On the roller coaster of the current market, it can be tough to find investments that are both safe and lucrative. You want the money you deposit to be secure, but to achieve a comfortable retirement, that cash also needs to have the opportunity to work a little and generate some interest. One of the easiest ways to avoid the pitfalls is to know what you're investing in the first place. Sounds like a no-brainer, but as more and more individual investors become involved in the market, we're finding that many are confused about their options.
In fact, AARP Financial released research this month that really puts a finger on this problem. They surveyed more than 1,200 adults and found that more than half said they've made a mistake because they "felt confused by" or "didn't understand" an investment. Seventy-three percent said that financial-service professionals use more jargon than car mechanics, making the problem even worse. The latest fallout of this confusion is, of course, auction rate securities. Investors were told that they were as liquid, not to mention as safe, as cash, but with a better rate of return, a dream come true for sure. The problem? The market dried up, auctions began to fail, and if you invested here, your money may be tied up for longer than you'd planned. "Brokers didn't understand what they were selling, let alone did people understand what they were buying," says Gary Schatsky, a financial planner in New York. "Now, firms are focusing on how to make auction rate securities more of a product that the public wants, but they are far from a product that I'd be stepping into right now." So how do you sort the good from the bad, while still maximizing your return?
Do your research
Don't make any moves solely because a financial adviser, friend or even a columnist tells you to. Listen to outside advice, sure, but then do some digging on your own so you can base decisions on a well-rounded education. Web sites like bankrate.com allow you to compare interest rates on money market accounts, and imoneynet.com is a good resource for comparing money market funds.
If you need to learn the basics of investing, hit a couple of the personal finance magazines' Web sites (Money and SmartMoney are two that I'd recommend) and read up. And if it all seems too confusing, invest in an hour or two with a financial planner. The Garrett Planning Network is a group of fee-only planners who charge by the hour, and organizations like the National Association of Financial Planners (NAPFA) and the Financial Planning Association (FPA) can also hook you up with a fee-based planner in your area.
Evaluate your needs
Start by weighing the short term against the long term. Short-term investments, like one-year CDs, are for the money you'll need in the next couple of years, maybe to foot your teenager's college tuition or go on a vacation. Cash like this doesn't belong in the market because if you see a loss, you may not have time to bounce back.
Also consider whether you need the funds to be liquid, as in the case of an emergency cushion, or if you can tie up the money for a set period of time and rest assured that you won't need to make an early withdrawal and thus incur penalties.
Look for hidden risks
You've heard what they say: No risk, no reward. But the key is to take appropriate risks, which becomes a bit of a balancing act. For starters, if you put your money in a place that's so safe it can't harvest a return (think some CDs, savings accounts and money markets), it may not be able to keep pace with inflation and taxes. If you err on the other side, you may end up with a big loss on your hands. And so maybe you have some money stashed in a high-interest savings account as an emergency cushion, and the rest invested in a mix of stocks and bonds. That mix should adjust, of course, as you age, so when you start to near retirement you're playing it a little safe with a greater emphasis on the bond portion of your portfolio.
Understand your investments
Part of that involves weighing the risks of each option, but it also means knowing any fees in advance. Whether you're investing in money markets, CDs, securities, stocks or bonds, make sure you understand the cost to get in and the cost to get out.
Brokered CDs, which are sold not through a bank but by brokerage houses, are a classic example of this: Someone calls you up and tells you that they can get you an FDIC-insured CD with a higher yield (sometimes upward of 5 percent) and it sounds like a great deal. What's the catch? "These instruments tend to be much longer term in nature. Some are 10 or 20 years long, and you don't want to lock yourself into that time frame," explains Greg McBride, a senior financial analyst with Bankrate.com. If you need to withdraw your money before it reaches maturity, you'll not only pay a penalty, you could also lose principal.
Bottom line: Be wary of any investment that you don't understand. Peter Lynch said it first, and he may have said it best: If you don't get it, you shouldn't own it. No matter who is trying to sell it to you, if you just can't grasp what you're buying and why, the answer should be no. I can't stress this enough.
Jean Chatzky is an editor-at-large at Money Magazine and serves as AOL’s official Money Coach. She is the personal finance editor for NBC’s “Today Show” and is also a columnist for Life Magazine. She is the author of four books, including 2004’s “Pay it Down! From Debt to Wealth on $10 a Day” (Portfolio). To find out more, visit her Web site, www.jeanchatzky.com.