Why You Should Know the ABCs of Investing Before You Start

Financial literacy in America has long been lacking, spanning the generations. It’s well-documented the problem begins with a lack of education on personal finance in youth and extends to the autumn working years, when many people are ill-prepared for retirement.

Yet, it’s never too late to address this shortfall of important knowledge, and for those trying to formulate a retirement plan, it starts with grasping some basic investment terms that many people find slippery, says Bob Kaye, a personal wealth manager and the author of How to Avoid Not Having Enough Money To Live On After Retirement: Making Smarter and Simpler Decisions for Stress-free Retirement. 

“In my work with investors who are planning for retirement, I have found there is generally a limited understanding of investment terminology,” Kaye says. “They don’t want to appear unsophisticated, so they will not ask the questions they should ask.

“The many types of retirement plans, tax statuses, etc., are complicated, and a simpler approach to learning them is needed. At the same time, there are conflicting theories, opinions and data in the investment field, and those factors can be detrimental to someone trying to plan for retirement.”

Kaye explains some key investment terms and how knowing them can help one avoid mistakes in retirement planning:

• Risk. People sometimes think an investment is risky if its value can go down. But Kaye says that logic may get you in trouble. “The stock market, which goes up and down, might be less risky over the long term than a savings account, which never goes down,” Kaye says. The reason: Based on historical averages, the stock market can increase eight times its value in a 20-year period. “A savings account might increase only twice its value in the same period,” Kaye says. “That’s a big loss on the potential return for the person who chose the savings account. Often, the definition of risk to most people does not include short-term or long-term loss, which it should.”
• Short-term investments vs. long-term investments. A failure to understand the distinction between short-term and long-term investments is responsible for a large portion of consumer unhappiness with investments, Kaye says. Examples of short-term investments are savings accounts, certificates of deposit, or fixed accounts. “Usually, any place to put money with a guaranteed rate is a short-term investment,” he says. “This is because you do not usually want money to fluctuate in value if you need it soon.”   Kaye draws the line of demarcation between short term and long term at about five years, and he puts stocks in the latter investment bracket. “Due to the frequent ups and downs of stock investments, they are usually only a correct investment for the long term,” Kaye says. “Historically, after five years, the market may be up or even, but not significantly down.”
• Mutual funds. “Some people get mutual funds and individual stocks mixed up,” Kaye says. “The risk can be significantly different. A mutual fund is usually a much safer way to invest than buying only one or two stocks. It is an arrangement in which someone invests in about 100 different stocks all at one time, requiring only one minimal investment. With such a diversified investment, even if one of the companies – and these are large companies – went completely under, you might barely notice the difference in your overall investment. Each company could be only 1 or 2% of your total investment.”

“Knowing the basics of investing cannot be accentuated enough,” Kaye says. “An understanding of them is needed to navigate a field fraught with conflicting opinions and advice, and to build a stronger foundation for financial success.”

Bob Kaye is a personal wealth manager, owner of Retirement Planning Associates, and the author of How to Avoid Not Having Enough Money to Live On After Retirement: Making Smarter and Simpler Decisions for Stress-free Retirement. He has been a financial advisor for professionals for 25 years and is a fully-licensed investment advisor representative in insurance, annuities, mutual funds, and stocks and bonds. He is also qualified as a Certified Funds Specialist®, a designation held by only about 1% of those licensed to work with mutual funds. He is certified additionally as a Chartered Life Underwriter®. Kaye was the recipient of the President’s Volunteer Service Award in a Capitol Hill ceremony in Washington, D.C., for his volunteer activities concerning human rights.