Most medium- and long-term goals require more than saving—they require investing. Our culture has become used to borrowing to reach goals, but if you borrow for everything you can't afford, you will be using future income to repay loans and credit card debt. You can't borrow for everything. You will still need a substantial down payment to purchase a home or buy a car. And borrowing for some things, like retirement, doesn't make sense.

Saving and investing allow you to make your hard-earned money work for you. Interest, dividends and capital gains build wealth over time. For example, $1000 invested in the stock market at an average rate of 10.4 percent (Ibbotson Associates) will grow to:

The Big Picture

Saving and Investing both have a place in your future happiness. Investing has a big advantage because you can choose ways that allow your money to compound over time.

How does your money compound? It depends on your investments, how much they earn, how often compounding is calculated and how long compounding has been working for you.


Compounding was once called Compound Interest, because its appeal comes from the interest your account earns, which is added to your account total and earns more interest. Investing is one way to make sure your money compounds over time.

The Power of Compounding
The power of compounding is visible as your money earns interest. The interest increases the total in your account, and that larger total earns more interest. You profit from what mathematicians call exponential returns. When this happens over and over, our savings and investments grow and wealth is accumulated.

Even at today's low interest rates, compounding makes a big difference over time. A $1,000 savings deposit at 3 percent compounded daily will grow to $2,460 in 30 years. Without compounding, the same deposit will be worth only $1,900 in 30 years. That's $560 extra!

Interest is determined by the amount we have saved or invested (principal), the rate we earn, and the length of time we can leave the amount invested.

To build maximum wealth to achieve your goals, you should:

If you love math, you can see how compounding works.

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Regular Investing Adds Up

The Big Picture

It's better in the long run to invest small amounts regularly than to invest larger sums occasionally.

How much should you invest each month? More is better, but some, even small amounts, will add up over time.

Instead of waiting until you have a lump sum of money, it's better—and easier—to invest smaller sums regularly. Most people wait until the end of the year—or even until April 15th of the next year—to make a contribution to an Individual Retirement Account (IRA). If you wait until the end of the year to put $5,000 in your IRA account, after 30 years it will be worth $590,677 (assuming an average return on equities of 8%). That sounds pretty good, but if you invest that $5,000 in equal installments of $417 each month over a year, and keep it invested for the same 30 years, your IRA will be worth $769,145! The extra $178,468 that you will have at retirement is your reward—thanks to the power of compounding—for putting your money to work earlier.

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Compounding for Mathematicians

The Big Picture

If you are a mathematician at heart, and you want to know the ins and outs of compounding, here it is. This section includes the formulas and examples.

How to know if your plan is on track, and doing the math for your annuity.

How Compounding Works Magic
Interest (I) is determined by the amount we have saved or invested principal (p) , the rate (r) we earn, and the length of time (t) we can leave the amount invested, as expressed by the following equation:

I = p x r x t

Compounding means that every so often we calculate the interest, add it to the principal, and use the higher principal for the next calculation of interest to arrive at a future value. To get from the original principal—or present value—to the future value, we use the following equation (where i is the interest rate per period and n is the number of compounding periods):

FV = PV (1+i)n

What does all this mean? It means that the future value of your investment depends on what you set aside today (present value), what rate you earn (i), and the number of times the rate is compounded (n).

Doing the Math for an Annuity
A series of equal periodic payments is called an annuity. To get from the future value of the annuity (FVA) to the periodic payment (PMT), we use the following equation (where i is the interest rate per period and n is the number of periods):

PMT = FVA x 1 % [n-1]

This means that the periodic payment or annuity investment you must make depends on the future value (or amount of your goal), what rate you earn i, and the number of payments you make n. Therefore, to keep your payments (delayed consumption) to a minimum, you should:

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Your Investment Strategy

The Big Picture

A strategy must be based on your goals and needs. There are websites that can help you find a strategy that works for you.

Every person invests differently based on goals, timing considerations, risk tolerance, willingness to delegate and knowledge. There is no "best" approach to investing that guarantees success.

A haphazard approach to investing may work when the whole market is on the way up. Consistent success comes more often from a strategic, deliberate approach. Your strategy may be different from anyone else's, but you should develop a set of rules to guide your investment decisions. You should have a very good reason to break your rule. More important, you should test your rules over time and be willing to change them when your circumstances (or the whole world's) change.

If you want to learn about strategies that others have used and see if they apply to your own situation, check out the Motley Fool at or browse the investment section in a bookstore.

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Investment Basics

The Big Picture

Risk and Reward are the two important considerations of investing.

Don't pay attention to tips, make up your own mind, based on how much risk you can take and what your goals are.

Spreading your risk keeps you safer. Beware of market timing. It may not work, even for investing experts.

How to do the research that will meet your goals.

Kinds of Investments that work best for short- to medium-term goals.

