making money work for you
The mission of The USAA Educational Foundation is to help consumers make informed decisions by providing information on financial management, safety concerns and significant life events.
This publication is not medical, legal, tax or investment advice. It is only a general overview of the subject presented. The USAA Educational Foundation, a nonprofit organization, does not provide professional services for financial, accounting or legal matters. Consult your tax and legal advisers regarding your specific situation. Information in this publication could be time sensitive and may be outdated. The Foundation does not endorse or promote any commercial supplier, product or service.
Table of conTenTs
planning for your future
2 3 5 7 11 19 30 32
setting financial goals
Knowing what you want to achieve
your financial resources your spending plan using credit wisely
Understanding your income and net worth
Developing an effective budget
Building a credit reputation without building debt
saving and investing
Starting and continuing a disciplined plan
protecting your financial future
Understanding the importance of insurance
measuring your financial progress
Staying on track
planning for your fuTure
What are your goals for the future? To attend graduate school? Start your own business? Maybe you would like to get married and start a family. You may dream of living in a certain type of home or of traveling abroad. Whatever your goals, your ability to achieve them will depend on the way you manage money now and in the future. This publication introduces you to the following basics of financial management, so you can begin building that foundation.
• Setting personal and financial goals. • Understanding your financial resources. • Creating a budget to manage expenses and minimize debt. • Establishing a good credit reputation and using credit wisely. • Saving and investing regularly. • Protecting your assets with insurance. • Adjusting your plans as circumstances change.
Financial management is a lifelong process. Doing it responsibly requires hard work and self control — but can lead to a secure and satisfying future. Remember, it is best to consult a financial planning professional before making any major financial decisions.
seTTing financial goals
As with most endeavors, financial planning begins with goal setting. Take time to determine your goals and how much time and money you will need to achieve them. You will need to set shortterm (3 years or less), intermediate-term (4 to 6 years) and long-term (7 years or more) goals.
While goals will differ for everyone, most individuals should at least consider the goals shown here. Begin saving and investing now for short-term, intermediate-term and long-term goals. short-Term
• Pay debt in full. • Establish a good credit reputation. • Implement a disciplined savings and investment plan. • Create an emergency fund of 3–6 months of basic living expenses. • Purchase a vehicle. • Purchase insurance coverages appropriate for your situation. • Prepare and execute a will and power of attorney.
• Make the down payment on a home purchase. • Plan for a wedding. • Increase income for additional goals and luxuries. • Prepare for the birth or adoption of your children. • Provide for your advanced education.
• Establish and work toward your retirement goals. • Provide for your children’s college education. • Plan to support aging parents. • Consider long-term health care. • Maintain desired standard of living for your lifetime. • Assess housing location and needs for retirement.
Quantifying your goals
Once you have determined your goals, identify how much time and money you will need to reach each goal. Allow for inflation, which has been rising 2 percent to 3 percent annually during the past decade.
financial goals work sheeT
goal sample goal:
Create an emergency fund of 3–6 months of basic living expenses.
3 years or less Time $ needed
4 To 6 years Time $ needed
7 years or more Time $ needed
your financial resources
Once you have established your financial goals, the next step is understanding the resources you will need to achieve them. If you are like most individuals, your primary resource will be your pay. If you manage your pay well, over time you will build net worth. Your net worth indicates your financial position at a particular time and is a measure of the progress you are making toward your goals.
understanding your pay
The amount of money you take home each month depends on various factors — your base pay, federal and state income tax deductions, Social Security contributions and other deductions you may authorize.
VisiT The irs web siTe, www.irs.goV, or consulT a Tax professional To learn how feDeral income Tax rules apply To you.
• Base pay makes up the largest portion of what you earn. The
amount you receive usually depends on your education, skills and level of experience.
• Bonus pay or incentives may be provided for those who have
special skills, hold certain types of positions or perform hazardous work.
• Gross pay is the total amount of your base pay and bonus pay
before deductions and taxes are subtracted.
• Deductions taken from wage earners’ gross pay include:
• Federal Income Tax Withholding (FITW). • State Income Tax Withholding (SITW), if applicable. State income tax deductions vary from state to state. Your employer’s human resources or payroll department can provide information about your state’s income tax rules. • Social Security and Medicare (FICA). • Other deductions that you may request such as savings or insurance payments.
• Net income is the amount of money you bring home after taxes
and other deductions are subtracted.
calculating net worth
Your net worth is the value of what you own minus the amount of what you owe. Use the following Personal Financial Statement to calculate your current net worth. To calculate your net worth, add all assets (what you own); add all liabilities (what you owe). Subtracting your total liabilities from your total assets will equal your net worth. Skip items that do not apply.
personal financial sTaTemenT
assets (what you own)
Cash Checking accounts Savings accounts Emergency fund Money market accounts Certificates of deposit Cash value of life insurance policies Retirement plans Pension/Profit-sharing plans (money owed you if you leave your employer today) IRA 401(k) Keogh plans Money owed to you Stocks/Bonds/Mutual funds Real estate investments Your home Other investments Rental or vacation property Vehicles Furniture/Appliances Jewelry/Furs Collectibles/Artwork Miscellaneous property Total assets $ summary Total Assets Less Total Liabilities net worth As of (date): $ $ $ Personal loans Vehicle loans Credit card debt Education loans Investment loans Life insurance loans Other Total liabilities $
liabilities (what you owe)
your spenDing plan
A budget, or spending plan, are essential in establishing financial control and direction. A budget helps you:
• Track how you use money each month and year. • Avoid wasting money. • Prepare for unexpected expenses. • Save for short-term goals and invest for long-term goals. creating a plan
Total every dollar you spend for a month and keep track of what you buy. You may be surprised how much you spend and on what things.
