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 paid off the credit card! Now on to the next goal!

I'm a fan of big, audacious goals and try to live by this rule: if you shoot for the stars and miss, at least you get the moon. That philosophy was a big reason I was successful in paying off my credit card debt in less than one year. If I dedicated myself to paying off every last dime but didn't make it, at the very least I'd have much less debt than I started with.

And so it is that one day after I made the final payment and reached my $0 Balance Goal, I'm immediately planning my next big, audacious financial goal will be. My immediate thought was to beef up my emergency savings and investment accounts and that's certainly doable given the amount of free cash flow I now have (since I'm not making a credit card payment anymore). But why not think bigger than that, and eye something else that will push me to stretch for the stars again?

So I've decided that my next goal will be that over the next year, I'm aiming to save and invest at least $25 grand. That's right. At least that much. That means I'll have to push myself to do more than just stash a portion of my paycheck: I'll have to continue to limit spending, network and be creative enough to create new income streams and be diligent enough to live off only the money I make at my nine-to-five and stash any extras away. It'll also mean I'll have to figure out some new tax strategies so Uncle Sam doesn't come and take it all. Wish me luck.

In the meantime, I'm going to continue to write about eliminating credit card debt and keep up my $0 Balance Challenge push. If you've already eliminated all your credit card debt, great. Start thinking about the next goal (and post it here in the comments section so you can encourage others.) If not, think of eliminating that debt as your first big, audacious goal and get to work.

Good luck!

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.

401(k) week, day 2

Yesterday, I mentioned asset allocation. Today a definition.

Asset allocation basically refers to where and how you invest you money. It's important to have the right allocation in a 401(k) because that will determine how well you take advantage of the

There are all kinds of investments and asset categories, but to keep it simple, I'll just divide them into two: those that are more aggressive we'll call "growth" and less aggressive we'll call "safety".

As a general rule, money you'll need soon should be in a 'safety' vehicle. An example is a bank savings account. Money there is insured and easy to access. On the other hand you won't earn much interest on it. It's only there for safe keeping.

In a 401(k), the less time you have left before retirement, the safer you want your money to be. Shifting your asset allocation toward things like bonds or money market funds makes sense. (Your plan's manager will likely use a term like "capital preservation" or "liquidity" to describe this asset class). Those are relatively low-risk investments that generate little return but also have little risk for losing any of what you've saved up.

On the flipside, if you're in your 20s, 30s or early 40s, you should be more aggressive by investing in growth assets. Stocks, international funds and the like carry more risk than safe investments, but come with bigger potential rewards. Your 401(k) manager will likely refer to these as "growth" or "aggressive growth" vehicles. Since you won't be touching the money for 20 years or more, you have time to make up any losses.

If all that still sounds like jibberish, the investment manager of your 401(k) should have an easy answer for you. Call them up and ask if they have pre-allocated portfolios set up based on the year you're supposed to retire. Most plans do this. If you don't know anything about how to invest your money, at least you know your age; someone who's 25 today would reach retirement around the year 2049, so they could simply ask their plan's manager if there is a portfolio pegged to that year, and allocate most, if not all, of their money in that.

Up tomorrow: why now is the absolute, positive best time to be putting money into a 401(k).

What the hell's an expense ratio and how much will it cost me

Blog reader Nadia in New York emailed me a question about mutual funds' "expense ratios." Sounds boring, I know, but if you own mutual funds (and you do if you're contributing to a 401(k) ), keep reading.

Nadia's question:

I am doing a direct rollover and the fund now has gone from 0 to 0.73% expense ratio. I called to inquire about how that is going to effect my pennies once everything is rolled over. I was told there would be no fees and he patted me on my head and that was that. This 0.73% means something...I work too hard for my money to be lining the pockets of fund managers.

Nadia, here's the deal: expense ratios are basically the percentage of a mutual fund's assets paid to fund managers for, well, managing the fund. Another way to look at them is as your costs of ownership. There are several types of fees that go into the ratio but unless you're interested in the minutia, all you need to worry about is the overall ratio itself. The Motley Fool has a good primer on expense ratios here.

Now, a fund having an expense ratio is not a bad thing necessarily; somebody has to pay the fund manager. That said, you don't want a fund with a ratio that's exorbitantly high compared with its peers in the same category. That'd be like buying milk for $5 a gallon when you know milk is on sale across the street at two gallons for $4.

Do some research on the kind of fund you're rolling your money into and what how its expense ratio compares with others that it competes with, and of course, pay attention to performance. And now that you know the basic definition of these fees, you should call your adviser back and ask some more informed questions.

I hope this was helpful to Nadia or anyone else out there who didn't understand what that expense ratio thing was on their mutual fund statement.

