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Supplement to “Kentucky Living’s 2012 Financial Planning Guide”


Assess your risk tolerance

SMART purchasing goals

LifeSmarts challenge game for teens

Financial Primer: Learn before you leap

Alphabet soup of investment terms

Types of investments

Helpful financial Web site

101 Investing: Top 10 Webs sites from AIE

Kentucky Living 2012 Financial Planning Guide

Assess your risk tolerance

Regardless of your age or income or financial goals, one of the foundational steps in making a financial plan is to determine your risk tolerance—the degree of risk (the probability of loss) you are comfortable with. There are numerous quizzes on the Internet that measure your risk tolerance. Remember, there are no right and wrong answers, so don’t answer what you think “should” be right. The more honest you are, the more accurate the assessment. Here are a couple of the best sites:

Bankrate
www.bankrate.com/brm/news/investing/20011127a.asp
This site asks, “What’s your money personality?” and offers a quiz to find out. “This is one of the best measures in seeing who you are as an investor,” the site asserts.

Rutgers New Jersey Agricultural Experiment Station
www.njaes.rutgers.edu/money/riskquiz/
This quiz was developed by two university personal finance professors, Dr. Ruth Lytton at Virginia Tech and Dr. John Grable at Kansas State University. They are conducting a study on measuring financial risk. By taking this quiz, you’ll discover your risk tolerance and also contribute to an academic study. The professors are not requesting any personal information.

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SMART purchasing goals

Every financial decision you make affects your overall financial health just as every food choice you make impacts your overall health. Use the SMART system to determine if a purchase is right for you.

Set goals for your money that are:
Specific
Measurable
Attainable
Realistic
Time-bound (that is, they have a deadline)

Ask yourself:
• Is this purchase a need or a want?
• Where would I rank this purchase on my list?
• Am I buying for an emergency, a real need, or for an impulse?
• Can I afford to buy this, or would I have to borrow money for it?
• Will this purchase interfere with my personal goals?

Source: National Endowment for Financial Education

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LifeSmarts: Challenge game for teens

Waiting until you are an adult to learn to make wise financial decisions makes about as much sense as waiting until you’re an adult to learn to read. Sadly, many schools offer little in the way of financial education. Enter LifeSmarts.

Developed by the National Consumers League, LifeSmarts is a group activity that helps 6-12th-grade students develop consumer knowledge and skills by focusing on five areas: personal finance, consumer rights and responsibilities, health and safety, technology, and the environment.

Kentucky students tend to do well in the competitions. Led by teacher Maggie Prater, the LifeSmarts team from Mason County High School, which is served by Fleming-Mason Energy Cooperative, went to the national competition the past two years and came in second the year before—especially impressive since they have only participated in the program for three years. Bracken County has been to Washington, D.C., San Francisco, Chicago, and other places for these competitions as well.

Preparation begins when students pick a focus area, Prater says. They gather materials and resources on the subject and take the online practice tests and quizzes provided by LifeSmarts. Guest speakers round out the education. The teams participate in an online competition, and the top 10-12 teams go to the state competition in Frankfort. The top team at the state level goes on to nationals.

“The students get acknowledgement for knowledge that isn’t celebrated traditionally,” says Prater. “They learn how to solve problems and about real-world encounters.”

To participate, young people need a coach. However, the coach can be a parent or other adult who is willing to make sure the team completes all online rounds of competition. A team is made up of four members plus an alternate.

To find out more, go online to www.lifesmarts.org or contact Lori Farris, Kentucky state coordinator for LifeSmarts and also a mediation branch manager with the Kentucky Office of the Attorney General’s Consumer Protection Division, at (502) 696-5394 or e-mail her at lori.farris@ag.ky.gov.

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Financial Primer: Learn before you leap

Financial talk can seem like a foreign language, but it’s a language you need to speak fluently. Dr. Robert Flashman is a state specialist in Family Resource Management with the University of Kentucky Cooperative Extension Service. He is also state coordinator for the High School Financial Planning Program (HSFPP) in Kentucky, for which he develops weekly financial lessons distributed to more than 360 educators.

