Invest on behalf of a child

Last week, a young reader wanted advice on investing for themselves after college. That prompted a different question about investing on behalf of someone younger:

What would be your advice on someone investing for their child? Is there a good long term low risk investment choice?

It'd be the same for anyone considering investing: do your homework first. Plunging money into anything you don't understand is a fail waiting to happen. Just ask anyone who got greedy during the housing bubble.

Second, you need to determine what exactly you're investing for: so the kid will have savings later? College? First house downpayment? Remember that different investment choices make sense for different goals, for example 529s & certain IRAs have tax benefits for education savings.

On the other hand depending on the child's age and when you'll want him or her to use the cash, you might want to buy stocks, which can be riskier but provide better returns over the long-term, or bonds or money market funds which have the goal of protecting your principal (the amount you initially invest) and could make sense if you want access to money in the shorter term shorter term.

I have to warn you, though, that I think looking for a long-term/low risk investment might be misguided. You always need to invest to your own sensibilities and risk tolerance and keep in mind the length of time before you'll want to cash out of your investment.

Remember, though, that as a general rule the longer the investment horizon, more risk you can afford. You can stand to have significant equity positions (stocks) in a portfolio if you're not planning on using that money until 10 years from now, because of the likelihood that long-term gains in the market will more than make up for short-term losses. But if you're trying to stash away some cash for something you want to buy next year, putting that money in the market would be foolhardy.

Take baby steps before you start investing

These are the questions I get most: young people who want to become investors but aren't sure where to start. And typically my answer is always the same: begin at the beginning.

Q: I am interested in investing but I do not know where to start. Is it better to do online investing? Or have a financial advisor? How do you find out when upcoming new projects are letting people invest in their company? Is it better to invest money into mutual bonds? insurance policies?

A: That's actually several questions but I'll try to give a thorough answer. As I said, I often get questions about how to start investing but many people aren't really ready yet. Pouring money into stocks, bonds, mutual funds or other types of market-based investments isn't a good strategy if you haven't done the financial basics.

What are the basics? Budgeting, assuring you're living within your means, having significant cash savings and investing in your company's 401(k) or other retirement plan if they have one.

My question to the reader who asked the question is have you done ALL of those things? Do you live by a strict budget under which you can see that you have money left over after all your living expenses to devote to investing? Are you living within your means every month or do you have revolving credit card or other consumer debt that you need to pay off? How many months could you live off what you have stashed in savings? Are you putting a significant amount into your 401(k) retirement account?

If not, begin at the beginning. Remember that becoming an investor isn't about how quickly you can get rich, it's about building assets over time. Of course the earlier in life you can begin that process, the better, but trying to pour a large amount of money into stocks, bonds or mutual funds before you have enough money saved up to last even a month in an emergency is a lot like trying to run a marathon before you can walk.

Take your time, crawl first and be sure your desire to become an investor doesn't make you trip all over yourself.

How moms can help their kids be better with money

Q: I am a mother and my daughters think money grows on trees. As a father with two sons are you currently teaching them the value of dollar? and how are you teaching them?

A: I'm constantly teaching my sons lessons about the value of a dollar, mainly by forcing them to work at wages that would violate child labor standards in Taiwan.

Seriously though, my philosophy on money is that as with other habits, children emulated what they've been taught. If they're not taught, they emulate whatever they see. So if your daughters think money grows on trees, it may be time to re-evaluate what you're teaching them about the value of money.

Are you prone to shopping sprees? Do they get an allowance? If they run out of their own money, do you still buy them the things they want or do you make them save? Teaching kids delayed gratification is hugely important.

I use every opportunity to teach my boys about the value of money, hard work and the difference between income and wealth. As a parent you can use ANYTHING to instill those values. For example: My sons are both Monopoly and chess freaks because I decided early on to teach them Monopoly to learn cash flow management, negotiation and real estate investing and chess to teach them to think ahead and strategize. My 13 year old could play circles around most adults in those games, and his business acumen is pretty high. He gets it.

