Investing Basics

Which comes first: the savings account or the investments?

Spoiler alert: it’s the savings account. If you’re thinking about investing, listen to this podcast. You might decide investing still sounds like a good idea—or you might realize you need to start saving first.

Podcast transcript


PETE: You’re listening to How Not to Move Back in With Your Parents here on the IU MoneySmarts Radio Network. I’m Pete the Planner and Alex is right there. Hello.

ALEX: Here I am.

PETE: This episode of the podcast, The Basics of Investing.

ALEX: This is a fun one because a lot of college students are really interested and like, I wanna invest my money and do some stocks, stuff like that. But no one actually knows anything, unless the very few 0.1% who do day trading.

PETE: You know what’s sexy? Don't answer that. Investing, people love to talk about investing. But no one ever takes a time to learn the basics and the boring part of investing. Think about, I know you don’t probably go to a lot of cocktail parties.

ALEX: No. I mean, maybe there are cocktails there.

ALEX: No, I’m not a big cocktail guy right now.

PETE: Yeah, we’ll get there. It’s funny, cocktail party is more of an idiom of being in the adult world, a working world, and you’re at a party having adult conversations, and people are like, what kind of stock tips do you have? And that seems appealing and interesting, but it’s a dumb conversation. Because investing, let’s establish first of all the difference between saving and investing. They are very, very different and people get them confused. Let’s start with saving. Saving is accumulating money. It’s three things. Accumulating money in case there is an emergency. So, your short-term needs. So any saved money technically is not invested money. That make sense?

ALEX: Yeah.

PETE: Number two in terms of saving is that you can’t concern yourself with what rate of return your savings is getting. Now that’s tough, right? Alex, if you made $5,000 a month, first job out of college, which would be great, take home pay, let’s say you did. Then I would say your emergency fund is 15,000 bucks, three months worth of expenses. Say it’s $5,000? $15,000. Does having $15,000 earning nothing seem like a bad idea?

ALEX: Yeah, but you have to have it.

PETE: But you have to have it, but the bigger issue is this. The idea of savings is not to grow your savings. That’s investing.

ALEX: Is to have it when you need it.

PETE: Savings is to have your back. It’s what we call in the biz, capital preservation, to preserve what is there. So saving is to have money when something goes wrong. It is not to grow that money. And the third component and this one is deep, is we’re always told to save money for accumulation purposes, to fund something in the future. But I think it’s important that we save a portion of our income to prove to ourselves that we do not need our entire income. The more you save of your money, the less dependent you are on your income. And as your income grows over time, if you don’t save a higher percent you become more and more and more dependent on your income, as you approach retirement. And retirement, Alex, as you know, is a time when oftentimes people have a lower income available to them than when they worked. And so if you created this dependency on a higher income yet you hit the wall of lower income, it’s a recipe for disaster.

ALEX: Yeah and the quality of life in a sense has to go down because you’re gonna be living on less than you have been for all those past years and it hits people pretty tough.

PETE: Yeah savings is about breaking dependency on your current income, okay? Let’s get to investing, quickly, because this is the basics of investing. I just spent three minutes on my savings. Yeah, I’m that good. Investing’s a little different. The point of investing is from a mid and long term perspective, to put money away to eventually be able to fund a business, a home, something like that, or to create an income stream. You know we talk about 401Ks from time to time on the show which is a retirement plan that your employer will have for you. And when you are in what is called the accumulation stage, which is pre-retirement, right, you’re just accumulating money, you just think I just want a bunch of money in here, you know I just want to keep put money in there but at some point that money turns into something, it turns into income, it turns into an income stream. So, investing oftentimes is to create more money out of invested money for the purpose of generally taking income at some point in time. Does that make sense?

ALEX: Yeah.

PETE: And the best thing you need to understand about investing from a soon to be college grad perspective is, the early money is the best money. What in the world does that mean? It means that the first dollars you put in to an investment are going to be the most powerful, because they will grow over time, they'll have the most time to compound. What’s strange is, the last couple of dollars you put in your account the very end of your career, are the least impactful necause they never really grew at any particular rate of return.

ALEX: So it sounds like the gist of it is start early.

PETE: Start really early, but I think you earn the right to invest once you've learned to save. Cuz savings is a habit, it teaches you again, to go without your income. I think you should invest, you should at least contribute to your employer-sponsored retirement plan up to the match. Again, a lot of times employers will give you an extra compensation. If you choose to put money into the retirement plan, they will put that same amount on your behalf which increases your income. You gotta do that right away.

ALEX: As far as retirement investments, all of that you should worry about coming out of college is that 401K, cuz there are IRAs, Roth IRAs. What’s the difference between those and what ones should you be looking at coming straight out of school?

PETE: Coming straight out of school your number one priority is to hit the match with your company-sponsored retirement plan. If you don’t have a company-sponsored retirement plan, which realistically you may not, open a Roth IRA.

ALEX: As opposed to a regular one?

