Evaluate purposes, risk before investing money

Investing for retirement, college, a down payment on a home or any other financial goal may seem like a series of tough decisions. Experts appear in every newspaper, magazine, television news program and infomercial around. Some claim to offer a sure bet that beats the market with the safety of a bank passbook savings account. Others offer the path to your financial future through funds you’ve never heard of or investments that are difficult to understand.

Then come the questions of how much money is enough and where one should invest. Understanding some basic purposes behind investing can help you prepare for your future financial needs.

1. Getting started

You’ve undoubtedly heard experts — including those from GuideStone Financial Resources — say that you need to save at least 10 to 15 percent of your income to meet your retirement goals. Depending on your situation, you may need to save more or less.

The reason is simple. The sooner you start, the sooner you’re able to take advantage of compounding, potentially growing your money at a faster clip each day it’s invested. Starting today, you can take advantage of the compounding principal (see story, this page) to grow your savings, but you have to get started.

While it is important to start saving, at least a small amount of money, you should plan to grow that amount as soon as you can. If you can begin investing 1 percent of your income into your retirement this year, set a goal that one year from today, you’ll invest 2 or 3 percent and grow it each year as you’re financially able to do so.

2. Retirement investing and employer matching

Does your employer offer a 403(b) or 401(k) plan? If so, your employer may already be matching the money you put into the plan. That’s free money. Let’s say your employer matches 50 cents for every dollar you contribute, up to a maximum 3 percent, which is a standard offer by many medium- to large-sized companies. If you’re contributing 6 percent to your retirement account, your employer contributes an additional 3 percent. That means you’ve got a 9 percent deposit into your account.

Employer matching is a way to grow your retirement investments quicker than you could do yourself. If your employer offers any kind of matching, your best bet is to invest enough to receive the maximum matching amount. Check with your company’s human resources or benefits department to find out the specifics of your employer’s plan.

3. Diversification

You’ve heard the old adage, “Don’t put all your eggs in one basket.” As anyone who lost his or her life savings during the corporate scandals in recent years will attest, putting all of your investments in today’s hot commodity may be a very bad decision in the long-term.

Financial experts encourage investors to diversify, or move your eggs into multiple baskets.

That may include investing in today’s hot commodity, but it also means investing in different industries and markets such as international businesses and real estate.

Do not assume, however, that the more stocks, bonds or mutual funds you hold, the more diversified you are.

The goal should be for you to maintain the asset allocation that best fits your age, your time horizon and your goals.

4. Asset allocation

Asset allocation is the percentage of your assets invested in bonds, stocks or mutual funds. You want to choose an asset allocation that allows for growth if you’re starting or building your investments or for preserving your assets if you’re at or near the final financial goal, like retirement.

The old rule offered by many financial advisers is to subtract your age from 120. The answer becomes the percentage of your retirement savings that should be invested in stocks or stock funds. The older you get, the more money you want in bonds or bond mutual funds.

While that rule may or may not apply for you, it can be a starting point. If you can’t sleep at night anytime the stock market dips, it may not be worth it emotionally to have so much money invested in stocks and stock funds. If you are close to retirement and have yet to start saving, you may need to put more money into stocks. Consult your financial adviser with questions about your specific goals.

There are two ways you can adjust your asset allocation as you approach your investing goal, be it a child’s college education or your retirement. The first option is actively moving money from a stock-heavy portfolio in the early years to one that has more bonds as you approach the final goal date.

The second option available to investors is asset allocation funds. These asset allocation funds may be static with a fixed asset allocation or may be dynamic, like a date target fund, which adjusts its asset allocation as you approach retirement.

In a fund with a fixed asset allocation, you have to move your money yourself from one fund to another as you approach your goals, but both types of funds offer investors the ability to let professional money managers adjust the funds’ holdings to allow investors to achieve their goals.

The best part? These asset allocation funds typically offer a one-fund solution to creating an asset allocation for the investor, as opposed to having an investor create an asset allocation themselves by picking different funds and deciding how much money to put into each one.

5. Understanding the relationship between risk and return

Generally speaking, if your investment has a high rate of risk, it has a higher potential return. Financial experts will tell you if you want to aggressively grow your money, you have to take on more risk. Risk is how likely you are to lose your investment principal.

There is no Federal Deposit Insurance Corporation for stock investing that guarantees you’ll keep your principal.

You could lose it all, but history has shown us that the greatest returns over the long haul are from the investments with higher degrees of risk.

Of course, diversification helps mitigate the risk. By investing in different companies and industries, you spread your money around so that downturns in one segment of the market might be offset by gains in another segment.

This is another area where mutual funds may be better for your investing needs. You can take advantage of professional money managers who watch individual stocks for signs they need to add more or sell those companies that might be in some kind of trouble.

Why not invest in the safest option available, thus guaranteeing that your principal would still be there?

One reason is that inflation will eat away at your money. For example, let’s say you invest $1,000 in an account that earns a guaranteed 5 percent return, with inflation running at a conservative 2 percent annually. At the end of one year, your $1,000 investment would have an ending balance of $1,050. But during that year, inflation would have eroded the value of the money to the tune of $21, making your purchasing power only $1,029. It doesn’t take a high inflation rate to eat away at your conservatively invested money.

6. Why invest?

Why does anyone invest? As Christians, we desire to be more faithful stewards of the resources God has given us.

Genesis 41 tells the story of Joseph interpreting pharaoh’s dream telling of the coming famine in Egypt. Joseph tells pharaoh that they need to set aside 20 percent of the grain during the plentiful years for reserve for the coming famine. That is a simple illustration for us to follow.

We don’t have the foresight to know how many years we’ll be able to work or how long we’ll need to provide for ourselves in retirement, for our children’s education or for the possible long-term care of a child or spouse. What we do know is that we need to prepare wisely for an uncertain future.

What is a mutual fund?

It is made up of individual stocks and bonds. Rather than owning 100 shares of one company, you own parts of several companies or bonds, thus spreading your risk around multiple companies or bonds. Some mutual funds invest in only one industry, while others cross several industries. Some involve risk, while some are made up mostly of cash equivalents.

What is a time horizon?

A time horizon is the time frame between now and when you plan to withdraw your investment income. Your time horizon helps dictate how much risk you can afford to take in your investments.

What are bonds?

Bonds are loans that investors make to corporations, governments or government agencies. Historically they are not as volatile as stocks, but they fluctuate in value more than cash equivalents.

EDITOR’S NOTE — Kenneth Wallace, chartered financial analyst, is the client service manager for GuideStone Capital Management, a registered investment adviser and a controlled affiliate of GuideStone Financial Resources of the Southern Baptist Convention.