Practical investing

Concepts: Impractical investing is the riskiest, often expensive, way of saving money for future use. Practical investing is the safest way to save money. The most practical investments are savings accounts, bonds, and brokerage accounts.

Practical investing is the long, slow process of saving money for future use.  Not by stashing it at home, but by giving it to a trustworthy person outside of home who will protect it, and better yet, put it to work earning extra money on your behalf.  ‘Protected money’ helps defend against future emergencies.  ‘Extra money’ helps pay for expensive things, caring for family members, and retiring from work.  The most practical investments are savings accounts, bonds, and brokerage accounts.  

Savings accounts are available in banks and credit unions.  Shop around to find the best deal for you and when you apply for an account, be sure it is FDIC insured (FDIC stands for the Federal Deposit Insurance Corporation). The FDIC insures against accidental or criminal loss of all the money held in your account up to the limit of $250,000 per account holder, per bank.  

  • ADVANTAGE- Money is easily deposited and withdrawn.
  • DISADVANTAGE- The interest rate is very low, usually below our national rate of inflation.
  • RECOMMENDATION- Use your savings account as an emergency fund to pay for catastrophes such as job loss, medical bills, and other overwhelming events. Try to save 3-9 months of wages in your emergency fund for the rest of your life. 

Bonds and CDs (CDs are certificates of deposit) usually pay more interest (interest is ‘extra money’) than savings accounts.  Bonds sold by the U.S. Government are guaranteed to be fully repaid with interest after a specific period of time.  Bonds sold by companies are fully repaid with interest unless the company is unable to make the payment.  CDs are sold by banks and credit unions, and insured by the FDIC.  

  • ADVANTAGE- The seller promises to repay you the full amount of the bond plus interest. 
  • DISADVANTAGES- The full amount plus interest is not repaid until the maturity date.   “Investment grade” bonds are usually repaid, but “junk bonds” may not be repaid.
  • RECOMMENDATION- Purchase bonds and CDs with maturity dates at or below 5 years in order to save for startup projects such as buying a car, new business, or new house.

Brokerage accounts sell securities such as stocks and stock-index funds.  The accounts are “SIPC insured” if the broker is a member of the SIPC (SIPC stands for the Securities Investor Protection Corporation).  The SIPC insures against financial failure of the broker and unusual loss of securities by the broker.  The SIPC insurance limit is $500,000 per customer, including no more than $250,000 cash, for all of the customer’s accounts combined. SIPC insurance does not protect against investment losses.

‘Extra money’ from stocks and stock-index funds might exceed the interest rates of bonds and CDs, and also exceed the rate of inflation.  But stocks and stock-index funds are riskier investments than bonds and CDs because you could lose money in the stock market.  

Three good ways of earning money in the stock market are 1) buying shares of a reputable stock-index fund, 2) holding the shares for a long time, and 3) reinvesting stock dividends.  All three ways are illustrated in the following graph:

dividend reinvestment

The graph shows 33 years of growth-in-value of a stock-index fund that was invested in a group of stocks measured by the Standard & Poors 500 Index (the “S&P 500″).  The stock-index fund earned ‘extra income’ in 2 ways: 1) from stock dividends and 2) from growth-in-value of the fund.  When all dividends were reinvested by buying additional shares of the fund (blue line), the final fund value of $6,000 was twice what it would be, $3,000, when the original number of shares were held without reinvestments (red line) for the entire time.  The blue line represents compounded growth.

Impractical investing is a very risky, often expensive way to save money.  The very risky investments include junk bonds, initial public offerings, partnerships, leveraged funds, commodities, currencies, collectibles, options, derivatives, hedge funds, and property ownership.  The possible expenses are high commissions, high tax rates, tax accountant fees, illiquidity (tied-up money), and costly mistakes.   

Useful references

FDIC. https://www.fdic.gov 

SIPC. https://www.sipc.org 

Introduction to Treasury Securities.  https://www.investopedia.com/articles/investing/073113/introduction-treasury-securities.asp 

TreasuryDirect®. https://www.treasurydirect.gov/ 

The Index Card.  Why Personal Finance Doesn’t Have to be Complicated. {http://wp.me/p1LlDo-KQ} Helaine Olen, Harold Pollack. Penguin Publishing, New York, 2013.

roadmap to investing.  https://www.sec.gov/reportspubs/investor-publications/investorpubsroadmaphtm.html 

Copyright © 2020 Douglas R. Knight 

 

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