Saks (NYSE: SKS) is Slow

Earnings Info: Earned $.01 cent per share versus a loss of $.32 cents per share in the same period a year ago.

Revenue dropped 8.5%.

Both earnings and revenues beat the consensus earnings estimates by analysts.

Same-store sales declined 10.1%.

“I’d hate to say that things are great. I’d say that things are a lot less bad,” CEO Steve Sadove said.

Comment: Luxury retail needs a long time to recover. Madoff victims are still in fear mode when it comes to spending, and big ticket items are continuing to sit dusty on shelves as the discounts are steepening to create appeal.

Target (NYSE: TGT): It’s pronounced ‘Tarj-ay’

Earnings Info: Earned $.58 cents a share versus $.49 cents a share in the same period a year ago. Consensus earnings estimates by analysts was $.50 cents a share.

Revenue increased 1.1% and beat analyst expectations by a slim margin.

Executive provided a very cautious outlook, “Target remains cautious about fourth quarter performance and is planning conservatively in both business segments.

Comment: Target issued a very conservative report. Their quarter was positive for both profits and sales. Target continues to remain lean and mean during the retail recession. Target continues to provide the luxury thunder to the middle-market consumer.

TJX (NYSE: TJX): TJMaxx taking it to the max

Earnings Info: Profit was $347.8 million, or 81 cents per share — up 32%. Revenue rose 10 percent to $5.24 billion.

Comment: TJX continues to benefit from the down-scaling of the American consumer. Based on their stellar performance, we anticipate many shoppers to flock to TJMaxx for holiday bargains.

No positions in the stocks mentioned.

Answer: Morningstar is an investment research company that provides information on a wide range of financial products to individual investors, financial advisors, and large institutional clients. 

For an individual investor, Morningstar provides some of the best investment research services available, and many of their services are free.  For example, on Morningstar’s website you can sign up for free email alerts so you can receive an email anytime one of your stocks, mutual funds, or ETFs is in the news or releases new financial data.  They also offer a premium membership which includes extra features like analyst reports, stock picks, and advanced screening tools.  The premium membership costs money, but Morningstar allows a 14-day free trial so you can test their services to make sure they’re worth your money. 

As a financial planner, I use Morningstar to aggregate clients’ accounts into one comprehensive portfolio, and to research stocks, mutual funds, and ETFs.  Morningstar also provides unbiased commentary on thousands of investments and offers recommended buy and sell target prices. 

Whether you’re a beginning investor or a large institutional stock trader, Morningstar is a valuable resource that can help you make smarter investment decisions.

Matthew Brandeburg, CFP® has seven years of financial planning experience and runs his own business, Bridgeway Financial Group, LLC, based in Columbus, Ohio.

Some parents with 529 college savings plans may not want to make contributions in 2009 due to fears about the economy. BusinessWeek reports grim data from investment research firm Morningstar: 529 fund offerings that had 80 percent or more of assets invested in equities were down an average of 38.4 percent in the one-year period ending March 31.* No wonder parents feel queasy about doling out more money to the funds.

Financial writer John Gilliam asked Wasif Latif, USAA’s vice president of equity investments, about the college-funding challenge USAA members face.

GILLIAM: What do you say to those who plan to skip making a 529 contribution this year?

LATIF: If you’re unemployed and can’t pay bills, you do what you have to do. But the percentage of members in that situation is small. To the larger group choosing not to contribute because of poor 2008 returns or fears about the economy, I say that decision may be costly and have a detrimental effect on their ability to fund a child’s education.

GILLIAM: Is skipping one year really that big of a deal?

LATIF: Yes. Successfully funding college through a systematic investing program is based on the most tried and true investment principles.
• No. 1: Start early to take advantage of the potential long-term performance and diversification benefits of stocks and bonds.
• No. 2: Contribute consistently to take advantage of dollar cost averaging, which means you buy more when markets are down, effectively lowering your average cost.
• No. 3: Make small contributions a habit, as re-starting is tough. These principles hold true for all types of systematic investing, including retirement.

GILLIAM: But when people look at losses of 30 to 40 percent in 2008, it’s hard not to get discouraged.

LATIF: Naturally. 2008 was a terrible year. But in any systematic investing program, you can’t just contribute when the markets are up, or you give up the benefits of the long-term approach.