• Total your income and subtract your expenses. Gather pay stubs and other income statements, check registers, bank statements, credit card statements or bills and receipts. Divide your annual net income by 12 to determine monthly net income.
• Copy the following Budget Work Sheet. Use it to record the amounts you plan to spend for
the month. Financial planning professionals recommend targeting at least 10 percent to 15 percent of net income for savings.
• Monitor your spending. Keep written records of your purchases and payments and record
the amounts you actually spent for the month.
• Review your spending plan at least once each month. Compare what you actually spent
to the amounts you planned to spend. How well did you do for the month? Did you have extra money (net cash flow) or did you borrow money by using a credit card? Look for areas requiring special attention and reduce or eliminate expenses as needed.
• Adjust your plan. Adjust expenses to reach your financial goals.
budget work sheet
Use copies of this work sheet to track your spending for several months. Skip items that do not apply.
buDgeT work sheeT
income for The month of: Gross monthly income Other income (spouse, interest, etc.) Total Gross Monthly Income Deductions FITW — Federal Income Tax Withholding (if applicable) SITW — State Income Tax Withholding FICA — Social Security FICA — Medicare Other deductions Total Deductions net monthly income (total gross income minus total deductions) monthly expenses giving Church Charity Other savings/investments (target at least 10%–15% of net monthly income) Emergency fund Other expenses Food Rent/Mortgage payment Renters/Homeowners insurance Utilities Home maintenance Property taxes (1/12 of total annual expense) Furniture Phone/Cell phone Internet service Other $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ amount planned actual expenses $ $ $ amount
buDgeT work sheeT (conTinueD)
monthly expenses education Tuition Room/Board/Travel Books/School supplies/Uniforms Transportation Vehicle payment Auto insurance Gasoline/Parking/Tolls Vehicle maintenance Registration/License fees (1/12 of total annual expense) Public transportation Debt Credit card(s) payment Loan(s) payment personal Clothing Laundry/Dry cleaning Grooming (hair care, toiletries, etc.) Child-care expenses (baby sitters, child-care center) Other recreation/entertainment Vacation(s) (1/12 of total annual expense) Entertainment/Dining out Hobbies (for example, golf or tennis equipment and fees) Club fees/Organization dues Cable/Satellite television Other Total monthly expenses net monthly income less Total monthly expenses (actual) net cash flow (Deficit) $ $ $ $ $ $ =$ $ –$ =$ $ $ $ $ $ $ =$ $ –$ =$ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ amount planned actual expenses
improve your cash flow
If you find that you do not have enough money for each month, improve your net cash flow by reducing or eliminating unnecessary expenses. To begin, look for ways to save money.
• Switch to a no-fee checking account. • Switch to a low-interest, no annual fee credit card. • Switch to a less expensive phone plan. • Use a less expensive Internet service provider. • Dine out less often. • Monitor your entertainment expenses. • Cut back on cable channels.
In addition, you may need to change your spending habits.
• Save for purchases that cannot fit into your budget. • Stop charging unless you can pay credit card balances in full each month. • Wait for sales and use coupons.
Once you have learned to monitor your expenses and spend within a monthly budget, you will have money to save and invest.
using creDiT wisely
Buying on credit has become such an accepted way of life in our society that many individuals look upon credit as a right. Credit is an important tool.
• It allows you to purchase items you could not afford with cash,
such as a college education, new vehicle, furniture or home.
• It helps you build a credit reputation — summarized in a report
— that businesses, landlords and future employers use to make decisions about your creditworthiness. Credit is a privilege and a serious responsibility. Unfortunately, it is easy to misuse. Some individuals view credit as a license to spend money they cannot repay. Poor spending decisions can leave them deeply in debt and damage their credit reputation for years ahead.
practice healthy credit habits
Use credit responsibly as part of an overall saving and spending plan. The following healthy credit habits can improve your credit reputation.
creDiT is a priVilege anD a serious responsibiliTy. unforTunaTely, iT is easy To misuse. some inDiViDuals View creDiT as a license To spenD money They cannoT repay.
• Set a monthly limit for charges and stick to it. • Pay bills on time and in full to avoid monthly charges. • Do not skip a payment. • Limit the number of credit cards you own. • Know the terms and conditions of your credit card(s) and loan(s). If you have questions,
ask for an explanation.
• Keep credit card and loan information in a safe, secure place. • Keep copies of sales slips and compare charges when your billing statements arrive.
Call your company immediately if there is a discrepancy.
read The fine print
A credit card account is much more than just the interest rate. In addition to the interest rate you are paying on your credit card, you should know what is in the credit card agreement as well. Read the fine print. You can generally find answers to the following questions in your credit card agreement.
applying payments: Is there more than one interest rate on the account? How are the payments applied toward the balance owed? spending limits and credit lines: Is there a spending limit? How much is my credit line? Can I increase, reduce or cancel the credit line at any time? Default rates: Will you change the rate on my credit card if I make a late payment to you or other creditors? fees: What fees will you charge — annual fee, a late payment fee, fee for insufficient funds or unsigned checks, fee for a copy of my statement and payment by phone? Disputes: What rights do I have in resolving disputes about my credit card account? grace period: What is the grace period for paying the balance due on my account? Is the grace period shorter than 25 days? authorizing charges: For what reasons would you reject my use of this credit card? Terms of agreement: When do the terms of agreement change and how will I be notified of changes? Remember, when you purchase something with a credit card, you take out a loan. With your signature, you enter a contract to repay the loan in full.
compare credit carefully
Credit cards offer a variety of rates, terms and features. Two cards, both with the same name, may offer very different features. Each financial institution that offers credit cards establishes its own terms. Be cautious of credit cards that start charging interest on items you buy the day each transaction is posted to your account. You pay interest on all purchases with this type of card. Compare options carefully.
