You’ve established your rainy-day fund. You’ve mastered your budget and you’re saving for retirement and other goals. Congratulations! You’ve accomplished what most Americans have not and your financial future will be bright because of it.
Now is the time to start considering the returns you are earning on your money. As I mentioned before, this conversation should be had with a licensed financial adviser that you trust who can come up with a plan and recommended products based on your needs and goals.
That said, I want to just mention a few points.
Inflation. This is the rate at which the value of our money decreases every year. Inflation has a number of causes, which are admittedly complicated, but they aren’t going away. This basically means that the one dollar you have in your pocket will be worth 98 cents next year if inflation is 2% annually. Why is this important when considering your rate of return? If your interest rate is 4%, after inflation, the value of your savings account is only increasing by 2% per year, in this example. Just keep inflation in mind when considering rates of return.
Volatility and Risk. As your saving (investing) becomes more advanced, you will undoubtedly venture into realms where rates of return are not guaranteed and you can actually take a loss on your principal if the investment does poorly. Typically, over time, you will still come out ahead, but you need to consider how short your investment time frame is when making decisions. For instance, if you are a few years out from retirement, most financial advisers will want you to start ratcheting down your level of risk and volatility by moving into more stable investments. Alternatively, if you are in your twenties and saving for retirement, you can probably tolerate a little bit more risk.
Tomorrow - The conclusion of my series.