Monitoring a 529’s asset allocation so that it’s more conservative as college approaches should help protect against dramatic losses. Our USAA 529 Plan starts off very aggressively, with a high allocation to stocks when the child is young, and gets more conservative as college nears. So the biggest losses would have been in accounts for very young children with time on their side. In these cases, you want to be buying when stocks are way down. It may not feel good now, but if market history is any guide, it potentially will later.

GILLIAM: Has USAA made any significant changes to its 529 plan?

LATIF: We’ve added new asset classes, including emerging markets and precious metals and minerals equities, and we’ve increased exposure to international investments — moves which allow us to apply more of our asset allocation expertise. For students in college, we currently offer a portfolio which has only 10 percent of its assets in USAA stock funds and the rest in USAA bond and money market funds. But we anticipate introducing a new portfolio soon that has a USAA money market fund as its underlying fund so that it seeks to preserve capital. ■

*BusinessWeek, April 30, 2009

Consider the investment objectives, risks, charges and expenses of the USAA College Savings Plan (Plan) carefully before investing. Call 1-800-292-8825 to request a Plan Description and Participation Agreement containing this and other information about the plan. If you or the beneficiary are not residents of the State of Nevada, consider before investing whether your or the beneficiary’s home state offers a 529 plan that provides its taxpayers with state tax and other benefits not available through this Plan. Please consult your tax advisor.

An investment in a money market fund is not insured or guaranteed by the FDIC or any other government agency. Although the fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the fund.

DON’T MISS: SPECIAL 529 RULES FOR 2009

For 2009 only, the IRS is allowing 529 college savings plan holders to switch the investment options on their existing contributions twice instead of just once per year.

Call USAA at (800) 583-8293 for a free portfolio review. Your investment choices now could make a difference for your child’s future — and your own. For more, visit USAA.COM (search: 529).
USAA, a diversified financial services group of companies, is among the leading providers of financial planning, insurance, investments, and banking products to members of the U.S. military and their families. For the past three years, BusinessWeek magazine ranked USAA among the top two “Customer Service Champs,” highlighting our legendary commitment of providing highly competitive financial products for approximately 7 million members. For more information about USAA, or to learn more about membership, visit usaa.com.

A: There are a number of different retirement plans available for your small business that allow you to save money in a tax-efficient way.  While some of the plans require time consuming administration, annual filing requirements and costly plan installation, there are two plans that are inexpensive and easy to establish: the SIMPLE IRA and SEP IRA.

SIMPLE IRA
A SIMPLE IRA (Savings Incentive Match Plan for Employees) is designed for small businesses with 100 or fewer employees (it’s ok if you’re the only employee).  You, as the employer, can save up to $11,500 per year through a SIMPLE IRA.  Setting up the plan is as easy as a phone call to a brokerage house like TD Ameritrade and filling out a form or two online.

SEP IRA
A SEP IRA (Simplified Employee Pension) lets you save money tax-deferred much like a SIMPLE IRA and it’s just as easy to set up.  However, a SEP IRA lets you contribute up to 18.6% of your net profit up to $49,000 in 2009.

SEP IRA vs SIMPLE IRA
Let’s assume your net profit for 2009 is $50,000.  In this scenario you could contribute up to $9,300 into your SEP IRA for 2009 ($50,000 x 18.6%).  Compare this with a SIMPLE IRA, which would allow you to save $11,500. There’s a crossover point to determine which plan lets you save the most money.  You will be able to save more money through a SIMPLE IRA if your net profit is $62,000 or below.  If your net profit is greater than $62,000, you may want to consider a SEP IRA. 

If you have employees or plan to hire in the upcoming year, the rules become more complicated because you may be required to contribute money on behalf of your employees.  You should consult your CPA to make sure you understand these rules and see if they’re applicable to your business.

Remember that as a small business owner you need to have an “out plan” which comes in the form of retirement savings.  When the time comes that you lose your ability to produce income, you need to make sure you have enough retirement savings to support your lifestyle.

Matthew Brandeburg, CFP® has six years of financial planning experience and runs his own business, Bridgeway Financial Group, LLC, based in Columbus, OH.

A: There are three factors that suggest the U.S. dollar will continue to decline in the near future.
1) The recent debt the U.S. has assumed trying to jumpstart our economy
2) The large U.S. trade deficit
3) The slow economic recovery from our current recession.