• Annual percentage rate (APR) — the rate of interest (expressed as a percentage) charged
for a loan over a year’s time. The APR includes interest, transaction fees and service fees.
• Fees charged by the card issuer — these may include over-limit fees, annual fees or cash
• Grace period — the amount of time you have to pay before interest is charged. • Other benefits — these may include frequent flyer miles or access to an automated teller
The four cs of creDiT
When you apply for a credit card or loan, potential lenders tend to look at the same factors to decide if you are a good credit risk. capacity collateral character creditworthiness Your ability to repay credit (your debt-to-income ratio). Your personal property, such as a bank account or vehicle, that provides the creditor with security if you cannot repay your debt. Your ability to use credit responsibly. Your credit history (how you have managed money in the past).
your credit reputation
By practicing healthy credit habits, you can build a good credit reputation.
• You have a better chance of being approved for credit when you need a credit card, vehicle
loan or mortgage loan.
• You are more likely to receive higher loan amounts at lower interest rates. • You are more likely to get a desirable job, secure an apartment and acquire insurance
coverage. The following steps can help you build a good credit reputation.
• Maintain active checking and savings accounts with no checks returned for insufficient
funds. This demonstrates that you can manage money well and have the discipline to save.
• Apply for a small, secured loan or credit card from your financial institution, backed by
your savings account. Use it carefully and make payments promptly. Paying small credit transactions responsibly establishes your creditworthiness.
• Limit your debt. Financial planning professionals recommend keeping your personal debtto-income ratio at or below 20 percent, excluding mortgage or rent.
Total monthly payments (exclude mortgage or rent) ÷ Net monthly income = Debt-to-income ratio example If your total monthly payments (excluding mortgage or rent) equal $400 and your net monthly income is $2,000, your debt-to-income ratio equals 20%. $400 ÷ $2,000 = .20 or 20%
Warning signs of overindebtedness come long before creditors start sending collection notices. Answer the following questions to help determine whether you are managing debt appropriately. 1. Are you borrowing to pay for items you once paid for with cash? 2. Is an increasing percentage of your income going to pay debts? 3. Are you paying bills with money reserved for something else? 4. Are you taking money from your savings to pay current expenses? 5. Is your emergency fund (which should equal 3 to 6 months of basic living expenses) inadequate or nonexistent? 6. Do you pay only minimums on your revolving charge accounts? 7. Are you making payments in 60–90 days that you once made in 30? 8. Are you near or at the limit on your credit cards and other sources of borrowing? 9. Do you take out a new loan before the old one is paid in full or take out a new loan to pay an existing loan? 10. Do you take out payday loans before receiving your scheduled pay? 11. Are you unsure about how much you owe? 12. Are you chronically late in paying your expenses? 13. Are you threatened with repossession of your vehicle, cancellation of your credit card(s) or other legal action? if you answered: “No” to all questions you are: Managing debt well. Getting out of control. On the verge of trouble. Probably overextended. you should: Continue practicing good money management. Stop using credit cards until current debt balances are paid. Stop using credit. Develop a budget and debt payment plan. Consult a financial planning professional now, before your financial goals become impossible to achieve.
q q q q q q q q q q q q
q q q q q q q q q q q q
“Yes” to any question 1–5 “Yes” to any question 6–11 “Yes” to question 12 or 13
getting out of Debt
If you become overextended, it takes personal effort and discipline to get spending under control. These tips will help you get back on track.
• Pay more than the minimum payment due on your credit card balances. It will help reduce
the length of the loans and interest costs you must pay. Continue until all balances are zero.
• Close all high-interest credit card accounts except the one with the lowest interest rate.
You may want to consolidate credit card balances to your lowest interest rate credit card. Use it for emergencies only.
• Use a debit card instead of a credit card. Because the money is taken directly out of your
checking account, you are spending money you have, not increasing your debt.
• Pay bills on time to avoid costly late fees and high interest charges. • Take advantage of free and low-cost credit advice from sources such as the National
Foundation for Credit Counseling, www.nfcc.org.
• Avoid payday loans.
aVoiD payDay loans
A payday loan may appear to be a short-term solution to a temporary cash-flow problem. In reality, it is a high-interest, high-fee loan which can quickly create long-term debt. Using payday loans often can lead to a pattern of debt and dependence. Payday loans usually range from $100–$1,000 depending on state legal maximums. They are repaid out of your next paycheck (usually within a 2-week period). Problems develop when unforeseen expenses arise and your next paycheck is already spent. Payday loans often carry high interest rates, unaffordable repayment terms and coercive collection tactics. Interest can be as high as $25 on a $100 loan usually for a 2-week period. Penalties for extending loan repayment can be severe. Calculating the actual cost of the payday loan may deter you from taking the loan. You should know the following.
• Some payday lenders take a post-dated check for the loan amount and fee. You must renew the
loan or be prepared to cover the check when it is presented for payment at your bank. If you cannot repay, you may be charged overdraft fees.
