Archive

When you get your paycheck, why should you invest it at all? Why not just leave it in your savings account?

The major problem is interest rates. Normal banks give horrible interest rates in the neighborhood of well under .5%. With inflation at over 3% annually, your savings account is actually losing you 2.5% of your money each year! Of course, no one wants to lose money.

Lending Club helps you put that money to use by letting you lend the money you aren't using to someone else. People who need loans can grab money from you and will pay you back at a higher interest rate. The interest rates you can get range from 7% to just under 12%. For the money you have that's just sitting around, wouldn't you rather make a profit than a loss?

A simple compound interest calculator can easily demonstrate the differences. Investing $1,000 for 4 years at .5% will make you $20 in 4 years. That's almost nothing! But what if you invest at 7%? You'll make $310.80. That's over 15 times the gains from your savings account! Leaving your liquid money in a savings account is almost the same as just stuffing your money under your mattress.

Regardless of how you choose to invest, you can be strongly assured that lending your money to borrowers on Lending Club will net you much more money than your savings account. Don't waste the opportunity: invest.

It’s never too early to start thinking about retirement. When you’re making your plan, it’s important to understand the difference between a defined contribution plan and a defined benefit plan.

The Defined Benefit Plan:
The defined benefit plan that people are the most familiar with is a pension plan. The way it works is that you get credit for the number years that you contribute to the plan. Contributions are generally small and based on a percentage of your salary. Your company, or an outside firm that they hire, will invest the contributions to ensure that they will be able to cover the benefits that need to be paid out down the road.

When you retire, the amount that you receive will generally be based on your current salary and the number of credits that you have. The actual formulas can get quite complicated, but years of service and final pay tend to be the most heavily weighted components. This type of plan is called a defined benefit plan because the amount of the payout is based on a predetermined formula. If two people both participated in the plan for the same amount of time and had the same final salary, then the benefit that they would be entitled to would generally be the same.

The Defined Contribution Plan:
The most common example of a defined benefit plan is a 401K. In this case, you contribute a set percentage of your paycheck into a tax-deferred account each pay period. You then select from a variety of investment options to determine how your money will be invested. When you retire, the amount that you receive will be based on the value of the accumulated assets in your account. This type of plan is called a defined contribution plan because the amount that you put in is known, but the amount that comes out is not.

Why You Should Care:
Many companies today are transitioning away from defined benefits plans. As the number of workers contributing to defined benefits plans decreases relative to the number of former employees receiving benefits, the cost of the plans becomes more and more expensive for employers. What’s more, the company must carry the liability of ensuring that a defined benefits plan will meet its performance requirements.

More and more workers are starting to find that a defined contribution plan is their only company sponsored retirement plan option. Unlike a defined benefits plan, where you would just need to make your contributions to receive your benefits upon retirement, defined contribution plans require continual action on your part to grow as efficiently as possible. If you make poor investment choices, or allow your account to under-perform, it will be your standard of living in retirement that will suffer.

Regardless of which plan you have in place, we here at Lending Club always recommend a diversified approach to saving money. Put some portion of your savings into different types of accounts to help ensure a good outcome for yourself.

The crossover point is a very interesting concept mentioned by Trent over at thesimpledollar.com. I mentioned it earlier in my article on the importance of wealth. I wanted to share with you some resources that will help you calculate your own crossover point.

I built a calculator to calculate this point---it's got a bit of an ugly interface, but it does work. You can type in your current income, your expected annual raise (a 10 percent raise should be entered as .10), the percent you invest of your income each year (again, in decimal form), the expected annual interest rate, and the number of years you plan to invest.

For example, imagine that you are currently making $60,000 and expect a 4% raise each year with 8% annual gains on your investments. If you invest 15% of your paycheck every year, in 36 years your investments will gross about $5,000 more than your income (As soon as the final box switches from negative to positive, you have reached your crossover point).

If you have a Google Docs & Spreadsheets account, you can also see a spreadsheet which calculates the same thing. I didn't write this one (it was written by Owen, who posted it at The Simple Dollar) but it is very interesting. Try it out---you'll need to copy it to your Google account or export it to Excel, but you might find some interesting results.

Reaching the crossover point is a very worthy goal. Once you reach it, you no longer need to work to maintain your standard of living--that means more free time to do whatever you want to do, and more money to lend on Lending Club! And if your idea of free time is the same as mine, you might be making a lot more money after your crossover point has been reached than before it.

I have always considered the tradeoff between risk and reward to be the most fundamental principle in savings and investment. Knowing how much risk you can handle, your risk tolerance, will help you to set realistic goals for your financial achievements. In fact, your desires for your finances may dictate the level of risk you are willing to take.

One of the key components of risk tolerance is time. As a general rule, the more time you have before you want to reap your reward, the more risk you can take on. Risk tolerance is generally discussed with regard to retirement planning, but a more intermediate goal may be appropriate. For example, you may be planning to send a child to college a few years from now, and that could set your window of time for planning purposes.

The reason that people can generally take on more risk with more time is that if things don’t go according to plan, they will have time to make adjustments to their plan in the hopes of still reaching their goal. People also take on risk to absorb volatility in the performance of instruments in their overall investment portfolio.

A second factor in determining your risk tolerance is your personality. If taking on more risk will cause you considerable stress and anxiety, then that alone may cause you to shy away from the greater returns that may accompany the risk. If you are constantly watching and worrying about the path you’re on, then you may find yourself considering deviating from your plan at the first sign of trouble.

While you should always stay on top of your plan so that you can intervene if necessary, you also need to give any plan of action time to succeed as well. Changing your plan frequently, particularly if you only do so because of a temporary setback, may make reaching your goals even more difficult.

There are many calculators available to help you gauge your risk tolerance. Most are geared towards retirement or stock allocations, but I like the one on MSN Money. While its results do tend to include investment guidance as well, it also provides insight into your mindset towards risk.

Whether you choose to use an online calculator, or just ask yourself questions to gauge your risk tolerance, this is an important exercise. You may find renewed happiness in your financial plans by finding your optimal level of risk while staying on course to meet your goals as quickly as possible.

If you don't know the answer by now, don't forget this. The answer is “none of them.” If there were a simple get rich quick scheme, everyone would be rich by now. Unless you have some super-sized inheritance coming (and you're willing to help "expedite" its arrival), there is no surefire way to get rich quickly.

Getting rich and amassing wealth is similar to losing weight: everyone knows how to do it, but most people aren't willing to put in the required effort. To lose weight, you need to exercise more and eat less. To get rich, you need to save money and invest it safely. Simple and easy.

As I wrote in my article about the rule of 72, your money will quickly grow as soon as you begin investing in decent funds. Index funds are a great way to get started, as are stocks. Putting your money in a retirement account will help minimize the taxes you pay as well. Read up on some of this here.

Practice makes perfect, so by investing your money every month, it will very quickly become a habit. And it will be strengthened when you see how quickly you are amassing wealth!

Take the first step. Open up an IRA and buy some index funds. Or, open up a Lending Club account and lend some money. You'll be surprised how little time it takes to become financially savvy.