If this assumption is correct and the U.S. dollar continues to lose value, then a collection of emerging-market currencies would be a reasonable way to protect your portfolios and act as a hedge against the currency risk.  But buying emerging-market currencies can be difficult because most of us have never traded foreign currencies before.  For this reason I recommend considering emerging market bond funds that invest in a collection of emerging market currencies.  I recommend buying bond funds instead of buying the actual currencies directly because each bond fund is professionally run by a bond fund manager, which decreases your investment risk substantially.  There are many different emerging market bond funds to choose from and you can research available options at www.morningstar.com

Why emerging market bond funds?  Unlike the US, many emerging countries run trade surpluses, are less indebted to the rest of the world and will likely grow faster than the US as a result.  This helps strengthen their currencies. 

If you’re interested in emerging market bond funds I encourage you to do additional research.  You should never invest in anything without first understanding all the risks involved and you should review your specific investment needs and risk tolerance with a Certified Financial Planner.

Matthew Brandeburg, CFP® has six years of financial planning experience and runs his own business, Bridgeway Financial Group, LLC, based in Columbus, OH.

Make Your Money Work for You
So now you have maximized your 401(k) and your IRA, you have your debt paid off, your emergency fund is set and you are finally ready to get into some serious investing on your own, the Wall Street way. Where should you begin? The best place to start is with a mutual fund.

Some of you are probably thinking, “Why start with a mutual fund? That’s what I have my IRA invested in.” Remember, the money you are investing now is nothing more than personal savings. This is the money you will use to supplement your retirement or buy a new car or a vacation home. You don’t want to lose the first part of your hard earned savings right away in some oil scheme. I’m not talking about putting all of your money in a mutual fund, just the first part. Once you have a decent balance established, you can begin to move money into other riskier ventures. At this point you may want to look into real estate or individual stocks. Perhaps you would like to diversify into corporate or government bonds, depending on your age and risk tolerance. If you have enough money and you really like to play with fire you could even get into commodities and options trading.

Since there are entire books devoted to these riskier types of trades, I am not going to get into too much detail, but I will give you an idea of what they are.

Diversify: All Your Eggs in One Basket
We have all heard the expression, “Don’t put all your eggs in one basket.” This statement definitely applies to the world of investing. You always hear about people making millions of dollars by investing in individual stocks. Some people have made a fortune by sticking with one company throughout their lives (Microsoft, Wal-Mart, Google). So what is wrong with doing the same thing? Sure it’s riskier, but people do it.  Well, let’s not forget about the people who invested all their money in Enron, FannieMae, or Kmart. If you like to gamble in Vegas with large amounts of money, perhaps putting all of your money into one stock is the way to go. Otherwise you want to diversify.

Why should you diversify? I’m not going to bore you with complicated graphs and statistics, but let’s just say your risk of losing all of your money when you own stock from at least 13 different companies is way less than if you own the stock of just one. This is how it works. If you own, for the sake of simplicity, 20 stocks, with the same amount of money invested in each company, and two of the companies go completely out of business, you have only lost 10% of your money. If you would have all of your money in any one of these two companies, you would have lost 100% of your money. Now, assume that three more of the stocks stayed the same, five went up by 10%, five went up by 15% and the remaining five went up by 25%, your total “portfolio” would have still increased by 2.5%, despite the two companies that went under completely. The key to protecting yourself is to diversify.

So how do you diversify? If you try to buy the stocks from 20 different companies, it would cost you a fortune in transaction fees, besides the fact that you could only afford a few shares of each company. There is a much better way to diversify. We call them mutual funds. Mutual funds are basically a large “portfolio” of various investments. Since many people own pieces of a mutual fund, all of their invested money is used to buy a larger share of each investment and it allows the mutual fund manager to purchase many different types of investments to create a diverse investment vehicle.

There are many types of mutual funds. Some invest in stocks, some in bonds, others invest in both. There are also real estate mutual funds and many more. Each fund must follow a set of basic rules that only allows them to invest in certain types of assets. For instance, a growth mutual fund manager would be looking to purchase shares of companies that are expected to grow, so the growth fund will probably not have the stock from larger well-established firms such as General Electric or Coca-Cola.

To invest in a mutual fund, you would go through an investment firm, such as Charles Schwab, Vanguard, etc. They would set you up with an account after you invest a minimum amount and perhaps set up a way to automatically contribute every month. The mutual fund manager takes your money, adds it to the money that is coming from other investors, and purchases either more shares of stock the fund already owns or perhaps shares of stock in companies that are new to the fund.