• Returned checks can make it difficult to open deposit accounts in the future. • Basing payday loans on personal checks leads some lenders to use coercive collection tactics
if the loan is not paid in full. Some lenders threaten legal action if the borrower fails to cover payday loan checks. In some states, lenders can sue for multiple damages under civil bad check laws. There are alternatives to payday loans.
• Establish and follow a realistic budget. Know your monthly net cash flow and plan expenditures
based on your income.
• Create an emergency fund. Even small deposits can help to avoid borrowing for emergencies,
unexpected expenses or other items.
• Research interest rates on loans offered by your financial institution, which can be more
competitive. Consider overdraft protection for your bank account.
• Seek consumer credit counseling.
your credit report
As you establish credit, you build a credit rating resulting in a record of creditors’ experience with you as a borrower. It is this credit report that future lenders, employers, landlords and other businesses review to make their own decisions about your creditworthiness.
Your credit report is a month-by-month record of your debt payment history with financial institutions or credit card issuers (companies that grant credit). It shows the following.
fiVe facTors DeTermining creDiT scores
• How much credit you are using. • How well you pay your debts. • Who is inquiring about your credit. • Information on bankruptcies or federal income tax liens. order a free credit report
The Annual Credit Report Request Service is a central contact for requesting your free annual credit report. It was created by the three nationwide consumer credit reporting agencies: Equifax, Experian and TransUnion. With a poor credit rating, you could be denied a loan or credit card or incur higher interest rates. You could also be turned down for insurance, an apartment or even a job. Review your credit report at least once each year to ensure it is accurate and that you are not the victim of identity theft.
• Payment history • Amounts owed • Length of credit history • New credit • Types of credit used
To orDer free creDiT reporTs
annual credit report request service (877) 322-8228 www.annualcreditreport.com
your credit score
In addition to your credit report, creditors may also look at your credit score. Your credit score is a three-digit numerical summary of your credit report. Credit scores range from approximately 300 to 850. The higher your score, the better. Most lenders consider scores above 700 a good indicator of low credit risk, while scores below 620 may indicate credit problems. A low score may cause you to be denied credit. With a slightly higher score, you could get credit but at a higher interest rate. If your score is high enough, you may qualify for the best rate on a loan or credit account. No single factor determines your score. But one or more of the factors may affect the final score more than others, depending on the overall information in your credit report. Your score can also change as new information is received by credit reporting agencies. Your score today could be different than the score you have 3 months from now. You may have different credit scores from Equifax, Experian and TransUnion, because some lenders report information only to one or two of these agencies. To understand how lenders evaluate you, review your credit scores from all three credit reporting agencies. You will probably have to pay a fee to obtain your credit score.
your credit rights
Under the Fair Credit Reporting Act and the Fair And Accurate Credit Transactions (FACT) Act of 2003, you have the right to require a credit reporting agency to do several things to ensure that your credit rating is accurate.
• Provide you a complete credit report. Anyone may request a free credit report annually.
You may request a free credit report anytime if you have been denied credit, are a victim of identity theft, receive welfare benefits or are unemployed but expect to apply for employment in the next 60 days.
• Investigate, at your request, erroneous or missing information in your report. The credit
reporting agency must provide you with a written report of the investigation, as well as a revised copy of your credit report if the investigation resulted in changes.
• Keep your credit report information from anyone other than legitimate users of the credit
• Remove detrimental credit information from your file after 7 years. Bankruptcy information
can be removed after 7 to 10 years. When you receive your credit report, you have the responsibility to review it and act on any errors you find.
• Understand the entries on the credit report. Each credit reporting agency’s credit reports
contain information such as how long an account has been tracked, the highest amount charged, the account balance at the time of the report and the type of account. Other entries identify creditors that have viewed your credit history. Codes indicate debtors’ arrangements, repossessions and bad debts, if applicable.
• Ensure the credit report is accurate. Common errors include incorrect personal information, missing information and failing to correct damaging information after the problem is resolved.
• Take action to correct errors. Document your actions and follow up until the problem is
• Inform creditors of errors. The credit reporting agency must investigate the items in
question — usually within 30 days — unless they determine that the dispute clearly lacks merit.
• Retain your written account of errors or discrepancies in your file. If an investigation does
not resolve the dispute to your satisfaction, you have a right to add a statement to your credit report file contesting the accuracy or completeness of the disputed information.
saVing anD inVesTing
Start saving and investing early and regularly to reach major financial goals. The key is to establish and continue a disciplined savings and investment plan. Although the terms are often used interchangeably, saving and investing represent different methods of using money to prepare for the future.
• Saving is accumulating money safely — in a bank savings
account, certificate of deposit (CD) or a money market account — generally for short-term needs such as upcoming expenses or emergencies. Typically, money placed in such accounts earns a lower, fixed rate of return. Your money is protected and can be withdrawn or accessed with relative ease. Although for CDs, penalties may apply for early withdrawal.
saVing enables you To make The mosT of your money by earning inTeresT.
• Investing requires that you take a risk with your money by buying securities, such as
stocks, bonds or mutual funds, with the hope of earning higher, long-term returns. Investments generally do not offer the safety that a savings account does; so your capital is at risk. In return for taking that risk, you have the potential for a more rewarding gain on your investment.
Saving allows you to make the most of your money by earning interest.
• Simple interest is calculated only on the principal balance, generally for a single period
of less than a year, such as 30 or 60 days.
