Investing Basics: Part 1

By Barbara O’Neill, Ph.D., CFP®, Rutgers Cooperative Extension, [email protected]

People invest for various reasons:

To achieve financial goals (e.g., buy a car)
To earn a higher return than bank savings accounts, money market funds, and certificates of deposit (CDs).
To increase current income (e.g., dividends, interest, and capital gains)
To achieve financial independence (i.e., the ability to live without an employer paycheck)
To have funds available to supplement Social Security in later life.

Below are five key action steps about investing to share with service members:

Address the Prerequisites- Get the following financial tasks done before investing: establish an adequate emergency fund (i.e., 3 to 6 months expenses in liquid cash equivalent assets), purchase adequate insurance, and develop an “investor’s mindset.” An “investor’s mindset” means that you are willing to accept the volatility of investment value that is associated with investing. In other words, you will not lie awake at night worrying about market downturns or panic and sell stock shares when market indexes drop.
Set SMART Investment Goals– List each financial goal with a time deadline and a dollar cost. Then match investment characteristics with the time period for achieving financial goals. For example, select money market mutual funds for short-term goals like a vacation in two years and stock mutual funds for long-term goals and a growth objective (e.g., retirement in 25 years).
Understand Risk-Reward Relationships– Picture a pyramid. At the base of the pyramid are low-risk cash equivalent assets such as savings accounts, money market deposit accounts, money market mutual funds, and certificates of deposit. In the middle of the pyramid are higher risk assets such as corporate bonds and growth mutual funds, At the top of the pyramid are speculative investments such as futures contracts. The higher up investments are on the pyramid, the higher their risk and potential return.
Understand and Accept Specific Investment Risks– Learn about the types of risk associated with different types of investment products. For example, market risk (i.e., the risk of security prices falling as a result of an overall stock market downturn) for stocks and interest rate risk (i.e., the inverse relationship between investment prices and interest rates) for bonds, and inflation risk (i.e., loss of purchasing power due to inflation) for money market funds and other cash equivalent assets.
Assess Your Investment Risk Tolerance– A variety of online tools are available to assess investment risk tolerance such as this empirically tested and valid assessment tool from the University of Missouri. Three common risk tolerance categories are conservative, moderate, and aggressive. Conservative investors are very concerned about declines in the value of their investments while aggressive investors are willing to pursue appreciation opportunities even though it puts their investment capital at high risk. Moderate risk investors are somewhere in between: willing to take some risk to pursue higher returns, but not too much.

For additional information about the basics of investing, review the OneOp on-demand webinar: Fundamentals of Mutual Funds.

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