Here are some of the financial terms and concepts Flashman believes everyone should know and understand, excerpted from the HSFPP guide.

Economic cycle
The stock market goes up and down. It’s important to know which cycle the U.S. and world economies are in so you know how to appropriately invest if we are in a bull market (growing economy) or a bear market (shrinking economy).

Those who invest in American companies can look at the Federal Reserve Board to tell which cycle we are in. When the Federal Reserve is raising the discount rate, it usually means the economy is growing and the Fed is concerned about inflation. If the economy is slowing down, the Federal Reserve Board may cut the discount rate to keep the economy from going into a recession.

The majority of profits come when the economy is growing, and most losses come when the economy is slowing down. When the economy is slowing down, you can reduce risk by moving some investment funds from stocks to saver investments such as certificates of deposit (CDs) or government securities.

In a typical recession you can lose 40 percent of the value of your stock portfolio before there is a reversal.

Rule of 72
This rule states that if you divide 72 by the interest rate, it will tell you how long it takes for your money to double. For example, assume you earn a 6 percent rate of return on your money. The calculation: 72 divided by 6 = 12 years for your initial investment to double. At 9 percent your money would double in eight years.

This rule can be particularly beneficial to younger people. Say an 18-year-old has $5,000. If the teenager puts $5,000 into an investment that earns 7.2 percent interest instead of buying a used vehicle for the same amount, the $5,000 will be worth $ 10,000 at age 28, $20,000 at age 38, $40,000 at age 48, $80,000 at age 58, and $160,000 at age 68. The last compounding obviously makes the most difference. That’s why starting early is such an advantage.

Diversification
If you have ever heard someone tell you not to “put all your eggs in one basket,” they were telling you to diversify. Diversification is reducing investment risk by putting money in several different types of investments. A diverse mutual fund composed of stocks from large, mid-size, and small companies as well as bonds is an example of an investment that uses diversification.

Investing in different types of investments—stocks, bonds, real estate, and certificates of deposit and having savings accounts—is another way to diversify.

Saving vs. investing
Saving is what people usually do to meet short-term goals. Your money is safe and easy to get to when needed but earns little interest over time.

Investing means setting money aside for longer-term goals in a venture that offers the possibility of growing in value as interest, income, or increased value. There’s no guarantee that the money you invest will grow. In fact, it’s normal for investments to rise and fall in value over time. However, in the long run, investments typically earn more than money placed in a safer investment such as a savings account at an insured United States financial institution.

Dollar cost averaging
This is the practice of investing a fixed amount in the same investment at regular intervals, regardless of what the market is doing. This eliminates the worry about investing at the “right” or “wrong” time because as the price of the investment rises, you end up purchasing fewer shares, and when the price falls, you end up purchasing more.

Rate of return
The percentage of gain or loss on an investment over a period of time.

Capital gain
The difference between the purchase price and the selling price when an investor buys a stock and sells it later at a higher price.

Capital loss
The difference between the purchase price and the selling price when an investor buys a stock and sells it later at a lower price.

Time value of money
The idea that money today is worth more than the same amount of money in the future due to its potential earning capacity.

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Alphabet soup of investment terms

Here are some other acronyms for financial products you are likely to encounter. The definitions come from www.investopedia.com. Like a 401(k), these are specific products within a broader category.

ETF–exchange traded funds. A security that tracks an index, a commodity, or a basket of assets like an index fund, but trades like a stock on an exchange. ETFs experience price changes throughout the day as they are bought and sold.

IRA–individual retirement account. There are several types of IRAs: traditional IRAs, Roth IRAs, SIMPLE IRAs, and SEP IRAs.