• Compound interest is calculated on the principal, plus all interest previously earned.
Interest can be compounded daily, weekly, monthly, quarterly or annually. The more often interest compounds, the greater your earnings.
when you are comparing saVings anD inVesTmenT opTions, ask These QuesTions. • • • • Does it earn simple or compounD interest? How often is tHe interest compounDeD? wHat is tHe rate of return? wHat is tHe risk?
a small increase in The raTe of reTurn reaps a big increase in your money oVer Time.
pay yourself first
Think of saving as paying yourself a salary. The money you set aside will earn more money if kept in an interest-bearing account. The sooner you begin “earning” by saving, the more you will accumulate over time.
• Automatically transfer a portion of your pay to a savings account as soon as it is deposited.
That way, you will not miss the money.
• Save at least 10 percent to 15 percent of your net income. If you cannot afford this
amount, save as much as you can. The key is to begin saving now.
• Create an emergency fund of 3 to 6 months of basic living expenses — enough to manage
a crisis without borrowing money. • The fund should be low risk and liquid, so the money is available whenever you need it. • An interest-bearing savings or money market account may be ideal.
• Increase savings contributions when you can. For example, when you receive pay and
longevity increases, federal income tax refunds, gift money and rebates, consider putting some or all of this additional money toward your savings goals.
ask Questions before you invest • What is my primary investment goal? To keep my money safe or grow my investment? • What is my risk tolerance? How much money can I risk losing? Risk-tolerance level
depends on several factors. • Age. • Current and anticipated income. • Financial responsibilities. How would possible loss affect my situation?
• Is my goal intermediate or long-term? • Will I need access to my money or can it remain untouched and potentially yield a higher
• What federal income tax issues should I consider when investing?
basic principles of investing
Investing is generally riskier than saving. Take time to understand various investment options and how they work. Those include setting goals, developing strategies, selecting the most appropriate investments, handling risks prudently and finding professionals to help when needed.
focusing your inVesTmenT sTraTegy
Focus your investment strategy on the following time-tested principles of good investing. invest regularly • Invest a set amount of money on a regular basis whether investment markets are moving up or down — a strategy known as dollar cost averaging. When prices are high, your regular contributions buy fewer shares (units of ownership in a company or mutual fund); when they are low, your contributions buy more. This approach tends to spread investment risk over time. Keep in mind that dollar cost averaging does not ensure a profit or protect against loss in a declining market. You should also consider your ability to invest continuously through periods when the market is down. • Give investments plenty of time to potentially grow and compound. Patient investors who focus on long-term goals can generally withstand stock market fluctuations. • Start investing early to give your money time to potentially grow. Do not try “timing” decisions to buy and sell based on the market fluctuations. No one has accurately predicted market fluctuations over the long term. Think and act intellectually. Do not let short-term variables or the latest news guide your investment decisions. Do not allow emotions to influence your financial decisions. Success requires patience and a steady approach. Do your homework; then stay on course. Read business periodicals and annual reports of companies whose securities you might want to purchase. Visit United States Financial Literacy and Education Commission at www.mymoney.gov/saving.shtml for links to more information on saving and investing. Avoid futures, commodities and other excessively risky investing — at least until you thoroughly understand how they work and you are able to accept the risk. Choosing investments by leaping into whatever is currently popular often leads to recurring losses over time. Today’s best performing stock or mutual fund may become one of the worst performers in subsequent years. Avoid keeping all your money in one investment or asset class. Diversify by selecting a variety of securities for your portfolio that do not react to market fluctuations the same way — an approach that can potentially reduce your overall risk. (Your returns and risks should equal the average results of all investments, rather than reflecting the performance of just one.) Evaluate your investment plan at least once each year and every time you experience a major life change, such as college graduation, marriage, birth or adoption of a child or purchase of a home. If necessary, adjust your investments to make sure they match your goals, risk tolerance and time horizon.
invest for The long-Term use Time not Timing keep emotions out of your Decisions increase your knowledge avoid high-risk investments avoid The crowd Diversify
review your plan
when you are reaDy for higher-risk, longTerm inVesTing, consiDer sTocks, bonDs, real esTaTe anD muTual funDs.
When you are ready for higher-risk, long-term investing, consider stocks, bonds, real estate and mutual funds. They provide potentially higher rates of return, with a corresponding amount of risk. Many mutual funds combine investments in stocks, bonds and other securities, providing built-in diversification.
investing in stocks
Companies sell stock to raise capital. When you buy stock, you become a shareholder and own part of the company.
• Your goal is to buy stock, hold it for a time, then sell it for more
than you paid for it.
• Stocks can receive capital gains treatment for federal income
tax purposes, which may be beneficial.
• A registered broker can help you buy and sell individual stocks.
Choose a broker having a securities license, who works as a registered representative of a brokerage or mutual fund company.
• Brokers charge a commission or sales fee for each transaction
reducing your returns.
• Low-commission or discount brokers are less expensive, but you
must be able to make your own purchase and sales decisions.
• Stock can also be bought and sold through an established
online investment account.
investing in bonds
Large organizations such as companies, the federal government and state and local governments need to borrow money occasionally. They often do so by selling bonds.
• By purchasing a bond, you lend money to its issuer. In return, the issuer agrees to pay you
a certain interest rate over a period of 1 to 30 years or longer.
• The issuer also promises to repay your principal on the bond’s maturity date, the day
the bond is due to be paid in full.
• Corporate bonds are only as reliable as the company issuing them. Before you invest,
consider what might happen to the company over the life of the bond.
