves for that matter. We potentially need to save and put some money aside as well. So, and lastly, we can never forget things like having something for a rainy day, that emergency fund aspect of it. Also of really big importance. So starting early as we know becomes a critical thing. So, savings, as we said before then, is not spending money today, so that we're going to have it tomorrow. That's a really important concept. That's something that, believe it or not, we often struggle with. We think about committing to not spending money today. Investing is we then kind of defined says, let's make that money work for us. Let's beat inflation. Let's get a rate of return that actually helps our money grow and increases our purchasing power. So we allocate current resources for future consumption in a trade off and return for purchasing power. That's kind of a big thing for us. Now one of the points we want to make about savings and investing, is that we have to balance this with our utilization of debt. Now, why is that? Well, because the truth is, is that if we're saving money, but we're really, overspending by taking on debt at the same time. We're not really getting far ahead in life. And that's because of the simple things when we think about rates of returns. If we know, if we think about it, for example, we might be paying as much as 17% on our debt. And we might only be earning anywhere from 7-10%, for example, on our assets. That's not a way to get ahead. Our net worth won't grow very effectively, when our debt is out pacing our assets. So we need to make sure that we're balancing, our wealth building activities with making sure that we're managing keeping out debt level very low. Now why is it so important to start early? You'll hear this a lot when we talk about investing and starting early is a critical piece. Let's use this example to help illustrate it. We've got Ron and Jon here, both twins brothers, age 21. Ron invests $2,000 a year each year for the next ten years, and then he's going to leave that money alone invested, until he's 55. Jon, on the other hand, wants to enjoy life a little bit, spend some money, live the high life for a while. So he's going to wait until he's 35, and then also invest $2,000 a year until he's $55. Assuming that they're going to invest the same way and earn the same rate of return every year on their money, who ends up with the most? Well, let's think about this for a moment. Ron is going to invest about $20,000, $2,000 a year for ten years and then leave the money alone. Jon's going to invest twice as much money, 2,000 a year for 20 years, he's going to invest 40,000 dollars. So who ends up ahead? If Jon is investing twice as much as his brother from the get go. Well, Ron 2,000 dollars a year for ten years and then leaves that money to loan, it grows to about 30,000 dollars after the first ten years of deposits,. And then he leaves it alone. That grows to $221,000. Jon on the the hand, invests his money for 20 years and ends up with $98,900. That's a difference of almost $123,000. In fact, even though Jon was already investing more money, he would have to invest an additional, almost $2,300, to catch up to Ron. Why is that? Why does that happen? And that's what we think of as the time value of money. Remember, as we've worked through that math before, time is a very important component of this. The more time we have, the more profound we'll see compounding. Ron has a lot more time to let his money compound. And is leaving that money alone for quite a while, that's a great recipe for success. So when we think about investment decision making, as always, there's a process to follow. So, the first step, is to think about where we want to go. Its really hard in life to make it to an, to the end, if we don't know where we're going. So, think of this as putting a destination on your financial GPS. That's what setting a goal is. We can't, a GPS is useless if we don't know where we're going. So, we start off with that. Then we think about how much money do we have to invest? What's our available capital? How much do we need to reach our goal? At that point, once we know where we're going. We think about what's the best vehicle to get us there. And that's really going to be the type of account. Now, why the account next? Well because a lot of times the account becomes an important feature. It, for example, will have tax advantages associated with it. It may limit the types of investments we have. It may provide matching funds from an employer. So the first thing we think of is, once we know what it's for, right, that helps us. And then we say, well, when do we need it? And, do we have earned income? And, is this something our employer provides for us? And even, are there minimum contributions? In other words, do we have enough money to open that type of account? So the types of accounts often we can think of. For retirement, 401Ks, 403B, on the personal retirement side, individual retirement accounts, IRAs, Roth IRAs, for example, and then we might also have education accounts as well. Coverdale IRAs, Section 529 plans, so all of these are different types of accounts, that go for specific goals that we might have. We may also use other things, passbook savings, or other types of savings and investment vehicles if our goals are shorter term in nature, aren't too lofty, and there's something that we really want something very simple to work with. Once we figure that out, we can think of what do we want to invest in? And remember, we need to respect the rules of investing, which we'll talk about in another presentation. But then we think about what do we invest our money in? Stocks, bonds, mutual funds, exchange traded funds, spiders, iShares, there's a lot of choices out there for us as investors. So, again, we think about first of all where do we want to go, how much capital do we have, what type of account do we want, and how do we want to invest it. Let's start off by thinking about goals for a moment. Goals are a very important thing that we want to focus on. Setting a goal and making it as concrete as possible, makes it that much easier for