PETE: Yeah and that is if you are making less than 100 grand or so a year because a Roth IRA you’re gonna put money in after tax. You know your purpose in life at age 22 isn’t to avoid taxes. Your income probably is not going to be to a point where you need to actually have legal tax evasion moves. Your goal is to put money away for the future. A Roth IRA is a type of Individual Retirement Account, I-R-A, in which you can take the money out tax free after age 59 and a half. A traditional IRA, you get to deduct it on your taxes in the year you put money into it, but when you take money out, you have to pay taxes on it. Your 401K is the same way. So, if you don’t have a 401(k) getting into a Roth IRA is a pretty good option. But the real focus should be funding that emergency fund because that earns you the right to invest.

ALEX: Yeah, and so when you get to that point of you have earned the right to invest you have saved up, have the emergency fund, where do you start there, that’s the big question?

PETE: Then we get into what’s called risk tolerance. Simply put, it’s will you lose sleep at night if your investments go down? And people misunderstand aggressive and conservative. There’s five investing styles, risk tolerance styles. There’s conservative, conservative to moderate, moderate, moderate to aggressive and aggressive. Now, because you’re not afraid of risk because you bungee jumped on spring break or whatever, that doesn’t mean you're an aggressive investor. Some people misconstrue aggressiveness and they do something foolish, right? And you have 100% of your money in the exact same investment. It doesn’t really make a lot of sense. Specifically, if it’s not a diversified investment. You hear diversified, what does that mean? Well, there’s two basic type of investments, stocks and bonds. Stock is when you own part of the company you’re invested in. You are actually one of the owners. A bond, you have no ownership, but you let an entity, a company, borrow money.

PETE: Okay. And so when people talk about diversified investments, they usually talk about funds, mutual funds, exchange traded funds, these sorts of things. And simply put, it is a group of stocks and or bonds that are put together so that if your portfolio is affected by a stock going down, it’s not that impactful because maybe there's 400 stocks within one mutual fund. So Alex, if you have $100 to invest you could either A invest in one stock or maybe you put that $100 into an ETF which is called an Exchange Trader Fund or mutual fund and that $100 actually just got partial investments in like four hundred companies, so it diversifies you automatically.

ALEX: And it is all about risk, as you said, because you can either gain a lot or lose everything on that one stock, but at the same time, with the mutual fund, the ETF, the different stocks will be kind of balancing each other out, so the rate of return will be a lot lower.

PETE: Sure, I mean since 1970, okay, so the last 44 years, the S&P 500 which is the way people measure the stock market’s performance, is the Standard and Poor 500 Index. It’s 500 stocks that are put in this portfolio, so that we can measure how the market does on a daily basis. Since 1970, it’s been down nine times. Okay that’s it. It’s been down nine years at the end of December 31st. It’s down this year, nine times. And each of those nine times, each of those nine instances, the index recovered to where it was before it fell within five years, okay, so that is to say the market generally trends up. And if you can be patient, you don’t overreact. You know this. The basic rule of investing is to buy low and sell high. Buy when things are inexpensive, let them increase in value, then you sell them to have what's called a gain, right?

ALEX: Yep.

PETE: When people get emotional, you know this too, when people get emotional with their investments, they tend to do the complete opposite. That the market’s going down, they freak out, I’m gonna lose all my money, so as it’s going down, as it’s low, they sell, right? And then they’re like, well I’m out of this. And I’m gonna wait until things recover and it’s on solid ground. Well what’s happened in the meantime? You’re in cash, the market went back up, and so you jump back in and buy high.

PETE: You do the opposite. So I guess when you start to invest, you just have to truly understand what risk tolerance is. You need to put money in your retirement plan as soon as you possibly can because it’s gonna be the best money. And the more education you have in relation to the stocks market, the more aggressive, suitably aggressive you can be. But when you don’t know what you’re doing, you either have to guess, which is a bad idea, really bad idea, or you can’t be that aggressive because you have to be too conservative.

ALEX: Quick question before we end.

PETE: No, go ahead.

ALEX: How long do you wait to get a financial advisor, or what does that look like? Cuz I know you recommend getting a financial advisor, right?

PETE: Sure, absolutely. I think when you start investing outside of your 401(k) is a great time to get a financial advisor. So, once you have three months expenses saved, and by the way your goal, eventually Is to max out your 401(k). So in 2014, if you’re under the age of 50, $17,500 is the most you can put into your 401(k). Now you’re not probably gonna be able to do that when you graduate from school right away.

PETE: But your goal is to eventually to do that, which sounds by the way, completely unrealistic, but it’s not. I mean it can happen over time. When you get a raise, if you save your raise into your 401(k), then it’s very easy to at some point max out your 401(k). At that point, you don’t want a financial advisor, but when you’re still trying to get out of credit card debt, you’re renting, and you’re trying to save an emergency fund, in my opinion there’s no need for a financial advisor. In turn, you just want to take personal finance information, like this, very podcast. That good?

ALEX: All right, yeah.

PETE: That was 12 minutes of amazing

ALEX: It’s a lot of heavy stuff.

PETE: I’m tired and my mouth hurts. All right, hey, if you want more information go to You’ve been listening to How Not to Move Back in With Your Parents podcast, here on the IU MoneySmarts Radio Network.