• Federal bonds are issued by the U.S. government — through the U.S. Treasury. Bonds are
also issued or guaranteed through federal agencies or government sponsored enterprises. These bonds are called Agencies. They tend to be safer than other investments.
• Municipal bonds are issued by state and local governments to help pay for schools, streets,
airports and other public works. Risk and liquidity vary greatly among these bonds, so do your homework when considering them.
investing in real estate
Real estate properties should be considered long-term investments. Consider the following.
• Real estate may be used as a hedge against inflation. Real estate values generally rise with
inflation, but this does not always occur.
• You are liable for property taxes when you own real estate. • Federal income tax deductions may be available for property tax payments, as well as for
interest charges and maintenance expenses.
• Real estate investments can suffer loss if a geographic area experiences a local recession. investing in mutual funds
A mutual fund is an investment company that pools the money of many investors for the purchase of stocks or bonds or other securities. Each fund — which typically may hold 50 to 200 or more stocks, bonds and/or investments — is professionally managed to achieve specific objectives at a chosen level of risk. Following is a list of mutual fund features and some of the advantages and disadvantages of investing in mutual funds.
Investing in various industries and categories of stocks, bonds and money market funds can potentially reduce risk. Generally, you may redeem (sell) your shares any day at their current net asset value.
You can over-diversify. High returns from a few investments may not make much difference in a portfolio’s overall return. Upon selling shares, you may have a gain that is taxable for federal income tax purposes. (A loss of principal may be deductible for federal income tax purposes.) Moving money between funds may result in a taxable gain for federal income tax purposes. (A loss of principal may be deductible for federal income tax purposes.) Automatic investment plans do not ensure a profit or protect against losses in declining markets.
Fund “families” offer various mutual funds with differing financial objectives managed by one company. You can reallocate investments among those funds as your goals change. Most funds allow you to invest automatically with an allotment or automatic withdrawal from a bank account. Generally, you can buy or sell shares by phone, mail or online. Professional managers research and evaluate the investment potential of hundreds of companies. Individual investors usually cannot get this level of advice without a large portfolio. The industry is regulated by the Securities and Exchange Commission (SEC), with requirements designed to ensure investors receive accurate, timely and relevant information.
Investors cannot directly select underlying fund investments and generally cannot control the amount of capital gains triggered by the fund. Mutual funds are not always tax efficient. Fund managers can be limited regarding type and number of investments.
choosing a mutual fund
Carefully read each fund’s prospectus — a legally required description of the fund’s activities, objectives, holdings, managers, performance and fees. Make sure you understand the following.
• fund objectives. Determine which fund’s investment objectives (such as income, growth
or balanced) match your long-term goals and risk tolerance.
• fund performance. Consider a fund’s performance (historic rate of return) over at least
3, 5 and 10 years. A consistent long-term performance may be a better choice than today’s front-runner.
• fund reputation. Research how long the fund has been in business and how it ranks
against other fund companies. Many mutual fund companies have their own Web sites, and it is possible to invest through online brokerage companies. Do not invest based on information learned online without carefully verifying the source.
• fund expenses. Check the fund’s fees and expense ratio, which is the sum of the fund’s
total annual operating expenses, expressed as a percentage of average net assets.
muTual funD expenses
Types of muTual funDs load mutual funds no-load mutual funds Carry a sales charge — a commission — that is paid to the investment firm that sells the fund. Only a portion of the investor’s principal contribution is invested. Do not carry a sales charge and are normally sold directly from the investment company managing the fund. All of the investor’s principal contribution is invested.
operaTing expenses Operating expenses reduce the fund’s overall return. They are not taken from the principal investment, but are deducted from mutual fund assets before earnings are distributed to shareholders. management fees 12b-1 fees other expenses Paid to the fund’s advisor for managing the fund. Pay marketing and distribution expenses. Pay to transfer agents, custodians, accountants, attorneys and others who provide services to the fund.
investing for retirement
Retirement may seem distant, but you should start investing for it nonetheless. Why start now?
• The sooner you begin, the more money you can accumulate. • You cannot foresee how long you will be able to work. Injury, illness or other difficulties
could interrupt your future earning and saving ability.
• You do not know how long retirement will be. With longer life expectancy, you could need
enough savings to last 20 to 30 years or more.
Take time to understand the following popular investment options. You may want to consult a financial planning professional for in-depth guidance about the best choices for your situation.
individual retirement accounts (ira)
These tax-advantaged accounts are not investments in their own right, but rather they “house” investments. An IRA can be opened using investment instruments, such as mutual funds or individual securities with a brokerage firm, bank CDs or a life insurance company annuity. Distributions may be taxable for federal income tax purposes upon withdrawal. A financial planning professional can help determine which IRA is best for you.
Any individual under age 701/2 with earned income is eligible. Qualified individuals under age 50 may contribute a maximum of $5,000 for 2008 and 2009. (After 2008 the contribution limit will be indexed to inflation.)
Any individual with earned income is eligible, regardless of age. Qualified individuals under age 50 may contribute a maximum of $5,000 for 2008 and 2009. (After 2008 the contribution limit will be indexed to inflation.) (Contributions are phased out for individuals with modified adjusted gross income (MAGI) exceeding certain limits.) For married couples filing jointly where only one spouse has earned income, $10,000 for 2008 and 2009 may be split between a spousal Roth IRA and an individual Roth IRA with no more than $5,000 being deposited in either account. Taxpayers age 50 or older by December 31 can make an additional $1,000 contribution. (After 2008 the contribution limit will be indexed to inflation.) Contributions are not deductible for federal income tax purposes.