us to act on it and prioritize it. If we never even write down a goal for example, or communicate it to others, it's easy for us to lose sight of it, because we haven't really, we haven't really committed to it. But let's commit to our goals. So let's think about wiring an objective statement. An objective statement, is something that becomes something we can work with. It becomes very useful from a financial planning standpoint. It makes it measurable. So we think of these as smart goals. Smart goals are specific. Measurable, attainable, realistic, and timely or time bound, meaning that we really have all those recipes. A smart goal answers really important questions, such as what is it? When is it? How much is it? These are all things we need in order to take action, so let's think about this for a moment. What's one of my goals? What do you think? Well, might have something to do with my son. I'm only saying him first because he's a little older. He's going to go to college, and he needs about $50,000, or I need it, I guess, in about seven years. So how much would I need to invest each year, if lets say I already have $30,000 invested for him, because we started when he was born? So lets assume I'm using a 529 account, and I'm going to choose an index fund. And we'll say that that has an average of return of 11%. So how much money do I need to be saving and investing, towards Ethan's college? Well, a solution $1,256. What if I was more conservative, investing in treasuries, need a couple hundred more dollars for that over the timeframe? And again, the longer this would be, the more pronounced these differences will be as well. So, this becomes the workable solution. I then go back to my budget and say, do I have enough money to reach that goal? And that becomes something that I operationalize. I put that into my family budget and we pay ourselves first. That's an important part of savings. If we pay ourselves first then we're making that a fixed expense that we have and we're paying it as regularly as we pay the grocery bill. As we pay the rent. If instead we simply say we'll save what's left over, we call that residual savings. That's pretty problematic, because a lot of times we'll have nothing left over, if we don't plan for it so it's important that we commit to our goal, so if we take a look right what types of accounts how would be invested, how much per year these are all things we have to kind of think about with all of these decisions so I have to go through all of this. And making decisions about Ethan's college savings plan. So before we get that far, before we tie up our money for the long term, right? Even though that's only seven years away. But if we think of retirement, we think of everything else, the first step is to make sure we have a buffer. And that means that if I put money into something like a 401k plan or a 403b plan, but I have nothing liquid for an emergency, what happens, if I actually need access to my money? I may face penalties. I may not even be able to get access to that money in a short time frame. So we always begin, before we tie up money for the long term, by making sure that we've dealt with our emergency fund. Remember an emergency fund should be about 3 to 6 months worth of our needed monthly expenses. So we need to have some liquidity. We also need to make sure that we've dealt with all the prudent risk management, or again, we end up finding ourselves having to tap into this savings and investing that we've done, in order to make ends meet when we have a resource shock. So we have things like income continuation or disability insurance. Maybe, you even have life insurance available, as well. And, of course, things like auto and homeowner's policies to make sure we protect against damage to our property and, of course, liability, as well. So we know that it's important then that we focus on a few things and we're going to. Share some of these over the next few presentations. How does the market work? What types of investment choices do we have? And what are some basic portfolio concepts that I like to call the rules of investing? Where do we get to our investments? This is always an important question. If we go all the way back to our path to financial security model, we remember that one of those key things we talked about was access. So where do we access investments? Well to some extent this is affected by what type of job we have, how much income we have, how much money we have to invest. Because those are going to dictate which points of access are most efficient or optimal for us. So that we could be using investment management services with a professional adviser, a financial planner for example. We might be working with commercial banks or credit unions. We may be using online investment services, the etrades, the ameritrades, the scottrades, there's a bunch of them out there for people to consider. And they all have pros and cons associated with them. So of course my answer of which one should you go with? Shop around. Make an informed decision. Employee provided plans as well. A lot of us, our first savings and investing activities will really be those retirement plans we have at work. So defined contribution plans as we mentioned before. 