There's other lessons: money they get for birthdays or holidays must be put in the bank. 15 percent of the oldest's allowance also gets stashed. If there's things they want, they have to earn it through their schoolwork or extra chores, or save for it out of their allowance.

Christmas gifts this year included shares of stock in the companies where they spend the most money: GameStop, the video game store for my oldest, and Heelys, which makes roller-sneakers, for my 10-year-old. I did the same for all my kid cousins and they were so enthralled by the possibility of making money from the stock that they made me sit down and teach them the basics of the market. If you want to do the same, you can check out OneShare.

My boys also have brokerage accounts for their college savings and I have them look at what's in them and how they're performing when I log in.

Your children's money habits start with you. They'll emulate what you do with your money and they have no choice but to follow your rules regarding their own. Take the lead as a parent and they'll follow.

photo courtesy photoexpress.com

I have a little bit saved. Is it time to think investing?

Question of the day from @ayyitsrawb on Twitter:

I have a little money saved, is it worth learning about investment and stocks, or should I just keep saving it?

The short answer: learning is always worth it, whether it's about investments or anything else. The more you know, the better you can figure out which tools work best for you. Think of it this way: if you're going to be without any investments in stocks, would you rather that be simply because of ignorance of how the market works or because you made an informed decision that that kind of investing isn't for you? I know which I'd choose.

All that said, your question seems to also be a little about whether or not you're prepared to take the plunge, since you can start learning about any subject at any time. That's not an answer I can give, you but here are a few things to think about:

When you say you've got a little money saved, how much is a little? Are we talking about a few hundred bucks or enough for you to live off of for several months if you lost your income? Most financial advisers will recommend you have between three and six months living expenses saved for a rainy day and that's pretty sound advice given the recession we're going through.

Secondly, you shouldn't consider investing and saving money as an either/or proposition. They each have different purposes and the money you put toward them should be for different things. If I were to look at my own budget today (do you have one of these that you adhere to? If not...THAT'S what you should be learning how to do!), I'd see that every time I get paid I have money going into a savings account, a brokerage account, and my sons' college funds. Of course, not everyone has my resources or circumstances, but the point is by having a realistic picture of how much money you actually have coming in, you can realistically allocate it toward saving for all of your goals, not just one.

Good Luck.

image courtesy of freedigitalphotos.com

Things for new investors to consider

Today's question from tweeted to me by @JNeedHisScrilla (love that handle):
What is the best direction to go for a first time investor with limited funds?
That's a tough question to answer, because like choosing a mate or a place of worship,choosing a smart investment strategy is intensely personal. Where you put your money, and how much of it you put there, should reflect your own goals, resources and time frame. There are as many reasons for investing, and kinds of investments, as there are people with things to spend money on.

But here are some common reasons first-time investors get in the game and things you should consider:

• To save for a first home. Usually, putting your downpayment savings into stocks or mutual funds doesn't make sense because of the risk of losing money. But if you're young and not planning on buying for 5-7 years, you might be able to weather a downturn and still see a return on your principal before you have to touch that cash. You probably still want to keep those holdings separate from any other investments.
• To save for retirement. This is likely to be the first introduction to investing that most young professionals will get. You start your first job and they hand you your benefits packet and that includes information on the company's 401(k) plan and an enrollment form. Read that information from first word to last, and then enroll at the maximum level you can afford to. If you're working and not in your company's 401(k) or other retirement plan, there's really no point in thinking about any other kind of investing.
• To save for a business. To build capital for a business. The same rule as saving for a home downpayment applies: don't put money into the market that you're going to need over a short time frame. But if you don't think you'll be hanging out your own shingle for at least five years or more, this might be an option.

In any event, the best thing you can do before you begin investing is to learn as much as you can about investing. Do you know the difference between equities (stocks) and fixed income investments (bonds)? Do you know what a mutual fund's expense ratio is (and do you even know the difference between funds and individual stocks?). Before diving into any major endeavor, you need to know as much as you possibly can to mitigate your risk.