Roth and traditional IRAs–established by individual taxpayers, who are allowed to contribute 100 percent of compensation (self-employment income for sole proprietors and partners) up to a set maximum dollar amount. Contributions to the traditional IRA may be tax-deductible depending on the taxpayer’s income, tax filing status, and coverage by an employer-sponsored retirement plan. Roth IRA contributions are not tax-deductible.

SEPs (Simplified Employee Pension) and SIMPLES (Savings Incentives Match Plans for Employees of Small Employers)–retirement plans established by employers or self-employed persons. Individual participant contributions are made to SEP IRAs and SIMPLE IRAs. Also referred to as “individual retirement arrangements.”

403(b)–A retirement plan for certain employees of public schools, tax-exempt organizations, and certain ministers. Generally, retirement income accounts can invest in either annuities or mutual funds. Also known as a “tax-sheltered annuity (TSA) plan.”

A few nonproduct related terms you may also encounter:
IPO–initial public offering. The first sale of stock by a private company to the public. IPOs are often issued by smaller, younger companies seeking the capital to expand, but can also be offered by large, privately owned companies looking to become publicly traded.

ROI–return on investment. Performance measure used to evaluate the efficiency of an investment or to compare the efficiency of a number of different investments. To calculate ROI, the benefit (return) of an investment is divided by the cost of the investment; the result is expressed as a percentage or a ratio.

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Types of investments

INCOME INVESTMENTS

Savings accounts–Often the first banking product people use, savings accounts earn a small amount of interest. Because the federal government guarantees the safety of these accounts, they are considered to be very low risk. Therefore, they tend to pay low interest rates, but you can also take your money out at any time without penalty, so a savings account is a very liquid asset, meaning that it can be easily converted into cash.

U.S. savings bonds–The federal government pays interest to investors for loaning it money just like banks and credit unions do, but bonds are different from savings accounts. A bond is a formal agreement where the borrower, in this case the federal government, can use your money for a set period of time and you as the lender get paid a specific amount of interest and return. In this case, you are agreeing to loan the government your money for at least a year, but savings bonds are designed to be held for up to 30 years, so if you cash a bond in within five years of purchase, you’ll pay a penalty, usually three months of lost interest. On the other hand, these bonds typically pay higher rates of interest than savings accounts. You can buy government-issued U.S. savings bonds from almost any financial institution or directly from the government. There are two main types: You can buy a paper series E savings bond for half of the face value. The minimum is $25 for a $50 savings bond. It is guaranteed to accrue enough interest to reach face value in 20 years. You can also buy online EE or Series I bonds at their face value and earn a fixed rate of interest.

Certificates of deposit–Banks and credit unions have their own versions of savings bonds, called certificates of deposit (CD). When you buy a CD from one of these financial institutions, again you are essentially loaning it money for a set period of time such as three months, six months, one year, two years, and so forth, and getting interest in return. The longer the term, the higher the rate of interest paid. CDs usually pay a slightly higher rate of interest than savings bonds, but like savings bonds you will lose a few months of interest if you cash them in early.

Money market deposit accounts–Banks and credit unions also offer money market deposit accounts (MMDA). These work like checking accounts so you can take your money out whenever you want, usually without any penalty. However, the bank or credit union may limit the number of checks you can write a month. MMDAs pay a higher rate of interest than savings accounts although usually lower than CDs, and are insured by the federal government. However, they usually require a higher minimum balance than savings accounts for the first deposit.

Money market mutual funds–You should know there is a similar option to MMDAs called money market mutual funds (MMMF). Often offered by mutual fund companies, “a type of investment company that invests shareholders’ money in a diversified group of securities of other companies” and brokerage firms, a MMMF is designed to be a stable way to save your money and earn potential income. While there is no guarantee with money market mutual funds and they are not insured or guaranteed by the U.S. government, they are generally considered to be pretty safe investments. MMMFs tend to earn higher interest rates than MMDAs.