Two financial pleddges you should take

I logged into my ING savings account the other day was redirected to their "Declaration of Financial Independence". It's 10 money practices they want people to commit to, and I gotta say it's a pretty good list.

Some of the highlights: "We will use our home as a savings account", a point in which they stress bringing a big down payment to closing and warns against borrowing against our houses; "We will invest for the long-term" and "We will ignore unsolicited credit card marketing."

What's interesting is that banks and investment companies have shifted their advertising to focus on more practical financial habits like saving instead of borrowing and bringing a down payment when buying a home instead of touting zero-down mortgages. The New York Times ran a story in August about how bank ads encouraged people to continue to go into debt. (A disclaimer here: ING Direct has always encouraged saving, given it's part of their business model. And by the way, they're not paying me to write about this).

ING isn't the first company to issue that kind of declaration. Check out Black Enterprise magazines' Declaration of Financial Empowerment, which they started promoting, if I remember right, in about 2000. It also has 10 good principles that everyone should try to apply (although #8, supporting African-American owned businesses, may not resonate with everyone).

A solid definition of investing

There were some good answers to yesterday's question about investing that showed at least people reading the blog have given the subject some thought. Too bad more people either weren't reading or commenting!

Either way, here's my definition: I think investing is any activity that involves the carefully considered allocation of your resources with the goal of appreciation over the long-term.

A few important points: Note I said "carefully considered". This is one of the biggest ways that investing differs from say, casino gambling or its close cousin, day-trading. Investing is strategic and is not done without planning for your goals and how much money or time you have to devote to them. If you're just pouring money into the market with the ONLY goal to have more money tomorrow, you're leaning more toward gambling than investing.

Also note that I said "resources" and not just money. On this blog, of course, the resource I talk about is money but there are many other resources with which to invest. Time is probably the most important one. If you're taking time out of your day to read this blog, you're making an investment in gleaning what you can about personal finance from my observations. You can invest in your education, your home, your children. The point is you're devoting a resource that's limited (time or money), which makes it valuable, and in exchange you expect an output worth more than what you put in.

My final point is that in most cases, investing is done over the long term. There's a commercial for one of the big brokerages that shows two runners: one is slow and steady, while another guy speeds past him. By the end of the commercial they've gone a few miles and you see the fast guy bent over, tired as hell, unable to make it over a big hill. Slow guy passes him.

Get the point? For most investors the point isn't getting rich fast. It's watching your capital appreciate over the long-term through steady, consistent practices. Too often those who are in a rush to make a bunch of money end up losing, like the runner who can't make it over the hill or the day-trader who's kicking himself right now for going long in mortgage-backed securities. Those who win are the ones who keep making the same contributions to their 401(k) plans for decades, making only the necessary adjustments and not worrying about temporary fluctuations in the market.

So now that you've read my definition of investing, has your opinion changed? is there anything you'd add or that you disagree with?

Coming later: Two pledges you should take and why Barack Obama should build trains.

Do you know what investing means?

Most people want to grow their wealth. Many believe investing is a good way to do so, and they're right.

The problem is many people don't understand what investing is. I came to that unscientific conclusion after a conversation this weekend with a Money Corner reader who had questions about everything from insurance to credit cards. Her most telling questions, though, were about investing: how to get started and isn't that really risky anyway?

The second question illustrates how a large number of people think about one of the most basic ways to put their money to work for them. Most young people who talk to me me about investing do so in terms that show they view the capital markets more like casinos than places where careful thought goes into making long-term decisions that mitigate risk. Many have actually said to me that they don't see a difference between playing the lottery and contributing to their 401(k)s or buying shares of companies they regularly patronize.

That's a scary and dangerous line of thinking, since in effect it helps keep people on the sidelines and in the case of most young people, that happens at a critical time because their youth puts long-term investing principles like compound interest and dividend reinvestment in their favor.

So I'm curious. If you were given a test with one question on it: "What's your definition of investing?", how would you answer it?

After I get a few answers from readers, I'll post my own personal definition.

Welcome to the Money Corner

If you read my old blog, thanks for following me over here. Newbies, here's an intro: I'm Keith Reed, a business reporter and economics commentator. I started blogging two years ago to share my answers to questions friends asked about how the economy, their spending habits, investing, saving and the like.

I'll take questions from anybody because I think there are few things more needed in America than more financially literate people -- check your credit card balance if you disagree.

Here's what I'm not: a day-trader, stock-picker or financial adviser giving out professional investment recommendations. Instead, this blog is a forum for your concerns and curiosities about money. I'm here to share my common sense opinions, informed by the hours I spend interviewing and interacting with entrepreneurs, analysts, executives and everyday people.

Hope you like the blog and find it useful.