Do you have a large amount of cash savings, but not much put into invested accounts for retirement?
If so, you’re not alone. A majority of Millennials prefer to keep their assets in cash and don’t trust the idea of putting money into the market. That’s not too surprising, since many members of Gen Y started life “in the real world” right before or during the Great Recession. We saw our parents retirement accounts crash and burn and we know people who lost it all.
But here’s the thing: investing is still important. One of the biggest risks to investing for millennials is inflation risk, which means that if your rate of return doesn’t outpace inflation, you’re actually losing money. Leaving everything in cash over the period of your working life — just like you should leave your contributions in your invested retirement accounts over your career — will leave you with cash that’s less valuable in the future than it was when you put it in savings. That’s due to inflation, and investing wisely can help you avoid losing a chunk of your nest egg to it.
If you’re in Gen Y and aren’t so sure about investing or the stock market, start with educating yourself. That’s the first step to feeling empowered with your finances and your investments. To get you going, review and learn these 17 investing terms all Millennials should understand:
1. ROI. Short for “return on investment.” Is a measurement that refers to the gain or loss experienced relative to the amount invested and is often expressed as a per cent. ROI is calculated by dividing the gain (or loss) by the cost of the investment. Example: An investment of $US1,000 grows to $US1,100 would generate an ROI of 10% ($100/$1,000 x 100).
2. Compound interest. Compounding means that when interest is initially calculated on the principal amount invested, the added interest can then also earn interest.
3. 401(k). A retirement savings account that takes advantage of a specific tax code to allow deductions (i.e. deposits) to be made from your paycheck on a before tax basis. Example: If your gross pay is $US900 and your 401k deduction is $US100, your taxes for that paycheck are calculated on $US800 instead of $US900. Some employers will also make contributions on behalf of employees (called “matching contributions”). There is a limit set each year to how much can be deposited. Earnings and deposits grow on a tax-free basis until withdrawn.
4. Roth IRA. A Roth Individual Retirement Account is a type of retirement savings vehicle. Unlike a traditional IRA, contributions to a Roth IRA do not receive an upfront tax deduction. Therefore, you can withdraw your funds tax-free in retirement since you already paid taxes when you put the money in. Another important thing to note is that you can withdraw your contributions at any time (just not the gain).
Note: If you’re wondering if you should contribute to a Roth IRA or a 401(k), this post might help you!
5. Certificate of deposit (CD). No, I’m not talking about those compact discs I bought in high school (yes, this ages me). A CD is a type of savings account offered by a financial institution. In exchange for keeping savings in the account for a specified period of time (i.e. 1 year, 5 years, etc.) often times a higher interest rate is given than you would earn on your savings account.
6. Money market account. A type of savings account offered through many banks and credit unions that pays higher interest, but also may require higher account balances or other restrictions, like the number of withdrawals you can make each month. However, two of my favourite money market accounts are at online banks: Ally Bank and CapitalOne 360.
7. Liquidity. The ability to cash out of an investment easily. Cash in your checking or savings account is the easiest to access. Money in investments needs to be sold before it can be accessed and it takes a few days for trades to settle and the cash to become available.
8. Stocks. When you own a stock, you own a piece of that company. A stock offers ‘shares’ of a public corporation, so you can take partial ownership and profit off of the company’s earnings.
9. Bonds. This is a debt security, where the investor loans money to government or corporate entities. In exchange, companies provide interest payments at predetermined intervals and pay back the loan in full.
10. Bear or bull market. A metaphor used to describe the investor environment primarily related to the stock market. A bear swiping its paws downward indicates a downward market; lowering of stock prices, investor pessimism, and lack of confidence. A bull with its horns pointing upward indicates investor optimism and confidence as well as a rise in stock prices.
11. Diversification. An investment strategy that in effect avoids “putting all of your eggs in one basket.” Using this strategy, investors have a variety of investments such as stocks, bonds, money market funds to minimize risk.
12. Buy and hold. A type of investment strategy where investors buy stocks and hold onto them, using the philosophy that long-term gains provide a nice return, regardless of short-term volatility or declines in the market.
13. Mutual fund. Mutual funds pool funds together from several investors which are then used to buy stocks, bonds or other securities which are managed by a professional fund manager.
14. Initial public offering. Also referred to as an IPO. An IPO occurs when a private company transforms into a public company and starts to sell shares of stocks to outside investors.
15. Dividend. A payment of profits, typically quarterly, to shareholders who invest in a company.
16. Inflation. An increase in the price and value of goods and services, often represented as an annual percentage.
17. Expense ratio. Expressed as a per cent, the expense ratio is the annual operating expenses for a fund for such things as administrative, operating and management fees divided by the value of assets under management.
There are a lot of terms related to investing, but starting to learn the basics will help you have a better grasp on your financial life and give you confidence to invest in your future. If you want to keep reading and learning, be sure to check out Investopedia. It’s a virtual content library and a great resource for anyone eager to find the answers to their questions.
Do you have specific questions about investing terms, or getting started with investing? You can schedule a call with me and we can chat more about your specific financial situation and questions.