Frequently Asked Questions

• What is the difference between saving and investing?
• How do I understand risks, rewards and investment planning?
• What is diversification?
• How do taxes affect my rate of return?
• What is asset allocation?
• What are a bull and bear markets?

What is the difference between saving and investing?

Saving generally refers to putting money in an interest- bearing account such as a savings account, checking account, or certificate of deposit administered by a bank and insured against failure of the banking institution by the Federal Deposit Insurance Corp. (FDIC) up to the maximum allowed by law.

Investing, unlike saving, can entail significant risk. When you invest, you risk the potential loss of some or all of your money. Investors hope to generate higher returns on invested dollars than on savings account deposits because they are taking a greater risk with their investment money. This is the concept behind the tradeoff between risk and potential reward. Higher risk investments have greater potential to pay higher returns, but they are also more likely to result in losses.

How do I understand risks, rewards and investment planning?

Investing is about taking calculated risks in return for potential financial rewards, such as being able to afford a secure retirement or sending your children to college.

On average, investments such as stocks, bonds, and mutual funds have historically (past performance is no guarantee of future results) delivered higher returns over time than interest paid on regular savings accounts. But the risks of investing compared to a savings account are greater: there is no guarantee of higher returns, and it's possible to lose your principal (for example, the amount you originally invested). Yet even in a savings account, money is vulnerable to the risk of inflation. As a result, investment professionals generally suggest that diversifying your investments based on your goals and needs should be considered. But investment planning is a lot more than just dividing your money across different types of investments.

The key aspects of most investment plans, whether they're done on your own or with the guidance of an investment professional, include:

1. Outlining short- and long-term life goals, and translating those goals into financial objectives (for example, how much money you'll need to meet your objectives)
2. Understanding the ways you incur debt and putting a plan in place for reducing debt if necessary
3. Determining tolerance for assuming risk and establishing the time frame you have to pursue your goals
4. Designing an investment plan with a mix diverse of investments (asset allocation) that can help your plan succeed. One key to successful investment planning is developing a plan that guides your investment decisions over time and helps keep pace with changes in your life.

What is diversification?

Diversification is the spreading of risk by putting assets in several categories of investments - stocks, bonds, money market instruments, and a mutual fund, with its broad range of stocks in one portfolio. Basically, diversification means "Don't put all your eggs in one basket." If you have a well-balanced portfolio, you should be protected against various market swings.

How do taxes affect my rate of return?

Depending on your tax bracket, a lower-yielding tax-exempt investment at 5% may make more financial sense than a higher-yield taxable one that pays 6%. It pays to do the math. While it might seem logical that an investment that yields 6% is better than one yielding 5%, this is not always the case. Your tax bracket can affect your rate of return.

Use the chart below to make simple comparisons. For example, in a 36% tax bracket, a 6% tax-exempt bond is equal to a 9.38% taxable investment.

What is asset allocation?

Asset allocation is one way for people to measure and control some of the risks and rewards they are taking and is an integral part of any investment plan. Asset allocation literally means allocating or dividing your investment dollars across an array of assets (for instance, stocks, bonds, mutual funds, cash equivalent securities) in order to diversify your portfolio and lessen the overall risk of your investments. For example, placing some of your money in higher risk securities and some in lower risk securities can help lead to a more balanced risk level in the portfolio. The overall level of risk you choose is based primarily on your tolerance to assume risk in exchange for potential rewards.

What are bull and bear markets?

• Bull market. A bull market is typically defined as an increase of forty percent (40%) in the Dow Jones Industrial Average or the S&P 500. Ups, downs, and losses can still occur in a bull market.

  Bull market gains are generally tied to economic prosperity. Investors enjoy positive investment gains for an extended period of time. Although the general trend is positive, prices may fluctuate daily during a bull market.

  Factors that could lead to a bull market:

  • Low interest rates
  • Low inflation
  • Strong corporate earnings
  • Low budget deficit
  • Political stability or lack of international conflicts
  • Low unemployment
  • Moderate economic growth

• Bear market. Bear markets are based on the changes of a stock index such as the Dow Jones Industrial Average or the S&P 500 - with a decline of fifteen percent (15%) or more over an extended period of time. Prices will fluctuate during a bear market, with gains realized from time to time. A bear market may last a few months or a few years.

  Factors that could lead to a bear market:

  • Rising interest rates
  • Increasing rate of inflation
  • Lower-than-expected corporate earnings
  • Political instability or international conflict
  • High unemployment
  • A major unexpected event, such as war or earthquake

  Some causes of past bear markets:

  • Iraq's invasion of Kuwait in 1990 caused an escalation in oil prices. Additional fears of inflation and a rise in interest rates sent stock prices falling.
  • Economic and political uncertainty related to the Arab embargo, Watergate and the Vietnam War prompted the stock market's decline in 1973-74.