For married couples filing jointly where only one spouse has earned income, $10,000 for 2008 and 2009 may be split between a spousal IRA and an individual IRA with no more than $5,000 being deposited in either account. Taxpayers age 50 or older by December 31 can make an additional $1,000 contribution. (After 2008 the contribution limit will be indexed to inflation.) Contributions may be deductible from your taxable income for federal income tax purposes depending on how you file your income tax return; whether you or your spouse participate in a retirement plan at work; and the amount of your modified adjusted gross income (MAGI). Even if you cannot deduct an IRA contribution from your income, you may still contribute if you have earned income.
TraDiTional ira (conTinueD)
Generally, money distributed to you from your IRA before age 591/2 is subject to federal income tax and a 10% penalty.
roTh ira (conTinueD)
Contributions may be withdrawn without penalty or federal income tax. Generally, earnings withdrawn before the Roth IRA account has been open at least 5 years or before age 591/2 are subject to federal income tax and a 10% penalty. Withdrawals of earnings can be made without penalty for certain qualified distributions. • Qualified first-time homebuyer expenses (subject to a lifetime limit of $10,000). • In the event of the owner’s death or disability as defined by the Internal Revenue Code. • Special rules apply for withdrawals of money in a Roth IRA that were converted from a traditional IRA. There is no mandatory requirement to withdraw money during the Roth IRA owner’s lifetime.
Withdrawals can be made without penalty for certain qualified distributions. • Qualified first-time homebuyer expenses (subject to a lifetime limit of $10,000). • Qualified education expenses. • Medical insurance if the account owner is unemployed. • In the event of the IRA owner’s death or disability as defined by the Internal Revenue Code. Mandatory withdrawals required at age 701/2.
roTh Vs. TraDiTional ira
A Roth IRA differs from a traditional IRA in three important ways. 1. You cannot deduct your contribution to a Roth IRA from your taxable income for federal income tax purposes. 2. Qualified withdrawals of earnings from a Roth IRA are free from federal income tax. 3. There is no mandatory requirement to withdraw money during the Roth account owner’s lifetime.
To access The irs publicaTion 590, inDiViDual reTiremenT arrangemenTs, VisiT www.irs.goV. Type in The keyworD “590.”
401(k) and 403(b) plans
These employer-sponsored retirement plans allow participants to invest a portion of their salary on a pre-tax basis up to certain limits.
• May be offered by for-profit businesses, such as corporations or limited liability
• Employees may invest a portion of their salary in an employer plan on a pre-tax
(and/or after-tax) basis up to certain limits.
• Some employers match a percentage of the employee’s contribution, such as 50
cents for every $1 contributed up to a set percentage of salary. Generally, participants should invest at least enough to get the employer match.
• Distributions may be made for retirement, death, disability, separation from
employment, reaching age 591/2 and hardship as defined in the plan description.
• Some 401(k) plans permit loans in certain circumstances. • In most cases, you must pay federal income tax and a 10% penalty for withdrawing
funds before age 591/2.
• Some 401(k) plans also have a Roth 401(k) feature that allows employers to
contribute after-tax dollars. Earnings grow potentially tax-free. 403(b) plans
• May be offered by nonprofit organizations and public education institutions. Only
employees of organizations granted 501(c)(3) status by the IRS qualify for 403(b) plans.
• Work similarly to a 401(k) plan. • Are a major retirement planning vehicle for school teachers and hospital workers. • With some exceptions, withdrawals made before age 591/2 are subject to federal
income tax and a 10% additional early distribution penalty.
The Roth 401(k) and the Roth 403(b) are employer-sponsored plans similar to a 401(k) or 403(b); however, the contributions are not deducted from your taxable income (no immediate tax savings). With these plans, the employee essentially pays the tax up front and can take qualified distributions free from federal income tax at retirement. You decide whether you want to be taxed now or taxed later. A number of factors come into play when deciding between the two, such as years until retirement, current tax bracket and tax bracket during retirement.
saving and investing for education
A college education is expensive. You will need to plan strategically to fund an undergraduate or graduate degree for yourself or your child.
• Start early and stay on course. The more money you can save and invest before paying the
first college expense, the less you will need to supplement with other funding options such as scholarships, grants and loans.
• Clarify college goals. Are you saving for a public or private college education? Will you rely
on other funding options? How many years do you have to save?
• Consider financial aid. It comes in the forms of grants, scholarships, low-interest loans and
work-study programs. Even if you do not think you will qualify, complete and submit the appropriate forms. Some colleges grant available aid on a first-come, first-served basis.
• Check on tax benefits. Ask your tax professional about tax incentives designed to help you
offset higher education expenses.
for more informaTion, VisiT www.irs.goV anD Type in The keyworD “p970” To View irs publicaTion 970, Tax benefiTs for eDucaTion.
proTecTing your financial fuTure
Even if you spend wisely, save regularly and invest strategically, you are not managing your finances well if you have not taken appropriate steps to protect your assets, your earning potential, yourself and your family from the possibility of suffering a loss. This protection is called risk management. Effective financial risk management includes obtaining adequate insurance for you, your family and your possessions. It also includes reducing your risk factors by purchasing vehicles with safety and antitheft equipment, taking a defensive driving course and installing smoke detectors and a security system in your home. These actions may also reduce your insurance premiums. An insurance policy is a legal contract between you and an insurance company to provide financial protection against losses described in the policy — up to a certain amount of money. Insurance can cover losses from events such as vehicle accidents, fire, illness, theft or death. You pay a premium to the insurer, and in return, the insurer agrees to reimburse you for a portion of the costs of your losses. The insurer agrees to indemnify (compensate) you for covered loss to your vehicle, property, life, health or whatever a policy might cover. You are liable for any applicable deductibles, co-payments or any damages exceeding the policy limits. Insurance can never repair the emotional damage a loss brings, but it can minimize your financial stress and help you preserve your personal financial resources if the worst happens. Before purchasing insurance, consider the following.