One important issue with mutual funds is how the investment firm makes money. There are several types of fees that can be charged by mutual funds. There are no-load funds, low-load funds and load-funds. A load is another term for a fee. A load can be charged at the beginning of an investment or when you withdraw your money. If you are charged a front-load fee, for every dollar you invest, a few cents comes off the top right away for fees. So your investment has to earn a decent return just so you can break even. Back-loads are fees charged if you withdraw your money within a certain time period, usually seven years. For instance, you may be charged 5% if you withdraw your money within the first year, 4.5% during the second year, 4% during the third year, etc.

I prefer no-load funds, but keep in mind there are still fees involved, even in no-load funds; after all, the investment companies have to stay in business. There are annual fees that may be charged. You definitely want to stay away from funds that charge more than 2% in annual fees. After all, if you earn 8%, but pay 2% in fees, you are only really getting 6%. That is before any tax consequences are considered. The lower the fees the better. Of course, don’t get so caught up in finding the lowest possible annual fees that you forget to see whether the mutual fund is right for you, or even if the fund has been performing well. What good is the lowest fee, if the fund is losing money?

Okay, so let’s talk a little more about mutual funds. There are several types of funds, which can be broken up into different fund styles. The styles really describe the styles of the managers of the fund. The style can be based on an index, investment strategy, a particular sector, company size, on bonds only, or a money market.

I prefer to invest in index mutual funds. An index fund simply holds a portfolio that represents a major index, such as the S&P 500 Stock Index or the Russell 3000. The advantage of the index fund is that the fees are usually lower since the manager does not have to work as hard to actively manage the fund. Since the goal is to imitate the index it is following, most of the guesswork is removed. There is no real statistical evidence that a professionally managed fund earns a better return for the amount of risk involved than an index fund.

Growth funds are managed to purchase stocks of firms that are expected to grow big over the next few years. Growth funds are riskier, because while they may return big, they may also fall big. Expect a lot of volatility with these funds as the value may go way up and way down from one year to the next. Value funds hold shares of companies the managers of the fund feels are undervalued in some way by the current market. They use all types of complex measurements and formulas, but the point is, they feel the market is currently undervaluing the stock at the moment, and they expect the market to eventually see the error of its ways, and bid up the price.

You can also look into sector funds. For instance, if you believe the health sector is on its way up, but are not quite sure which companies will be the winners, you could invest in a health sector fund, which will invest in the stocks of various firms within the healthcare sector. There are funds for almost every sector available.

Company size is usually split between large-cap, mid-cap and small-cap funds. All this tells us is the relative size (or capitalization) of the company relative to the market. Most large-cap funds invest in companies with market capitalization of $8 billion or more, while mid-cap funds stay above $1 billion and small-cap fall below $1 billion. Large-cap funds are the least volatile, but also results in lower returns. The smaller the capitalization, generally the more volatility, but the greater potential for growth and returns.

Bonds
Bonds come in all shapes and sizes. You can get everything from low-yield treasury bonds that are backed by the full-faith of the federal government to junk bonds, which are high-risk bonds issued by companies with credit problems. Government bonds include those issued by federal, state and local governments, while corporations issue corporate bonds. Bonds are rated according to their credit worthiness, much like we have our own credit score. Moody’s and MorningStar are the two major credit-scoring companies in the bond market. The better a company’s credit rating, the lower the risk they impose to the investor. In return, they will be able to get a lower interest rate.

From your perspective, bonds are like loans in reverse. You give a large chunk of money to a corporation (say $10,000) and they make monthly or quarterly payments to you in the form of interest. At the end of the bond term, say 20 years, you get your principal back.  One of the biggest drawbacks of purchasing bonds is that you lose the benefit of automatic compounding interest. You see, if you receive a payment from a bond every six months, you have to reinvest it at the same rate to enjoy the benefits of compounding. That is one of the reasons to invest in a bond fund instead of individual bonds. The bond fund manager can use the interest payments of the investors and collectively purchase more bonds.