Corporate and government bonds–Among all the income investments, these bonds typically pay the highest interest rates. A bond’s potential return is usually referred to as its yield. U.S. government bonds, also known as treasury bonds, tend to be safer than corporate bonds because they are backed by the “full faith and credit” by the U.S. government. Corporate bonds usually offer higher interest rates. The time period for both types of bonds can range from two-30 years. In general, the longer the time period, the higher the interest rate the bond earns. With the exception of savings bonds, few bonds are sold for less than $1,000 and you may be required to buy more than one. This can make it an expensive investment for individual investors. The cheapest way to buy U.S. treasury bonds is directly from the government. Investment brokers sell corporate bonds, and usually charge a fee for the transaction.

GROWTH INVESTMENTS

Stocks–Having stock in a company means that you own part of that company. A company usually begins issuing shares of stock to make money for reasons such as buying new equipment or hiring more employees. Investors who buy stock are called shareholders. They actually own shares of or equity in the company. Stocks are usually riskier investments than income investments because you can potentially lose more money, but over longer periods of time, stocks tend to make more money than income investments. And while there are no guarantees you will make money, stocks are generally liquid. You can usually sell stocks back at any time.

It’s still a secret to many, but more than 300 of America’s biggest companies sell stock directly to investors, which is definitely the cheapest way to invest in stock. Sometimes you need to own at least one share of stock to buy more directly from a company. Of course, you can also buy stocks through a low-cost online brokerage or mutual fund company. The most expensive option is investing through a financial advisor, but the advantage is that he or she can also help choose the right stocks for you.

Real estate–Real estate investors buy properties such as land or buildings hoping to generate a profit. If you own your home, you own real estate, but there are many other kinds of real estate investments, such as malls, apartment complexes, undeveloped land, commercial buildings, and farmland. Real estate is considered less liquid than stocks because it is more complicated to sell. You usually have to put the property on the market, wait for a buyer, negotiate a price, and then sign a contract.

Collectibles–Collectibles are items that are relatively rare in number. Paintings, sculptures, and other works of arts are all collectibles. So are baseball trading cards and antiques. Just as with stocks or real estate, collectors buy items they hope will increase in value over time. Investors in collectibles don’t make a profit or loss until they sell their items. Because there is a much smaller market for collectibles, investors view them as very high risk.

Mutual funds–Many investors like the affordability and convenience of owning mutual funds instead of individual stocks and bonds. A mutual fund takes money from many investors and uses it to make growth or income investments based on a stated investment objective.

Some funds are designed to produce income by investing in bonds, CDs, and other income-producing investments. Others, designed to produce growth, invest in stocks or real estate.

Mutual funds have several key benefits. First, they offer investors an affordable way to own shares of many stocks, which is less risky than owning just a few shares in one company. If one stock does poorly, you won’t lose as much money as you would if that was the only stock you owned. Second, they are professionally managed by an investment expert (also known as a portfolio manager). The portfolio manager makes all buying and selling decisions for the fund more affordably than you would likely get on your own, And third, with more than 6,000 mutual funds to choose from, you can probably indulge any interest you have in a particular type of company or investment style.

Reprinted with permission from the National Endowment for Financial Education

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Helpful financial Web sites

INVESTING

www.morningstar.com
A trusted, independent ratings organization that evaluates financial products.

www.aaii.com
Good site from the American Association of Individual Investors for those who have some knowledge about investing. Includes asset allocation models, surveys, investor updates, and articles on a broad range of investing topics.

www.investoreducation.org

Set up like a book clearinghouse, this site from the Alliance for Investor Education contains resources directed to virtually every investor demographic, as well as articles such as age-specific financial education for kids.

www.saveandinvest.org
Put together by the Financial Industry Regulatory Authority (FIRNA), this site offers “free, unbiased financial information for military families and older investors (55 up).” Of particular interest in the section for older investors is information about the tactics fraudsters use, and ways to keep from being a target.

www.401k.org
From the Profit Sharing 401K Council of America, this site is a public service to help individuals learn about saving and investing for retirement.