401k plan or a Roth 401k plan are options for us. If you're with non-profits or education it might be referred to as a 403b plan. Very similar vehicles, not identical, though. And then of course just general investment companies like those, for example, that provide mutual funds available for us. And we'll talk about mutual funds as their own animal soon enough. As we start thinking about savings and investing it's also important that we think about the uncertainty associated with it. So, certainly we know that there's some risk associated with investing. If we're doing it right, we're not taking unnecessary risk. But there is often a prudent amount of risk that we need to assume. We need to get a sense of what's our sleep at night factor. How much risk can we be comfortable with. So the first thing we think about is subjective measures of risk tolerance. And we have a few links for you to check out on the course website to determine your personal risk tolerance. A lot of times these are done by thinking about your feelings, about certain situations. Asking you to make a choice in a hypothetical scenario and there's lots of different other survey instruments out there as well that will help to kind of guide based upon some of your preferences in certain circumstances. Whether or not you're willing to take on a little bit of financial risk to get higher returns, no financial risk. kind of of putting you into that perspective. This is helpful for your own advantage point of thinking about what am I comfortable with. And should you chose to work with a professional, this becomes a critical piece of information for them so that they can help to shape recommendations for you. There's also objective measures too. While there's the sleep at night factor, with how much risk I'm comfortable with. There's also these factors that say, well how much risk should you be taking, based upon your actual circumstances. This may or may not be consistent with how we feel about risk. So for example, the longer the time frame I have, the more aggressive I probably can be with my investments, all things equal. So someone who has 25 years until retirement probably should be reasonably aggressive in their investments, but what if they're not comfortable with that? Well that's sort of where the challenge comes into play. We can also look at ratios, too. How much of our wealth are we risking with this particular investment? So all of these things can be put together and used to give us a picture of how much risk we're comfortable with and how much risk we can really have the capacity to take on. So how does our money grow with investment. We said that it does pretty good, that we're putting money aside to do it, but how do we make money? Well, on one hand we make money when things we buy go up in value. So, and no. We're not talking about collectors items here. That's a whole other subject, but here we talk about something like capital gain. We buy a home. It increases in value. We sell it. The difference between what we paid, and hopefully what we sold it for, for more is a capital gain. Stocks work that way, bonds work that way. So in general when we buy an investment asset, we're hoping that it goes up in value. And when we do so, we can sell it. Capital gains can have favorable tax treatment, too. They may, if we hold them for longer term periods over a year, be taxed at a rate better than the rest of our income will be. That's pretty good, and something to keep in mind. So capital gains can come from real estate, from stocks and other investments, as well. There's also cash flows. A lot of investments will produce different cash flows. So for example, stocks may pay dividends, and that's going to be money that they pay quarterly to shareholders. Depending upon how many shares you have, that'll affect how much money you receive in dividend checks. Not every stock pays a dividend though, some are more focused on growth and simply reinvesting all the earnings back into the company. There's going to be different sides for that and we'll kind of take a look at that more when we look at stocks themselves. We also from bonds for example, or savings accounts, receive interest payment. So this is going to be interest paid. And why is that? Well because a bond and other types of investments as we'll see is a loan we're making to a company or to a government. And we may, if we own real estate, also be receiving rent. So these are all different ways in which our money will grow for us when it's invested. So we kind of put this all together and think about, how is our portfolio doing? Some assets may be producing great income, others may not. And we'll think that's something that we have to balance out over time because we can't always pick the winners. because we're just not that lucky. Taxes are going to affect our return. So we make that money. We mentioned capital gains can receive favorable tax treatment as well. I want to just kind of think a little bit about how this can make sense for it. So let's say Michael earns 15% as in, on his investment but he's going to have to pay taxes on the earnings each year. If he has 150,000 dollars invested and is in the 31% tax bracket, how much is he going to have in ten years? Well let's think about what that after tax rate of return is going to be for him. So if we take the taxes off, that gets us to about 10.35 percent. So we end up with about $401,000. So it's important that we think about after taxes, because our 401(k) plans, which again are going to be one of the most common things that most of us end up with in terms of a retirement savings account, are tax-deferred. So we won't pay taxes on the money today, but when we take the money out, we will pay taxes on it then. So, when we look at the balances, and it's important to realize, we won't have all of that money available to spend. I also want to touch base, too, thinking about inflation. We mentioned before that there are different types of assets and some of them will have a great rate of return much higher than the rate of inflation. And some like our savings accounts may not really keep pace with inflation they might be lower than that. So we want to think about how is our rate of return relative to inflation. Are we beating it? So we have two rates that we've defined. The real rate is the after inflation adjusted return. Or what we call the purchasing power rate. That actually measures right what our money can buy for us. The nominal rate measures just how much the dollars have changed, what's the change in dollars. How much have they increased? So real rates of returns consider how much inflation has affected our money. Nominal rates of return simply look at the absolute value of how our money is grown. So we look at this as a simple equation where little r is the real rate and big r is the nominal rate. So, 1 plus the little r equals one plus the big r, divided by 1 plus i, where i is inflation. So in other words, right, we net out the rate of inflation. And make sure that what we're