In many ways bonds can work like stocks. Once you buy a bond, you are not necessarily stuck with it until maturity. You can sell the bond in a secondary market, similar to the stock market. In fact, you may have purchased it in this same market. Some people invest in bonds for a period of time, and then sell the bond to get money out for various things such as a vacation, education, etc. The question is how much can you get out of a bond when you sell it? That depends on the rating of the bond, the interest rates at the time and the coupon rate. As interest rates rise, the value of existing bonds falls. Why is that? If you have a bond that pays 5% interest, and new bonds are issued paying 10% interest, why would anyone be willing to buy your bond? They would want the new ones that are paying 10% interest. So how do you sell your bond in this case? You sell it at a discount. If you have a $10,000 bond and you sell it for less than $10,000 then you are selling it at a discount.

Let’s say you have a 10% bond and the interest rates fall to 5%. Now the value of your bond just increased. After all, everyone wants to buy your 10% bond, since all the new ones are only paying 5%. In this case you will sell your bond at a premium. Your $10,000 bond will sell for more than $10,000.

Options
Buying and selling options is perhaps the closest thing to legalized gambling, next to state lotteries. With options big money can be made and big money can be lost. It is not uncommon for a person to make $20,000 in one day with options trading… and then lose $25,000 the next day. By no means should anyone try options trading based on the information I am giving you. If you want to seriously trade in options, there are appropriate books available that discuss the topic in detail. I am just giving you an overview.

Instead of purchasing a $50 stock, you could purchase an option, for say $5, which gives you the right to buy that same stock for $47. At first this may not make sense, because you paid $5 for something only worth $3 (If you would purchase the stock for $47 and sell it at $50, it’s current value, you would make $3, but the option cost you $5, so you essentially lose $2).

At this point your option is “out of the money,” that is, it is worth less than it’s cost. You are probably wondering how this gives you any advantage… why not just buy the $50 stock? Well, if the stock increases in value by 10%, it is now worth $55. You could turn in your option at this point, pay $47 for the stock and sell it at the current market price of $55. You just made $8 profit, minus the $5 cost of the option, which means you netted a gain of $3. Big deal you say? Look at it this way. The stock price only went up 10%, but you made a 60% return on your money. How? You only invested $5, but earned a $3 return on your money.

To make this example clearer, let’s compare two scenarios dollar for dollar. Matt and Pat each have $50. For simplicity sakes, let’s ignore brokerage fees. Matt buys one share of ABC stock for $50. Pat buys 10 options, each $5, which give her the right to purchase the stock for $47 per share (total cost to each Matt and Pat is $50). If the stock’s price increases by 10% to $55 and Matt sells his share, he made a total of $5, or 10% return on his money. Not bad Matt. Pat, on the other hand, exercises her 10 options and buys the 10 shares for $47 each and sells them for $55 each. Pat just made $30 compared to Matt’s $5. Pat got a 60% return on her money. Sorry Matt.

You might be thinking, “Wow, that’s amazing. Why doesn’t everyone just buy options?” Two reasons. First, not every stock has an option attached to it. Second, the losses can be more significant if the stock decreases in value. Using the same example, if the stock decreases by 10% to just $45, then Matt loses $5 or 10% of his investment. Pat, on the other hand, loses the entire $50 since her options are now worthless (the stock costs less than the price her option allows her to purchase it). Pat lost 100% of her investment. Sorry Pat.

Dollar Cost Averaging
The easiest way to save money is to put away the same amount each month or each pay period. One of your regular monthly expenses should be your savings. When you invest in the stock market, you can expect stock prices will fluctuate. Dollar cost averaging is a way to let you invest without really worrying about what the individual prices of the stocks are at any given moment. Essentially you put the same amount of money in your investment every month (or pay period) no matter if the price is up or down. When the prices are up, the same $100 will buy you fewer shares, but at least your overall account has gown since the price increased. When the price goes down, it is like buying the same shares on sale.

Consider the following example. You invest $100 per month into the ABC mutual fund. The shares cost $20 each when you start investing so you own five shares. Next month you contribute the same amount, $100, but the shares fell to $10 each. Your account balance went down since the shares decreased, but now you are able to buy 10 shares at $10 each, so you own a total of 15 shares. When the price recovers to $20 per share the next month, your account balance is up to $300! You only contributed $200 so far and the price is the same as it was when you started, yet you have earned $100. Also, you will contribute $100 since you do so every month, which buys you five more shares. Next month the price increases to $25 per share, so your account balance is $400! This month your $100 savings will only buy four shares, leaving you with a total of 24 shares and an account balance of $600.