RETIREMENT

www.choosetosave.org
Developed by the Employee Benefit Research Institute (EBRI) and its American Savings Education Council (ASEC) program, this site includes sections on how to prepare for retirement, manage debts, effectively budget, talk to kids about money, and avoiding the “sub-primate” (not losing your home if you have a subprime mortgage).

www.myretirementpaycheck.org
The National Endowment for Financial Education addresses eight areas in its Web site: work, Social Security, home and mortgage, insurance, retirement plans, savings and investment, debt, and fraud.

www.psca.org
This site, from the Profit Sharing and 401(k) Advocate, is geared more to the advanced investor and those interested in news and government action regarding investments.

www.ssa.gov
The official Web site of the U.S. Social Security Administration is a good place to start with questions about Social Security and Medicare, as well as the place to go online to apply for disability, retirement benefits, etc.

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101 Investing: Top 10 Web sites from AIE

Alliance for Investor Education (AIE) is the organization of the United States’ leading financial-related foundations, nonprofit organizations, associations, and governmental agencies.

Are you a recent college graduate looking to start an investment portfolio and want to learn more but don’t know where to start? Have you been saving for a few years and built up a good cushion and now want to start investing? Are you nearing retirement age and want to make sure you have everything in place for your golden years?

Alliance for Investor Education President Sue Duncan, who also serves as vice president of the ICI Education Foundation (ICIEF) at the Investment Company Institute, says: “The start of a new year is a great time for people to get serious about investing. The Alliance for Investor Education wants to make sure all Americans educate themselves about the various types of investment vehicles and evaluate their risk tolerance before deciding how and where to invest. Investors who have dabbled in the market and want to learn more can also use the resources we’re highlighting to expand on their knowledge. Education and due diligence are the best way for investors to ensure their investments will work for them.”

The new “Investing 101: Getting Started” section of the AIE Web site features the following 10 top resources for consumers:

1. Smart Investing www.finra.org/Investors/SmartInvesting/index.htm, Financial Industry Regulatory Authority/FINRA Foundation.

2. Where Do I Begin? www.cfainstitute.org/about/investor/Pages/index.aspx, CFA Institute.

3. Take the First Step: Invest Money to Reach Your Goals www.smartaboutmoney.org, National Endowment for Financial Education.

4. Investing Basics www.investor.gov/investing-basics, U.S. Securities and Exchange Commission.

5. Introduction to Capital Markets www.888options.com, Options Industry Council.

6. How Do I Get Started in Investing? www.aaii.com/investing/article/investing-basics-faqs#1, American Association of Individual Investors.

7. Investment Planning: The Basics www.360financialliteracy.org/Topics/Investor-Education/Investing-Basics, 360 Degrees of Financial Literacy/American Institute of Certified Public Accountant.

8. The Basics of Saving and Investing www.investorprotection.org/teach/?fa=basics, Investor Protection Trust.

9. Opportunity and Risk: An Educational Guide to Trading Futures and Options on Futures www.nfa.futures.org/nfa-investor-information/publication-library/opportunity-and-risk-entire.pdf, National Futures Association.

10. Gen i Revolution www.councilforeconed.org/ea/program.php?pid=43, Council for Economic Education.

For an overview of the rest of the best investor education resources on the Web from AIE members, go to www.investoreducation.org.

ABOUT AIE
Founded in 1996, the Alliance for Investor Education Web site at www.InvestorEducation.org provides investors with access to a full range of information they need to make wise investment decisions. The 21-member Alliance for Investor Education is dedicated to facilitating greater understanding of investing, investments, and the financial markets among current and prospective investors of all ages. AIE pursues initiatives for education and joins with others to motivate Americans to obtain objective information and increase their knowledge and understanding of investing.

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Kentucky Living 2012 Financial Planning Guide


To read the January 2012 feature that goes along with this supplement, go to Kentucky Living 2012 Financial Planning Guide.

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