Friday, December 13, 2013
Many clients have expressed interest in educating their children on basic finance principles. In response, our team has developed a brief “Finance 101” curriculum to encourage young adults to start considering the benefits of saving and investing, and to reap the rewards of those benefits.
Saving is the act of setting aside money for the future in lieu of consumption today. Saving money creates a safety net in the near-term and promotes financial independence over the long-term. It’s like paying yourself first! In general, think of saving as a way to develop financial stability and fund immediate needs, while investing is a way to fund long-term goals.
Investing is the act of committing money or capital to an endeavor with the expectation of obtaining additional income or profit. Investing allows your money to work for you – even when you’re not working. There are many ways to invest – through bonds, stocks, mutual funds, and much more. Saving and investing over time will create financial security and freedom.
The Power of Compounding
When it comes to successful investing, time is on your side. The sooner you begin investing for the future, regardless of how much, the sooner you can put the power of compounding to work for you. Compounding allows you to earn interest on your assets while reinvesting that interest to earn additional interest. A quick example: if you invest $10,000 today in an account earning 10% annually, your balance after one year will be $11,000 (a gain of $1,000). In the second year, your new balance of $11,000 earns 10% and becomes $12,100 (a gain of $1,100). As interest is added to the principal of your initial investment, that additional interest also earns interest, providing increasing value as time goes on.
What are Bonds?
A bond is a formal contract to repay borrowed money with interest at fixed intervals (e.g., annually, semi-annually, etc.). Bonds can be issued by governments (local, state, and federal) or corporations. Many of the things we see and use every day were built with bonds (public schools, sports stadiums, public transportation). Bonds are generally safer than stocks, but the underlying strength of the issuer will directly impact the safety of your investment.
What are Stocks?
The owner of stock in a company literally owns part of the company. If a company has issued a total of 1,000 shares of its stock, and you own 10 shares, you own 1% of the company. Stock ownership entitles you to your proportional share of the company’s profits, dividends, and appreciation (or depreciation) in value of the company. Stocks tend to be more volatile than bonds, but also offer great upside potential.
Diversifying your investments reduces the risk that any single investment will have a dramatic impact on your portfolio. There are many ways to ensure a diversified portfolio. You may own diversified mutual funds, which are groups of stocks and/or bonds managed together as one portfolio. You may own a combination of both high quality bonds and diversified stocks. You may also own a broad variety of “asset classes” (e.g., large growth, small value, domestic, international) to further reduce volatility and enhance return potential over time.
To quote Aristotle, “Good habits formed at youth make all the difference.” We agree, and we hope this brief introduction to Brighton Jones Finance 101 initiates a conversation between you and your children about the importance of being financially responsible and the rewards of being financially savvy!