Author DM Celley

SAVINGS:  THE MOTHER OF INVESTMENT

The key to any investment begins with the potential investor coming up with a supply of available money.  Often this occurs with a windfall such as a tax refund, an inheritance, or a bonus at work, etc.  But what if a potential investor doesn’t have any of these windfalls?  How can a potential investor get started?  The following methodology will help as long as the money saved is never used for anything except further investment.

Passbook Savings Account:  For beginners, a passbook savings account at a bank or savings institution that is inconvenient to get to is a good place to start.  By that I mean, it should easy for the saver to deposit money but difficult to withdraw it.  Each month the investor sends a check to this out-of-the-way bank just like it’s another bill to pay.  It can be small, medium, or large depending on what is affordable.  Best practice is to keep it modest and the exact same amount each time so the saver won’t bypass it during months when cash is a little short.  If the money can be accessed via cell phone, it probably won’t grow very much.

IRA or Roth:  Early on in this process the saver must decide how to leverage the tax benefits of an IRA or Roth account.  They’re very similar savings devices, but have a key difference in how the tax exemption works.  For the IRA, the investor can deduct the amount invested in the year the investment is made, whereas for the Roth, the investor will not be taxed when the withdrawals are made during retirement.  This could call for some planning as the tax deduction for the traditional IRA may turn out to be more beneficial than the tax paid during withdrawals after retirement.  The Roth is never taxed, but doesn’t provide the tax deduction, either.  No matter what’s chosen a retirement account with some form of tax benefit is a key building block for many private investors.  These retirement accounts will have certain restrictions applied, but the investor can maintain a separate brokerage account for those investments that can’t be managed with an IRA or Roth.

Mutual Funds:  Most savers are not skilled in the investment trade when the time arrives for making bigger investments from savings.  The smartest move at that point may be to put together a small collection of mutual funds.  There are several advantages a mutual fund brings to a fledgling investor not the least of which is a professional manager and staff who are responsible for the investments and returns.  The funds can be tailored to fit a specific purpose such as a college fund for the kids, and by their nature they provide a certain amount of diversity that will end up protecting the investor’s assets.  When investing in an area that the private investor is unfamiliar with (for example, China, or biotechnology), it would be wiser to leverage the knowledge of the manager and research staff.  In any case, the cost of the fund is paramount to the investment decision.  A China or biotech fund might have lucrative returns, but also may have a higher cost of up to two percent.  On the other hand, index funds will provide as much return as can be derived from balanced index-based investments, but will cost only one percent or less.  Mutual fund investments should be growth-oriented providing private investors a way to invest in growth stocks with a controllable amount of risk, and a minimal amount of attention on the investor’s behalf.  It’s not necessary to use a mutual fund for bonds as they can be bought individually through a broker without the cost of a fund.

Sixty/Forty:  As the private investor gets a little older and closer to retirement, the amount of overall investment should begin to gravitate away from growth and more toward income.  By that I mean the investments should include more yield-based instruments such as bonds and dividends that render a return without having to cash in any principal.  One such tool would be a sixty/forty mutual fund or a private portfolio balanced to sixty percent stocks and forty percent bonds.  The bonds will not fluctuate in value in the same manner as the stocks since the risks are slightly different.  And further, they will send in cash payments (usually every six months for corporate bonds) without any consumption of principal.  The stock portion of the portfolio will provide more growth.  Why sixty/forty?  There is no real reason except that the amount of income generated will furnish enough cash over time to add additional stocks or bonds without necessarily cashing in existing capital. 

Income Portfolio:  When retirement comes around, the private investor should convert a major portion of his/her portfolio to bonds or dividends as the cash will be required for monthly budgets as well as special activities like travel.  There is usually some recoup of capital in this process, but it is a major consideration of every retired investor to ensure that there will be a sufficient amount of cash coming in without recouping an inordinate amount of capital.  As the capital supply recedes, so does the income stream.  And the retired investor is often hard pressed to replace capital once it’s gone. 

4 thoughts on “SAVINGS:  THE MOTHER OF INVESTMENT”

  1. Jack Donald (Don) Harris

    Thanks David. I have been preaching this to my kids for years. Finally got both to open a Roth.

    1. It’s important to note that no one ever gets ahead by constantly borrowing money. Home mortgages and car loans notwithstanding, young people have to learn not live inside of a credit card.

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