PERSONAL FINANCE TIPS, VOLUME THREE:
INVESTING MADE SIMPLE- 401(k) and 403(b)

I am well aware that many people do not invest for many reasons. Many Americans lack the knowledge, means, time, or desire to invest. All of these excuses are valid, but they can be quite costly.

First and foremost, never invest unless you have enough liquidity (cash in the bank) to cover at least three months of living expenses (mortgage, car payment, groceries, insurance, utilities, etc.). Secondly, as mentioned in a previous personal finance article, make sure that your family is protected with an ample amount of life insurance, in the event of an untimely death. Now, that being said, after you have at least three (preferably six) months of savings to cover living expenses, and you have plenty of life insurance, there are easy ways to begin investing (retirement planning).

Most people invest for their retirement. The easiest, most beneficial, and convenient way to begin retirement planning is to maximize your 401(k)/403(b)/company sponsored retirement plan. If your company will match any contribution up to 6% (ex: company will match 50% of your contribution if you contribute 6%), do it. Do it now. Do it today. That is free money.

Remember that in the financial world and investments, risk and return are correlated- the higher the return requires higher risk.

If your company matches 50% of your 6% contribution, that means that if you earn $40,000, you contribute $2,400/year and your company contributes $1,200. In the simplest terms, your $2,400 has instantly become $3,600. You cannot get that anywhere else, without absorbing an excessive amount of unnecessary risk. Also, since the $2,400 annual contribution is taken out throughout the year-say twice a month- you are only investing approximately $93 per pay check. I have even better news for you (did you think this was possible?)- Your contribution is done on a pre tax basis, so the actual “cost” of the $93 investment may be closer to $75 or $80 out of pocket. Please allow me to summarize- For approximately $2,000 out of pocket annually, you will have actually invested $2,400, which becomes $3,600 after your company matches 50%, and you have turned approximately $2,000 into $3,600, and that does not include any gain (or possible loss) that your money invested may receive in the stock/bond markets.

Many Americans have no idea what their 401(k)/403(b)/etc. invests in. A lot of people that do invest, simply sign up when hired, or later with the HR department, and have no clue what their investments are. Simply stated, your retirement account is comprised of mutual funds which consist of stocks and bonds. The beauty of a mutual fund is that it allows you to diversify your portfolio, provides professional management, and reduces risk. Your 401(k) may have three mutual funds and each mutual fund may have 50 or 100 stocks and bonds, in various industries, minimizing the risk while maximizing the return. Diversification is the single most important factor when investing. The reason that the employees at Enron lost their entire life savings/retirement was that every dime they had in their retirement fund was in Enron stock. When Enron crashed, they lost everything. Now, let’s say they had a 401(k) plan, and only 2% of their retirement comprised of Enron stock, they would still have a steady, well balanced portfolio.

An IRA is similar to a 401(k). They are both primarily comprised of mutual funds (stocks and bonds that are professionally managed, convenient, and well diversified), but an IRA does not have the advantage of a company matching your contribution. An IRA is an individual retirement account, whereas the 401(k) is a company sponsored retirement account. There are two main types of IRAs (traditional and Roth). The basic rules of IRAs are tax deferred growth/tax advantages, diversification, and flexibility. It is important to know that with an IRA (and 401(k) plans, that you may be penalized if you withdrawal your money before the age of 59 ½, there may be tax consequences of withdrawals, but that you do have access to your money without penalty for certain reasons (first time home ownership, medical reasons, etc.) It is important to research the different types of IRAs and the tax benefits If you have the means, it is important to first only fund your 401(k) to the level where your company will match. After that, if you have the financial resources to invest more, an IRA is the next best option. You can start funding your own IRA at most banks, insurance companies, and investment houses.

Day trading, options and futures trading, and commodities are way too advanced for a great majority of American investors. I do find great enjoyment by watching Jim Cramer on CNBC's "Mad Money." He is literally a genius when it comes to picking individual stocks. That being said, nobody, and I mean nobody who is interested in retirement planning should ever become involved in day trading, options and futures trading, or commodities. Yes, there is potential for enormous returns. That being said, remember that in the financial world and investments, risk and return are correlated- the higher the return requires higher risk.

In summation, once you have your financial house in order (three to six months of cash in bank to meet unexpected expenses and an ample amount of life insurance to protect your family), it is very important to begin retirement planning via a 401(k), 403(b), or any other company sponsored retirement fund, and then an IRA (if you have the financial means). A retirement account, such as the ones listed above, consists of mutual funds (stocks and bonds), which offer professional management, convenience, and diversification-which is the most basic rule of a balanced portfolio). Just like with life insurance, it is important to start your retirement planning as soon as possible, because the longer your investment horizon is, the greater your chance of a more fruitful financial future for your retirement.