Today’s fantastic family finance article is:
“Investing, blah, blah, blah, cash, blah, blah, blah, stocks, blah, blah, blah, bonds, blah, blah, blah, diversification, blah, blah, blah, time horizon, blah, blah, blah, risk tolerance, blah, blah, blah, return, blah, blah, blah, asset allocation, blah, blah, blah, rebalancing. Got it?”
“Dad, you lost me at ‘investing.’”
Let’s try something different. A simple picture.
First, let’s draw a horizontal line representing when we anticipate needing some money. It starts with “right now” and works its way up to “decades from now” and beyond.
Now, let’s draw a vertical line showing how much risk we’re willing to take with our money. It starts with “no risk” and works it’s way up.
If we need the money right away, we don’t want to be taking any chances with it. That’s a dot in the lower left corner.
If we don’t need the money for decades, we’re more willing to take some chances. Why? It turns out that if we take more risk, we have a better chance of getting more reward. That’s a dot in the upper right corner.
Now, connect the dots. That shows us how "when we need the money" (our "time horizon") affects how much risk we’re willing to take.
Now let’s consider some of the most popular places to keep money.
- As cash in a bank account. Not risky at all. In fact, if something happens to the bank, the government will step in and make sure you get your money back. (Up to $250,000 — as long as your account is FDIC insured. Make sure it is.) Write “cash” in the lower left corner of the chart.
- Invested in stocks. Can be extremely risky — especially if you hold individual stocks or hold for short periods of time. (Hint: be sure to check out low cost index funds or ETFs as a way to hold broadly diversified collections of stocks with lower risk and strong returns over the long haul.) Write “stocks” in the upper right corner of the chart.
- Invested in Bonds. Typically somewhere in between cash and stock when it comes to risk/reward. Write “bonds” in the middle of the chart.
So, where should you keep your money?
When do you need it?
Everyone needs some now for everyday spending, regular bills, and short term savings goals. Think cash. And remember, an emergency could happen any time, which means it could be today. That's why emergency funds should be in cash.
Everyone needs some for the future. The younger you are, the more decades in that future. So, the more you should be thinking stocks. As you get older, fewer decades, less stock which means more bonds and cash.
That’s the big picture when it comes to investing. Pretty simple.
Make sure your kid understands the big investing picture. You can wow her with the fancy jargon later.
Get tomorrow’s tip here.