Bill Pratt is a former credit card executive turned student-advocate. He is the author of Extra Credit: The 7 Things Every College Student Needs to Know About Credit Debt & Ca$h and The Graduate’s Guide to Life and Money. Bill speaks at colleges to educate and entertain students about real-life issues in money, leadership, and success. His goal is to help students succeed personally and financially so they can improve the lives of those around them. You can learn more at www.ExtraCreditBook.com or www.TheGraduatesGuide.com.

Q: Should I invest in my home country India or should I invest in Singapore?  The conversion rate is something like 1 SGD = 34 INR.

A: No matter where you invest, you’ll be subject to currency risk.  Trying to predict where currency exchange rates will go is not recommended unless you’re an expert.  Before you invest in either country make sure you fully understand the risks involved.  This may mean you should not invest in either country, but I cannot make that decision for you.  If you decide to invest in India or Singapore, make sure you are able to view your investments online or receive monthly paper statements.
Q: From what I have read, I believe that investing in stocks is a bit risky and I may need another 2 years to take that risk.  So, what are the best investment plans for me?

A: Unless you have 10 years to leave your investments in the stock market, you’re right, you may be best to avoid the stock market because of the risks involved.  In the mean time you can invest in money market funds, CDs, and highly rated corporate and municipal bonds.  There are many suitable alternatives to stocks but it will depend on your specific investment needs.
Q: Should I invest in bulk or is it advisable to save a small amount every month and invest it?  Mutual funds or unit trusts?

A: In general it’s best to dollar-cost average into your chosen investment by investing equal dollar amounts each month or each quarter so you will buy more shares when prices are low and less shares when prices are high.  Mutual funds are a collection of stocks, but your earlier question mentioned you plan to stay out of the stock market.  Make sure you understand that if you invest in mutual funds that is the same as investing in the stock market.
Q: How much money should I have for starters.  Presently, I can invest around 50SGD per month.  Should I invest more?

A: I can’t tell you how much to invest per month. But I can tell you, that every bit counts even if it’s only a small amount.  Whatever amount you decide to invest, remember that a little is better than nothing and try to dollar-cost average into the market if possible.  As a rough estimate, you will need about 25 times your annual living expenses by the time you plan to retire.  You mention you are 20 years old so you have plenty of time left before retirement, but you should start saving today to let your investments compound.

Matthew Brandeburg, CFP® has six years of financial planning experience and runs his own business, Bridgeway Financial Group, LLC, based in Columbus, OH.

The Rule of 72

Now that you have a better understanding of where to put your money and when, you may be asking “Why?” After all, you’re a smart college graduate and you want to actually understand why money works this way, you’re not content just letting me tell you what to do with it, right? To simplify everything, it really boils down to the rule of 72.

The rule of 72 is a simplified way to discuss compound interest. When you put your money in a bank, for instance, you may earn about 3 percent interest (plus or minus, depending on the economy). If you put $100 in the bank at 3 percent interest, you can expect to have $103 in your account after one year. Big deal. But let’s say you leave that $103 in the bank. The next year you will have $106.09. You earned interest on your interest! You earned 3 percent on the $3 interest you left sitting in your account. The extra nine cents may not seem like much now, but after 24 years, you will have about $200 in your account. That’s right, you will have doubled your money in about 24 years. What if the interest did not compound? You would only earn $3 interest per year and it would take 33 years to double you money. You doubled your money nine years sooner just because of 3 percent that was compounding. What if it was 6 percent or 12 percent?

The rule of 72 says that if you divide the number 72 by the interest rate, the result is how many years it will take to double your money. Seventy-two divided by three is 24. It will take 24 years to double your money at 3 percent. Seventy-two divided by 12 is only six. If you were investing and earning 12 percent per year, it would only take you six years to double your money. This simple rule explains why the amount of interest we earn is so important.

Let’s look at a few examples. Larry, Carrie and Mary are triplets who were each given $1,000 from their parents for Christmas on their 25th birthday. Larry puts his money in the bank and earns 3 percent interest. Carrie buys some corporate bonds and earns 6 percent interest. Meanwhile, Mary invests her money in the stock market and earns a 12 percent return annually. Forty years later, when the three are ready to retire, they check to see how much money they have. Larry is disappointed when he sees that he only has $3,315. Carrie is happy to see that she has $10,957 waiting for her after selling her corporate bonds. Meanwhile, Mary is able to do all the traveling she wants in her retirement with the $118,648 she has earned from the stock market!