Good luck.

photo courtesy of freedigitalphotos.net

An answer to a question about investing

A question from @lastmojican on Twitter:
What are your thoughts about investing in the stock market? I want to invest but I have lost faith knowing that greed and ignorance created this problem. How do we trust again?
Great question.

I understand your fear about being in the stock market right now. The simple answer to your question is in the question itself: "greed and ignorance created this problem." How do you combat greed and ignorance in investing? You do so with knowledge that informs a well-crafted plan focused on your own goals rather than simply the accumulation of more.

The truth about what happened in the meltdown is that many people jumped into investments they didn't understand. And you're right, they did so out of greed. The unfortunate part is that all of us suffered to some extent because of that greed.

The silver lining, though, is that on the other side of a stock market drop is essentially a fire sale. Just like when your favorite store has a clearance, prices on shares of many solid companies and funds are well below where they should be. That means investors can buy more and make steady gains, especially if you follow dollar-cost averaging strategy (which just means you invest a specific amount at regular intervals over a given amount of time).

The most important thing to remember is that investing is not gambling. Many novice investors make the mistake of letting the word "investing" conjure up the image of some guy locked in his home office, risking his kid's tuition money trying to time the market. Before you dive in, arm yourself with as much knowledge as you can about the basics of investing by going to the library and checking out something as simple as "Investing for Dummies". There are all kinds of resources out there to help novices become literate about investing and the more literate you become, the more confident you'll be. Take your time and take it slow.

Now is the time for young people to become investors

Are you investing right now? You probably should be. In fact, despite all the fear about the stock market and people's 401(k)s tanking, investing is one of the few areas I think people should be cutting back on now.

Why? For the same reason I tell people (at least young people), they shouldn't stop contributing to their 401(k) retirement accounts: the stock market is on sale and the bargains are better now than they have been in years. A few examples (disclaimer -- these are EXAMPLES, not stock-picking advice. Choose your own investments carefully based on your own financial situation):

• On Jan. 20, shares of PNC Financial Services Group Inc., which last year bought National City Corp., closed at $22 a share. Nobody liked bank stocks then (most investors still don't). But yesterday PNC closed at $40.93, meaning if you bought then, you'd have doubled your money.
  
• Last October, I interviewed an investor who told me he thought he was getting a bargain by buying Procter & Gamble stock while it was trading in the $57 range. Right now, PG is trading at about $49; it's worth less than it was then, but it's a strong company (everybody needs toilet paper and detergent) who's shares are going for a bargain.

This month's Black Enterprise magazine has a cover story on investors in their 20s who have picked up on this and are taking the opportunity to make long-term investments while stocks are cheap. What about you? Are you investing now, or sitting on the sidelines until the market picks up.

60 Minutes: older workers might not get to retire

Today's post was supposed to be an update on Bobby and Aleks' house hunt but I get so many questions about 401(k) plans that I had to post about last night's episode of 60 Minutes. They looked at the devastating impact a tough economy has had on many people's retirement investments and gave a good history on 401(k)s and how they came to be so prevalent. It was sobering: many people in their 50s are finding out that they aren't going to be able to retire when they wanted to, or at all, because their portfolios have lost tens or even hundreds of thousands of dollars in value. What was also angering was the discussion of how 401(k)s were intended to be part of a "three-legged stool" of retirement finance that also included pensions and social security. But greedy companies have all but eliminated pensions and the government can't pay for social security for too much longer, what with all the wars it has to finance and the bank bailouts that are more important than your retirement.

Definitely watch the video, but keep a couple things in mind: before you get ready to pull out of your 401(k), remember that your situation is probably very different from the people depicted. People over 50 should definitely have lessened their exposure to losses by moving most of their investments over to bonds and cash, not the stocks that have taken such a beating. And if you're in your 20s, 30s or even early 40s, you still have time to make up what you lost over the past 18 months.

