Learn basics before investing

Getting Started

Your Money

March 28, 2004|By Carolyn Bigda

VENTURING into the investment arena can be intimidating. With such a wide selection, where do you begin?

Start by learning basic concepts. Once you've mastered them, it becomes easier to figure out a game plan.

First, recognize that you'll have short- and long-term financial goals. A short-term goal might be taking a vacation this year or paying for a wedding in the next six months.

For these obligations, you don't want to risk your principal by being aggressive. A couple of safe choices - money market funds and certificates of deposits - offer a better return than ordinary bank savings accounts.

A money market fund is an investment pool offered through mutual fund companies and brokerages. Unlike bank accounts, your money isn't protected by the Federal Deposit Insurance Corp. But these funds are invested in secure, short-term financial bonds and notes that produce greater returns than a traditional bank deposit. This is a good place to store savings for which you have no specific timeline but still need quick access.

Certificates of deposit are loans you make to a financial institution for a specific term, usually six months to five years. The longer the loan, the greater the rate of interest. CDs issued through a bank are FDIC-insured. You can't make withdrawals without penalty before the CD comes due, so place money with specific deadlines here.

Remember: the less risk, the less reward. So stashing every last dollar in these accounts will not help you meet long-term goals, such as retirement income.

To increase your nest egg, you need to take on some risk. For most of us, that means buying stocks and bonds, or buying shares of mutual funds that hold stocks and bonds.

A stock, or share, is a piece of ownership in a corporation. Companies that offer stock ownership are referred to as public, since anyone can buy these shares, not just a few individuals who have a stake in the business' earnings.

As an owner, you have the potential to gain in two ways: from dividends the company may pay each quarter and from appreciation of the stock price. However, neither is a sure thing. There may be years of losses, and if you cash out when the share price is down, you've lost money.

That's why stocks are a long-term investment. You need to give your investment time - at least three to five years. It's a good idea to spread your risk by not buying too much of a particular stock.

Spreading your investments around is called diversifying, and many investors put their money into bonds as well as stocks.

Also referred to as fixed-income investments, bonds are essentially loans that you can make to the government or a corporation. In return for your money, the borrower pays you interest over a set period. When the bond matures, the initial amount lent is returned to you.

Government securities are considered the most secure since they are backed by the "full faith and credit" of the United States. Interest rates of new issues are generally set at auction.

Corporate bonds pay different returns based on the company's bond rating, which can be checked at such Web sites as www.moodys.com or www.standardandpoors.com. Bonds are traded like stocks, and their value fluctuates depending on current interest rates.

Spreading your risk is easier when you buy mutual funds, which are investment pools that shuttle cash into a variety of stocks and bonds with varying levels of risk.

A professional manager decides which securities to buy or sell. You pay an annual percentage of your investment and sometimes a flat fee (called a load) to open or close an investment.

Mutual funds are not without risks. The recent mutual fund scandal, in which certain managers favored particular clients in late-day trading, underscores the need to be informed about the funds you choose.

Before you invest, ask for the company's prospectus, which explains fees and objectives, and keep tabs on the fund's performance.

E-mail Carolyn Bigda at yourmoney@tribune.com.

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