From the above example you can see that the interest rate makes all the difference in the world. Three people had the same amount of money to invest, and kept it invested and compounding for the same amount of time, but Mary, who was earning 12 percent ended up with more than 35 times the amount that Larry had earned! By the way, Carrie was no longer happy with her $11,000

The power of compounding works best when combined with the power of time. You see, if the three of them would have checked their balances after 12 years, Larry would have about $1,433, Carrie would have about $2,051 and Mary would have about $4,191. There is still a significant difference between the three, but not as much as there was after 40 years. That is why you need to start thinking about your retirement now. Look at Figure 11-3 to see how compounding works over time.

What you should see in Figure 11-3 is that in the beginning, compounding creates a little bit of upward momentum during the first several years (through year 11). Then, the pace seems to pick up a little more (years 12 through 25), and then it really picks up the pace (years 26 to 33). Finally, look at how quickly the investment grows towards the end of this 40-year picture (years 34 to 40). Remember, this is just a one-time investment of $1,000 earning 12 percent interest per year. This example assumes no more money was added.

To get an even better picture of how compounding works, let’s say the three siblings from the above example decided to save an additional $1,000 each year until age 65. After 40 years, Larry would have about $80,000, which is not bad, considering he only had to contribute a total of $40,000. Carrie would have about $175,000, which is really good considering she also contributed the same amount, $40,000, over her working career. Mary, if you can believe it, would have over $1 million. That’s right, she would have over $1 million and she only had to save a total of $40,000 over her working career. Mary is on her way to a very comfortable retirement.

Bill Pratt is a former credit card executive turned student-advocate. He is the author of Extra Credit: The 7 Things Every College Student Needs to Know About Credit Debt & Ca$h and The Graduate’s Guide to Life and Money. Bill speaks at colleges to educate and entertain students about real-life issues in money, leadership, and success. His goal is to help students succeed personally and financially so they can improve the lives of those around them. You can learn more at www.ExtraCreditBook.com or www.TheGraduatesGuide.com.

Emergency Funds

Emergencies come in all shapes and sizes. If you get into a small accident you may need to pay the $500 deductible on your car insurance. Maybe your furnace will need replaced and it will cost $1,500. Perhaps you will get laid off from work and it may take a few months to find a new job. As you can see emergencies are unexpected events that drain our finances. Imagine if you had no money saved and you had to replace your furnace. What are you going to do, use a credit card? Do you really want to get back into that again? Let’s say you lost your job. How are you going to make the credit card payment for your new furnace when you have no income? How will you eat?

Not to sound too dramatic, but you have to save at least $1,000. Everyone should have at least $1,000 in his or her savings account. From there you should build up your emergency fund to cover three to six months worth of expenses. Notice I said expenses, not income. We make more than we spend (hopefully). Also, we spend more than we need. What is three months worth of expenses? Well, rent or mortgage is needed, as well as other payments such as your car and insurance. You will also need to pay for utilities and food. What you do not need to worry about are things like savings, dining out, entertainment, etc. Sure, these things are nice, but you could probably forgo them if you had to.

So now you are contributing to your 401(k) at work, and you are saving money towards your emergency fund. You may be thinking there is not enough money left for anything else. Don’t get too hung up on your emergency fund. If you save just 10% of your money towards an emergency fund, it will take you about two full years just to save three months worth of living expenses. My recommendation is to save the first $1,000, then focus on paying off your debt. After all, your living expenses will be lower if you do not have any debt payments.

Individual Retirement Accounts (IRAs)

After you are more comfortable financially, perhaps once your debt is paid off, you can begin investing on your own. You can invest outside of your 401(k) for your retirement, and you can actually invest just to make money. This is what we mean by making your money work for you. When you invest for retirement purposes, you can shelter your investments from taxes by using an Individual Retirement Account (IRA). An IRA is not an investment of its own, it is a type of investment. An IRA could be a stock investment, a bond investment, a mutual fund, a certificate of deposit (CD), or a few other types of investments. You can choose between a traditional IRA and a Roth IRA.

The Individual IRA allows you to deduct the amount you contribute from your current taxable income. Thus, just like your 401(k), you will not have to “give up” as much money as you contribute from your current income. If you are in the combined 30% state and federal tax bracket, and you contribute $2,000 to your traditional IRA (the current maximum contribution allowed), you will save $600 in taxes this year (30% x $2,000 = $600). Now, it gets even better. Any gains you receive while your IRA is growing are not taxable. That means if your IRA increases from $10,000 to $20,000, you pay nothing. Once you retire and start withdrawing from your IRA is when you pay the taxes. You will be taxed as if the money you are taking out is regular income. In theory, by the time you retire, you will be in a lower tax bracket since you will not be working. That depends on what the current brackets are when you retire and how much money you take out of your IRA each year.