Safety and liquidly of these investments.

Investing is a topic that you can study for a long time before running out of new material. You don't have to be an expert to get started, but it helps to know the basics before you set a strategy for investing.

  1. Beware of the "Sure Tip"
    Investment ideas often sound tempting, particularly if they come from a professional. Some companies pay their sales staff a commission to sell certain investments. Do your homework before investing. Never rely on a "tip" without checking it out first. There are companies and mutual funds on the Yahoo! Finance site. At the very least, if you prefer to delegate the research work, get a second opinion from someone who has nothing to gain from your decision.

  2. Understand Risk and Reward
    Investment risk means you can tolerate some losses while waiting for some gains. When you invest in the stock market, risk is a given. There are many levels of risk, from the relative safety of cash (e.g., bank savings accounts) to the high-risk world of stock futures. The amount of risk you can stand is the amount that will let you sleep at night while your money is invested.

    Generally, the longer you have to recover from a loss, the higher the risk you can afford. But the overall risk tolerance varies from person to person and is something you must know before you start investing.

  3. Know Your Risk Tolerance
    Determine your tolerance for risk by completing any of the questionnaires available at financial publications such as Kiplinger's. Keep in mind that if you decide to risk more than you normally would, you will most likely manage that investment emotionally rather than intellectually. You may panic at the first sign of trouble and sell when you should be buying.

  4. Spread Your Risk
    Don't put all your eggs in one basket. Take advantage of the benefits of diversification (spreading out your risk) and asset allocation (investing in a variety of funds). Your Thrift Savings Plan, which may be invested in index funds, provides plenty of opportunities for diversification. Mutual funds, in particular Life Cycle funds, can achieve diversification and asset allocation for your investments outside the TSP. Learn more about these at Morningstar.

  5. Don't Believe in Market Timing
    Research has shown that attempts to "buy low and sell high" often fail. Big market moves often happen within a short time frame. By the time most people decide that the market is "going up," most of the money has been made. Rather, consistent investment over long periods of time has generally paid off. Refer to the sections on Dollar Cost Averaging and Share Purchase Plans and Dividend Reinvestment Plans.

  6. Do Your Research
    Finance experts disagree on whether it's possible to "beat the market." Those who say that you can beat the market recommend extensive research to uncover information about stocks that are under- and overvalued. Others say that market movements are random and stocks are always priced correctly. This debate will not be resolved soon—perhaps never.

    You will be a calmer (and maybe richer) investor if you do your homework. Researching stocks and mutual funds before you buy has many benefits, whatever you believe about the market. It may not enable you to uncover hidden gems, but at the very least, it will focus your decisions, provide information about the costs of investing, and provide some protection from being victimized by financial predators.

  7. Keep Your Costs Low
    Do your own research at Morningstar and Yahoo! Finance to find quality no-load mutual funds with low expense ratios. If you purchase stocks on your own, consider buying through Share Purchase Plans (Sharebuilder), a deep-discount brokerage (TD Ameritrade), or directly from the company (determine whether you can do it by reviewing the Investors section of the company's Web site).

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Investment Basics Plus

The Big Picture

Risk means you can lose money, but without risk, you can't make money by investing either. Knowing how much risk you can handle is the key to investing. There are different kinds of risk, and each kind varies over time.

How to control risk with diversification.

Asset allocation will keep your portfolio balanced, and watching transactions costs will keep it growing.

Dollar cost averaging keeps you in the market through ups and downs and helps keep your earnings on an even keel. A chart shows you how it works.


In investing, risk is the chance of losing money.
People ordinarily do not take a financial risk unless there is also a chance of making money or being rewarded. If you make an investment that has a real chance of a high return—such as in the equities market—then you are also taking a chance of a low return, or a loss of your money. If you invest in a lower-risk, short-term, fixed-income security—such as a bank savings account—both your risk and your returns will be lower.

How Risk Varies
For example, the historical average monthly return on equities (e.g. stocks) has been a gain of 0.85 percent (10.2 percent annually). At the same time, these returns varied, on average, from a loss of 0.61 percent (7.28 percent annually) to a gain of about 2.6 percent (31.32 percent annually). In other words, $1,000 invested in equities at the beginning of a month could be worth, at the end of the month, as much as $1,026 or as little as $994. At these rates over a year, your $1,000 might grow to $1,313 or decline to $927. [Siegel, Jeremy, Stocks for the Long Run, ©2002, McGraw-Hill.]

Keep in mind that all these returns are averages. Any single stock in any single year could gain or lose a much greater amount. For example, in 2001 Enron lost 95 percent of its value ($1,000 invested in this stock became just $50). In 2002, ICG Communications gained 3400 percent of its value ($1,000 became $35,000)! [Reference: Denver Post, July 23, 2003 ]

Systematic Risk
Risk that the overall equities market will decline is called systematic risk. There is nothing you can do to reduce this risk except to completely avoid investing in equities. But remember that you are giving up the chance of making an average return of as much as 31 percent in a year while avoiding an average possible loss of only 7 percent. Financial professionals would call this a bad trade-off, and they advise most people to invest at least some of their long-term funds in the equities market.