left with measures purchasing power for us. This is important especially for long-term things like retirement, where we think about how much of a lifestyle do we want to be able to afford. When we think in lifestyle terms, we're thinking in terms of purchasing power. We're thinking of how much do I want to be able to spend. Well that's after taxes. And after inflation in some ways, especially the further off in the future it is. So if Michael can earn a nominal return of 15% of it, on his investments, and he expects inflation to grow for 3.2%, how much money will he have in today's dollars? And that's a way of saying, what would it buy me today? And that's how we account for inflation. So we make this little adjustment here, take it off, and the after inflation adjusted return is about 11.43%. So again, it shows us really what's the measurable amount of money we have. This doesn't account for taxes yet, if we took taxes off we'll see there's even a lot less money there. So we want to keep these things in mind, because if were investing for the long run again,. If we have certain goals, we need to think of those in terms of those are after taxes already, and oftentimes not adjustable for inflation. So how do we decide the right account? Well, if it's for education, then we're going to look at things like section 529 plans, Coverdell IRAs. Why? Because they have tax advantages associated with them. Money that we put in to those accounts, if they're used for qualified higher education expenses, when they're, when the money is withdrawn, its not subject to taxes, that's fantastic right? That's more like a raw fire rate, where money grows, we don't get any deductions today,. But money grows tax-free if it's used properly. And then of course, right, we have the retirement account. The IRAs, the 401(k)s, the 403bs, and in many of these cases we have a choice between Roth or Traditional. Now again, I get asked this question a lot, Doctor G, do I want Roth or do I want Traditional? Let's put it to rest and say we're never not going to pay taxes on this money, alright? That's seldom going to be avoided. With a traditional IRA, or traditional 401k, so let's say traditional versus Roth for argument's sake. With traditional, we will typically get a deduction today for the amount of money we're putting in, and the money will then grow tax deferred over time. When we take the money out, we'll have to pay taxes on it then. With Roth accounts we don't get a deduction today, hence we are paying taxes on that earned income today. But then when we, as long as we follow the rules, we don't take it out too early, we're using it for the right purposes, then we won't pay taxes on it when we take it out. So I'm either going to pay taxes today, or I'm going to pay taxes tomorrow. when do you want to pay your taxes? That's really the important question. Pay them now or pay them later. And you may think, does it matter? It does. Because, the tax rate you're in today may not be the same as it is tomorrow. Even assuming tax laws don;t change at all, if you're really young, maybe in your young twenties, you might be in a pretty low tax bracket relative to where you'll be when you're approaching retirement. Hopefully, your earnings grow up and as a result your income tax rate will go up as well. So do we want to pay taxes today potentially at our lower rate. Or pay them in the future at a higher rate or vice-versa, depending upon our own unique situation, career path, and income path as well. So for a lot of college students, for example, we'll often make the case, think about a Roth IRA. It might be a good fit for you. But it's not an absolute. We're all unique. And we still need to make sure that we make the right choice for us. We also think about minimum contributions, whether or not we have enough money to put in to open that type of account. Some IRAs will have different limits for it. But the nice thing about an employer provided plan is that you're qualified for the plan so you often just get to select how much do you want to invest from your paycheck and how do you want that money invested? So as always, we say when do we need it? If we need the money in a really short time frame then often times we might just be using basic types of accounts. Investment company accounts cash accounts that we might be working with. We may still be investing, but we might not really be able to take advantage of a lot of tax savings as a result. A Roth IRA, for example, does allow us to take money out earlier for specific purposes. So, in general, we have to leave the money in, in those retirement accounts until age 59 and a half. But with certain IRAs, we're able to take the money out for a first time home purchase, potentially in the event of disability to make sure we're able to make our healthcare premiums and other expenses we may have. We can also use them for qualified higher education. So if we're saving for the long run, but we may have some of these other needs coming up in advance, that account might still work for us, even though we may need the money before age 69 and a half. So you want to make sure that you read up on those and have a clear understanding of the different types of plans and the different types of accounts. So to kind of come back to this, again, we set our goals, we establish a budget to determine how much money we need. Think about the type of account, and think about what to invest in. We need to always make sure that we'll respect the rules of investing, and we'll be focusing on those in the following presentation. So let's recall, savings is an important decision we make, the act of making sure that we're not going to spend money today, but we're going to put it aside for future consumption. We can invest that money, in order to get a rate of return, make that money work for us, and beat the rate of inflation. It's important that we're making decisions about savings and investing. That we consider both inflation and taxes as we're picking the right types of accounts and even the right types of investments. Tune in next time and start learning about the different investment types.