• Carefully assess what you need to protect. • Determine the level of coverage you require. • Compare several companies’ premiums, services and reputation. • Ask friends and coworkers for recommendations. • Consult consumer publications, A.M. Best insurance company reports (available in most
libraries) and your state insurance department.
Types of insurance
auto insurance This is usually the first form of insurance you need. Premiums vary by state. Generally, auto insurance does not cover personal possessions that may be stolen from your vehicle. For that, you need property insurance, either a renters or homeowners policy. Most personal property will be covered by a renters or homeowners policy; however, some property, such as CD players and digital audio players, may be limited. When you have your own apartment or home, you need renters or homeowners insurance to protect your personal possessions if they are stolen or damaged. These policies may also pay damages if you are held legally liable for injury to another person or for damage to their property. This coverage protects your finances from health costs associated with an unexpected accident or major illness. Generally you are covered by your parent or guardian’s policy until age 23. When you become employed, take advantage of employer-sponsored/group employment benefits if they are available to you. Purchase an individual insurance plan if you are between jobs, self-employed or work for an employer who does not provide health insurance. Carefully review the outline of coverage provided by the insurance company, which should describe the plan’s benefits. You need life insurance as soon as a spouse, family member or other individual depends on your income. Even if you are single with no dependents, you should purchase enough life insurance to pay your debts and final expenses. Because premiums increase with age and declining health, you should generally purchase life insurance while you are young and in good health. This form of insurance provides you with income if you are unable to work due to injury or illness. Many employers provide disability coverage, often at little or no cost to employees; however, coverage may be limited and benefits may be taxable. If your employer provides limited coverage, an individual plan can also be purchased to supplement your employer coverage.
The usaa eDucaTional founDaTion publicaTions, Basic insurance coverages, auto insurance, Homeowners insurance, HealtH insurance, life insurance anD estate planning, offer more informaTion. see “resources” on The insiDe back coVer of This publicaTion To orDer free copies.
Note: Insurance descriptions are general in nature. For precise information on coverages, limitations and conditions, contact your insurance company.
measuring your financial progress
Once you know what is involved in managing your finances, you are ready to apply your knowledge and review your progress over time. Periodically review this list to determine how well you are managing your finances. Check all that apply.
❏ ❏ ❏ ❏ ❏ ❏ ❏ ❏ ❏ ❏ ❏ ❏ ❏ ❏ ❏ ❏ ❏ ❏
I know my short-term, intermediate-term and long-term financial goals. I understand my financial resources; I am familiar with my income and the deductions that determine my net income; I have calculated my net worth. I follow a spending plan, or budget, for managing my income and expenses. I target at least 10 percent to 15 percent of my net income for savings/investments each pay period. I have an emergency fund that can pay for 3 to 6 months of basic living expenses. I use credit wisely; I pay my balances in full each month. I limit my open lines of credit. I know my credit score and the information contained within my credit report. I check my credit report at least annually for accuracy. I understand my consumer rights and take steps to ensure my credit rating is accurate. I am investing for retirement. I contribute to my 401(k) or 403(b) at least enough to obtain the entire match offered by my employer. I am familiar with the federal income tax advantages of IRAs and other plans. I am familiar with my options for saving and investing for education. I am familiar with the basic investing implications of stocks, bonds, real estate and mutual funds. I have purchased appropriate auto insurance coverage for my vehicle(s). I have purchased renters insurance to protect my personal property (if you do not own a home). I have insured my home for its complete replacement value (if you own a home). I have appropriate life insurance for my situation. My death will not create a financial burden for my family. I have the appropriate level of health insurance for my situation. I have appropriate disability income insurance.
The USAA Educational Foundation offers the following publications. managing creDiT anD DebT (#501) buying or refinancing a home (#502) basic inVesTing (#503) geT moneywise (#504) buying, selling or leasing a Vehicle (#505) managing your personal recorDs (#506) life insurance (#507) choosing a safer Vehicle (#510) financial planning anD goal seTTing (#511) financing college (#513) muTual funDs (#517) esTaTe planning (#518) iDenTiTy ThefT (#520) auTo insurance (#526) basic insurance coVerages (#530) changing Jobs (#532) renTing a home (#533) geT creDiTwise (#534) long-Term care (#537) healTh insurance (#545) sTocks anD bonDs (#553) homeowners insurance (#558) safe on The roaD (#570) making meDicare choices (#582)
To order a free copy of any of these and other publications, visit www.usaaedfoundation.org or call (800) 531-6196.
USAA is the sponsor of The USAA Educational Foundation. The USAA Educational Foundation www.usaaedfoundation.org is a registered trademark of The USAA Educational Foundation. © The USAA Educational Foundation 2008. All rights reserved. No part of this publication may be copied, reprinted or reproduced without the express written consent of The USAA Educational Foundation, a nonprofit organization. 70523-0508 EDF-2008-745