The Roth IRA does not provide immediate tax deferral like the traditional IRA does. In other words, if you are in the 30% tax bracket and you contribute $2,000 (the maximum allowed), you will not save on any current taxes owed. The advantage of the Roth IRA is that you will not pay any taxes on your money when you withdraw it. Also, you will not pay any taxes on the money as your IRA grows (just like the traditional IRA). Basically, you have already been taxed on the money, so you are done paying the government their share.

So which do you choose? There are several factors that determine the best fit for our finances. The IRS has specific rules that govern how much you can earn and still be eligible to contribute. Assuming you do not make too much to be eligible, it really depends on how much money you have. As a rule of thumb, if you cannot afford the whole $2,000 contribution, just stick with the traditional. That way you will either be able to contribute more, since you will save tax dollars, or you will still have spending money left over after you contribute. If you are easily able to maximize your $2,000 contribution, you may want to use the Roth IRA, since you will be able to withdraw more when you retire (since the Roth IRA will not be taxed when you withdraw). Here is an example.

To illustrate this with numbers, let’s assume Matt contributed the maximum to a traditional IRA and Pat contributed the maximum to a Roth IRA. We’ll assume their IRAs were both invested in the same mutual fund, so both of their accounts are worth the same amounts. If Matt withdraws $50,000 at retirement and he is in the 30% tax bracket, he will pay $15,000 in taxes and will only have $35,000 left to spend. If Pat withdraws $50,000 at retirement and she is in the 30% tax bracket, she will pay no taxes and will have the full $50,000 to spend. Again, this only applies assuming you can afford to maximize your contribution; otherwise you might as well use the traditional IRA.

There are special rules to consider with the IRAs. There are severe penalties if you withdraw your money early (before age 55 ½). You will pay a 10% penalty for withdrawing the money in addition to your regular income taxes. To make matters worse, if you withdraw a large portion of money from an IRA, it may actually push you into the next tax bracket. Assuming a 30% tax bracket, if you pull out $10,000, you will pay $1,000 in penalties and $3,000 in taxes. Thus, you are losing $10,000 in your retirement portfolio, and you only get $6,000 of it. Not a very good deal. If you pulled out enough to knock you into the next tax bracket, you would end up paying even more because a portion of that $10,000 may be taxed at 35%. As you can see, it pays to keep your money in your retirement plan.
Bill Pratt is a former credit card executive turned student-advocate. He is the author of Extra Credit: The 7 Things Every College Student Needs to Know About Credit Debt & Ca$h and The Graduate’s Guide to Life and Money. Bill speaks at colleges to educate and entertain students about real-life issues in money, leadership, and success. His goal is to help students succeed personally and financially so they can improve the lives of those around them. You can learn more at www.ExtraCreditBook.com or www.TheGraduatesGuide.com.

A: Exchange-traded funds (ETFs) are a great to way invest in the stock market, especially for first-time investors.  Similar to mutual funds, ETFs are a collection of investments such as stocks, bonds, commodities or real estate.  However, ETFs are quickly gaining popularity over mutual funds because they hold a few key advantages such as tax efficiency, low expenses and flexibility.

If you’d like to invest in ETFs I recommend opening a brokerage account that lets you buy and sell ETFs for only a small transaction fee.  TD Ameritrade (www.tdameritrade.com) is a great choice because they don’t charge a set up fee or annual maintenance fee.  They only charge a small transaction fee of $9.99 per trade (subject to change).  Because you will have to pay a transaction fee, you should consider investing in ETFs if you have at least $500 to invest.  Otherwise the transactions costs may overshadow the benefits.

Once you’ve opened an account that lets you buy and sell ETFs, you need to decide which fund(s) to invest in.  There are a number of different fund families that offer ETFs and I recommend starting your search with iShares.  I like iShares because they have a very user-friendly website (www.ishares.com) that provides straightforward information about their funds.  Their website also features an education center that includes on-demand presentations.  To access these presentations and other educational information visit their website and click on the “Get Started” and “Education Center” tabs at the top of the page.  This should provide the extra training you’re looking for.