Money and the options for saving/investing have always been confusing to me. I know that there's much more out there than checking and savings accounts, but I didn't know what they were. My dad kindly sat down with me over winter break and explained some things. Just to warn you, it's long and could be a little boring. And, if you already know this stuff, apologies and feel free to skip this blog post! But, these are all things I was learning for the first time and I'll probably come back to this page often for my own sake.
Anyway, without further ado, Part 1: learning and understanding financial terms and options
Traditional IRA: IRA stands for Individual Retirement Account. A traditional IRA is set up through a stock broker/e-broker. The basic idea here is that you invest money into this account before taxes and it grows tax free. You only pay taxes when you take money out of it when you're retired, which assumes that you are in a lower tax bracket and thus paying fewer taxes. However, there are limitations to the amount of income you make to have a traditional IRA, as in, you can't make too much money.
Roth IRA: A Roth IRA is also a retirement account, but you invest money here *after* you pay taxes. So, you can't deduct this money on your taxes, but the amount you can put into a Roth is more than you can put into a traditional IRA. Since you're putting in money after you pay taxes on it initially, you only pay taxes on the gains of the IRA rather than the whole amount.
401(k): This is ALSO a retirement account, but this one is sponsored by your employer. The tax code allows you to put more money into this type of account than the Roth or traditional IRAs. The money you put in is before taxes and you're only taxed on the withdrawals (similar to the traditional IRA, but the salary and contribution limits are both higher). The two aspects that seem particularly appealing about this kind of account are 1) after 50 years, you can start adding in an extra $5500 per year; and 2) sometimes your employer will match the money that goes into your account. Free money! Who doesn't like that??
Pension: This was an olde tyme retirement plan that was meant to supplement Social Security. However, a lot of companies were mismanaging the accounts, and when you went to get your money when you retired, you didn't get what you'd been promised. (Bad companies!) This type of investment isn't common anymore, partly because of that reason.
Stocks: A piece of ownership of a certain company, obtained by buying shares. There is higher risk when investing in individual stocks, because you're only depending on one stock to do well. Stock transactions are handled by a broker or e-broker.
Splitting the stock: When a company increases the amount of shares by issuing more shares to existing shareholders. For example, a company could double the amount of shares so that each share is now worth half of what it was worth. This means that less affluent people can afford to buy into the stock.
Mutual fund: This is an investment vehicle run by money managers. These managers pool money from many of their clients (with their permission, of course!) and use that money to buy stocks that are in line with a goal (income, growth, etc.). Usually these stocks are spread across various industries so that there is a better chance of at least a few stocks doing well!
CD: Certificate of Deposit. Basically, this is a glorified savings account, but with better interest than you would get through a savings account. CDs are available through banks, but they are only valid for a certain amount of time: you can't leave money in a CD for life. Also, you aren't allowed to withdraw the money until that time is up. So, the risk is low on a CD, but it has to be money you wouldn't need in an emergency.
Gains: This is fancy speak for the money you make on an investment.
Dollar-cost averaging: This is a scenario of investment. If you invest at a regular period, and the stock is going up and down (as it is wont to do), you can buy more shares at the lower price and come out ahead. For example, say you always invest $100 every month. Maybe in January, the shares are $10 each. Now you can get 10 shares. In February, they're down to $7 apiece, so you can buy 14 shares. But maybe in March, the shares have spiked to $20 apiece. Now you can only get 5, but even just in the last 3 months, without altering how much you're spending, you've gotten 29 shares! This is in stark contrast to timing the market, where people try to buy when the stock is at its lowest and sell when it's at its highest. There are so many factors to the market that trying to predict this is almost impossible! There have been studies that prove that dollar-cost averaging will make you come out on top in the long run.
"On-paper": Fancy talk for how much money you would get if you cashed out THIS MOMENT RIGHT NOW.
Liquid assets: These are assets (or, big piles of money) that you can cash in on and have available within several days (stocks and mutual funds). Illiquid assets are piles of invested money that you can't get out if you need it quickly; for example, real estate, fine art, and expensive instruments.
Default: This word is used in bad situations. It's referenced a lot in home mortgages, where the owners can't honor the terms of the loan, and they have to default on the loan. Someone ends up losing money in this situation. :( not fun.
Part 2: Start saving money for retirement
Being a self-employed, freelancing musician who is still in graduate school makes it extremely difficult to save money for the future. The best thing I can do (says my dad!) is to put away money in an account as an "emergency fund": in other words, 3-6 months' worth of money for living expenses. Then, once I have that much set aside, I can start saving for other things. Since I'm (so far) self-employed, a Simple IRA is an option for me (it's only available to those who are self-employed). I was also encouraged to start building credit. This is done by getting a credit card in my name and showing that I can pay it off. Even if it's not a lot each month, it will start to build credit and help me financially later on down the road.
Mutual fund: This is an investment vehicle run by money managers. These managers pool money from many of their clients (with their permission, of course!) and use that money to buy stocks that are in line with a goal (income, growth, etc.). Usually these stocks are spread across various industries so that there is a better chance of at least a few stocks doing well!
CD: Certificate of Deposit. Basically, this is a glorified savings account, but with better interest than you would get through a savings account. CDs are available through banks, but they are only valid for a certain amount of time: you can't leave money in a CD for life. Also, you aren't allowed to withdraw the money until that time is up. So, the risk is low on a CD, but it has to be money you wouldn't need in an emergency.
Gains: This is fancy speak for the money you make on an investment.
Dollar-cost averaging: This is a scenario of investment. If you invest at a regular period, and the stock is going up and down (as it is wont to do), you can buy more shares at the lower price and come out ahead. For example, say you always invest $100 every month. Maybe in January, the shares are $10 each. Now you can get 10 shares. In February, they're down to $7 apiece, so you can buy 14 shares. But maybe in March, the shares have spiked to $20 apiece. Now you can only get 5, but even just in the last 3 months, without altering how much you're spending, you've gotten 29 shares! This is in stark contrast to timing the market, where people try to buy when the stock is at its lowest and sell when it's at its highest. There are so many factors to the market that trying to predict this is almost impossible! There have been studies that prove that dollar-cost averaging will make you come out on top in the long run.
"On-paper": Fancy talk for how much money you would get if you cashed out THIS MOMENT RIGHT NOW.
Liquid assets: These are assets (or, big piles of money) that you can cash in on and have available within several days (stocks and mutual funds). Illiquid assets are piles of invested money that you can't get out if you need it quickly; for example, real estate, fine art, and expensive instruments.
Default: This word is used in bad situations. It's referenced a lot in home mortgages, where the owners can't honor the terms of the loan, and they have to default on the loan. Someone ends up losing money in this situation. :( not fun.
Part 2: Start saving money for retirement
Being a self-employed, freelancing musician who is still in graduate school makes it extremely difficult to save money for the future. The best thing I can do (says my dad!) is to put away money in an account as an "emergency fund": in other words, 3-6 months' worth of money for living expenses. Then, once I have that much set aside, I can start saving for other things. Since I'm (so far) self-employed, a Simple IRA is an option for me (it's only available to those who are self-employed). I was also encouraged to start building credit. This is done by getting a credit card in my name and showing that I can pay it off. Even if it's not a lot each month, it will start to build credit and help me financially later on down the road.
Stay tuned for the adventure of doing my own taxes, coming March/April 2017!
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