Non-systematic Risk
Risk that any single stock will lose money (or go to zero) is called nonsystematic risk. The good news is that this risk can be minimized. Overall, nonsystematic risk may be diversified by owning several stocks. This is referred to as holding a portfolio, and it relates to the old saying, "Don't put all your eggs in one basket." The chance that a single stock will lose money is offset by the chances of your other stocks making money.

Controlling Risk through Diversification
Equity investors can build a diversified portfolio by buying several stocks that have different risks. This generally means owning stocks of companies in different businesses. Some, like retailers, will do better when the economy is growing and inflation is low. Others, like gold-mining companies, will perform better in times of high inflation or political instability. Another way to diversify is to own stocks of companies that operate in different parts of the world.

Transaction costs
Charges such as brokerage commissions, associated with creating and rebalancing a diversified portfolio can add up and reduce your returns. For example, $2,000 invested at the end of each year for 30 years earning 12 percent per year will grow to $482,665 if there is no sales charge on the investment. A front-end load of 8 percent will bring the value of the same investment to $444,052. In other words, the front-end load (e.g. a sales expense charged on each contribution/deposit) will cost you $38,613! To obtain a diversified portfolio at a lower cost, you can invest through your Thrift Savings Plan, dividend reinvestment plans (DRIPs), and mutual funds.

Asset allocation is another way to diversify overall investment risk. Portions of an investor's assets are invested in equities (both United States and international), fixed income (various types of bonds), commodities (such as gold), and real estate. The percentage invested in each type of asset is determined by your stage in life. Once again, you can achieve an effective asset allocation using mutual funds and real estate investment trusts (REITs).

Dollar cost averaging is the process of purchasing stocks or mutual funds periodically at different market prices. You must commit to investing the same amount of money each time, regardless of what happens to the market price of the stock or mutual fund.

Here's how it works:

Let's look at an example (refer to the table below):

Month Market Price Amount Invested Total $ Invested Number of Shares Total Shares Average Cost per Share
$10.00 $50 $50 5.0000 5.0000 $10.00
$9.00 $50 $100 5.5556 10.5556 $9.47
$8.00 $50 $150 6.2500 16.8056 $8.93
$7.00 $50 $200 7.1429 23.9484 $8.35
$6.00 $50 $250 8.3333 32.2817 $7.74
$6.00 $50 $300 8.3333 40.6151 $7.39
$7.00 $50 $350 7.1429 47.7579 $7.33
$8.00 $50 $400 6.250 54.0079 $7.41
$9.00 $50 $450 5.5556 59.5635 $7.55
$10.00 $50 $500 5.0000 64.5635 $7.74
$10.00 $50 $550 5.0000 69.5635 $7.91
$10.00 $50 $600 5.0000




Now let's analyze the results.

Market Price
Amount Invested
Total $ Invested
Number of Shares
Total Shares
Average Cost per Share
$10.00 $50 $50 5.0000 5.0000 $10.00 $50.00 $600.00
$9.00 $50 $100 5.5556 10.5556 $9.47 $95.00 $540.00
$8.00 $50 $150 6.2500 16.8056 $8.93 $134.44 $480.00
$7.00 $50 $200 7.1429 23.9484 $8.35 $167.64 $420.00
$6.00 $50 $250 8.3333 32.2817 $7.74 $193.69 $360.00
$6.00 $50 $300 8.3333 40.6151 $7.39 $243.69 $360.00
$7.00 $50 $350 7.1429 47.7579 $7.33 $334.31 $420.00
$8.00 $50 $400 6.2500 54.0079 $7.41 $432.06 $480.00
$9.00 $50 $450 5.5556 59.5635 $7.55 $536.07 $540.00
$10.00 $50 $500 5.0000 64.5635 $7.74 $645.64 $600.00
$10.00 $50 $550 5.0000 69.5635 $7.91


$10.00 $50 $600 5.0000 74.5635 $8.05 $745.64 $600.00

Some words of caution:

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Investing for Education

The Big Picture

College tuition is getting higher every year. How can you provide for education for your children?

College tuition costs have risen faster than the rate of inflation for many years. Today it is not uncommon for parents to pay more for their child's four-year college education than they spent to buy their first home.

Public colleges—including community colleges and state universities—are supported by taxes on residents, so tuition is usually much less than private colleges. Most public colleges charge out-of-state residents higher tuition. Because members of the military may be deployed anywhere in the world, they are not eligible for in-state tuition everywhere. When you plan for college, be sure to ask whether you will qualify for in-state tuition.