It's a recession; should I stop contributing to my 401(k)

A question from a reader:

My company recently suspended its 401(k) match. They used to match up to 6 percent of employee contributions -- now they match none. I'd taken advantage of it (and built up a nice start to my retirement savings) in recent years, but after they announced the match suspension (a few weeks ago) I lowered my contribution back down to 3 percent.

So here's the thing: it's a recession. And my money is getting increasingly tight (we're not even going to TALK about the pay cut they want us to take here). I know I should be saving, but is it okay if I just eliminate my contributions all together and have that extra 3 percent stay in my paycheck? What should I be thinking about (beyond setting myself up for the future)? What do you suggest I do? I'm 25: I would like to buy a new pair of shoes or something, not just work so I can pay my bills.

I understand your concern. Most of the questions I get are about 401(k) plans and with the economy being what it is being worried makes a ton of sense.
But I can never advocate making a short-term decision when looking at a long-term problem. I'll use myself as an example: I started my first 401(k) maxing out but quickly figured out I had a cash flow problem. What I should have done is what you did: rolling back my contribution just enough to still get the company match, but no less. What I did was pull completely out for about a year or so. that was a mistake.

Why? Because when you're young, what matters is not how much money you're putting in, it's how many shares you accumulate. The principle of compound interest is at work, meaning you accumulate enough shares on a regular basis, and over the long term those shares increase in value and give you a better return on your investment.

Right now (and I've said this before), the market is on sale. Everything is cheap. And while that doesn't make every stock or mutual fund a good investment, it does mean that accumulating shares of good stocks or funds is easier to do. So even though you're worried about the economy, to an extent the turmoil in the markets works in your favor. But that's only if you keep accumulating shares by contributing to your 401(k).

There are a few questions you should ask yourself. How much money would really go back into your paycheck after taxes if you stop making your 3 percent contribution? I don't know how much you make, but it's entirely possible that the tax benefit you lose by not contributing would negate any after-tax cash you'd get back. Would it really be worth it if you'd have to pay an extra, say $75 in taxes if all you were getting back after tax was $125 each pay? Find a 401(k) calculator and do the math before you act.

Also, I know you want to live and enjoy your youth but are you sure the ONLY place you could cut back is your 401(k)? If you really want a few new pairs of shoes, why not try and shift some other discretionary spending. Cut back on cable, maybe? Fewer meals out? Not as much long-distance driving on weekends? Whatever it is, there's usually some discretionary money that you can shift around to make a difference.

Last, do you have any credit card debt? If you do, think of the money that's going to pay off whatever you bought as your discretionary spending right now. If you're still paying off some shoes you bought last year (with interest), does it really make sense to take money from your nascent nest egg to have fun with. Think of your credit card balance as the bill coming due for fun you've already had but didn't pay for.

A lesson in losing money by not paying attention

This is a link to a chart of my money going down the drain.

I got a letter from the brokerage UBS. I'd been getting these letters for a while but always ignored them because I knew what they were about: my old New York Times Co. employee stock purchase account. I only put money into it a few times about five years ago, then stopped because the stock sucked and even with the discount I got on shares they always ended up underwater (worth less than I was paying for them).

Problem is I never dumped the shares and forgot I had them, until this week. Anybody wanna guess how shares of newspaper companies have done since November, 2004? If you answered by farting or picking your nose, you're right. The 39 shares I owned were worth $41.06 apiece, for a total of $1,601.34, the day they were purchased. It was a good deal then because I only paid $34.90 a share; I saved more than $300 off their market value.

But the stock was only worth $5.53 a share as of this morning, meaning I've lost more than a grand by forgetting I owned them and thus forgetting to sell them before the losses were too heavy. (Click here to see its current value).

Anyway, you don't need to be a stock market genius to get the point: PAY ATTENTION TO YOUR MONEY!!! That means whether you own individual stocks like in this case, of if you have a 401(k), which you shouldn't be actively trading in but should at least make sure you have the right asset allocation for the age that you plan to retire at. Even if you're just trying to get on a budget and pay down some debt, staying organized and keeping track of every dollar you spend is the difference between success and failure.