| How to Prepare for College and Retirement, Part 3 |
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Understand the limitations of investments. Because investing in the stock market is a long-term financial technique, it should be kept in its proper perspective. It's important to understand you can't invest your way out of financial problems such as having inadequate insurance coverage or spending beyond your means. Keep cash equivalents accessible for your immediate needs. The money you need for your immediate living expensesyour "I don't need credit cards" money-should stay in highly stable accounts, such as money market accounts or FDIC-insured bank accounts. Put emergency funds into Certificates of Deposit (CDs). You may wonder whether CDs are liquid enough for emergencies. But with CDs, you'll be less tempted to spend the money, and you may earn a little more interest than with bank accounts. If you do need the money for a true emergency, the amount of the early withdrawal penalty is usually inconsequential in comparison. Put your emergency fund into a "CD ladder" to minimize early withdrawal penalties. Instead of putting, say, $20,000 into one two-year CD, split it up into four CDs of $5,000 each, maturing in six, twelve, eighteen, and twenty-four months. As each CD matures, re-deposit it into a new two-year CD. Then make sure all four CDs are set up to automatically roll over at maturity for another two years. Now you'll have $20,000 (plus interest) growing for you at two-year rates, with $5,000 available every six months. And if you do need to withdraw money for a $5,000 emergency, you'll pay an early withdrawal penalty on only one quarter of your emergency fund. Don't exceed your own tolerance for risk when investing. With investments, there's no chance of reward without at least an equal risk. If you would be heartbroken to ever lose any of your money, stick to FDIC-insured bank accounts. Better still, educate yourself about investment risks so you can take appropriate amounts of risk wisely. |
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