For more details on investing for education, visit Education Planning.

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Investing Your Retirement Account Money

The Big Picture

Since your employer has a retirement plan, use it. The difference between stock, bonds and cash equivalents, and how each fits into an investment plan, is the amount of risk in each.

You have an ownership interest in your retirement accounts. You will probably have investment choices with your thrift savings account, and you certainly have choices with your IRA account. Rely on your financial advisor to the extent that you are comfortable; but as the account owner, you will pay the price or benefit from whatever happens. Learn at least the basics:

The investment terminology might be new to you, but the facts won't be. There are different kinds of investments you can buy with your retirement dollars. You will want to choose a certain mix of investments for your account that reflects the amount of risk that you are willing to take. Remember that as the rate of return you want to achieve goes up, so does the risk. You will want a balance that gets you to your goal with a risk factor that you can live (and sleep) with. The main categories of investment opportunities are:

Stocks—High Return and High Risk
Stocks, also called equities, represent ownership rights in a corporation. You might receive dividends and share in the company's growth. There's no guarantee that the company will grow and do well, so you could lose value rather than gain value. Over the long run, stocks in general have always brought the highest return. If you've got time to recoup from down periods in the market, you should be able to tolerate the higher risk of stocks.

Bonds—Moderate Return with Lower Risk
Bonds are loans issued by a debtor (a company or the government) and bought by a creditor (an individual investor like you or an investor fund). You can expect higher returns than with cash, but lower than with stocks. Treasury bonds and mortgage-backed bonds are safer than corporate bonds.

Cash and Cash Equivalents—Lowest Return with Lowest Risk
If you keep your money in certificates of deposit (CDs) and money market funds, you'll preserve the dollars with which you started but earn a low income on those dollars.

Think about how you would like to allocate your assets. It's the most important decision you have to make about your retirement accounts. Investment selections and timing within the allocations are other factors. Consider your specific investment goals, financial resources, time frame and risk tolerance. Some financial advisors suggest that you subtract your age from 120 to determine the percentage of your assets to invest in stocks. The remainder would be invested in bonds and cash or cash equivalents. For example:

You can get decision assistance from online calculators with graphics. If you visit and click on "Calculators," you will find an asset-allocator calculator that you can use to try different asset mixes. You will find a mix that is comfortable to your risk tolerance. If you need additional help or want professional guidance, ask a certified financial planner (CFP).

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Ways to Fund Your Retirement

The Big Picture

Your Thrift Savings Plan is the foundation of your retirement.

Start contributing early, find out your risk tolerance, and set an asset allocation that matches your ability to take risk.

Don't touch your retirement money; everything you take out will not be there for your later years.

Consider Savings Bonds. There are many kinds, each with different benefits and risks.

Mutual Funds can add a lot to your retirement. Look at the different kinds and what they can do for you. REITS and UITs are investments you can consider, and DRIPs help you roll dividends back into investments.

IRAs are another retirement investment, largely for people who don't have retirement plans at work. But you can supplement your work plan with them, too. There are many different kinds of IRAs. You can use more than one kind in your plan.

Thrift Savings Plan

The TSP is designed to supplement your retirement benefits in a tax-effective manner. Contributions from taxable income are invested on a tax-deferred basis, while contributions from tax-free income (such as combat-zone pay) remain tax-free status. When you arrange to have a portion of your taxable income invested in the TSP, you immediately save money on taxes. In other words, when you contribute $100, your net paycheck may be reduced by only $85, because the contribution isn't taxed until you use it when you retire. Yet you will be able to invest the entire $100. You'll pay tax on the amount that the $100 becomes in the future. TSP information is subject to change, so check for updates at

Thrift for Retirement
Investing in the Thrift Savings Plan (TSP) for your retirement is a no-brainer! Quite simply, you should invest as much as you can afford in the TSP because:

Start Contributing Now
The first step is to complete a TSP election form (TSP-U-1), using these guidelines:

Allocate Your Investments for the Long Haul
All of the investment choices available in the TSP offer diversification to reduce risk, but only the Government Securities fund (G) guarantees that you won't lose money. It would be prudent to invest any TSP funds that you anticipate withdrawing within five years in the G fund. You will earn a medium-term (four-year-plus), government-securities return on your money in an investment that you can turn to cash at any time.

Higher Returns Mean Higher Risk
The more risk you take, the better the chance of making more money. You should take a look at how your investments are allocated every year or two. Investment performance (gains and losses) will change the percentages over time. You can rebalance your asset allocation by making transfers among your different investments groups.

Don't Touch Your Money Before Retirement
Any time you take money from your fund, you are taking money out of your retirement. The best plan is to never touch the money until you retire. Sometimes you find yourself in financial trouble. Before you take out money, consider taking a loan from the plan-borrowing money and paying yourself back.

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