Pathways to Getting Ahead

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--Select a Section-- Introduction Knowledge and Skills: Where the Path Begins Jobs Plus: A Path to More Than a Paycheck Savings and Investments: Advancing Along the Path Links to Informational Web Sites Sources of Statistical Data About the Sponsors Table of Contents

 

Savings and Investments: Advancing Along the Path

Savings and investments are another step on the path to economic security and opportunity. They include cash in savings and checking accounts, stocks and bonds, and ownership of a house or other property. If large enough, they can give you extra income now and, even more important, make your retirement years more comfortable. They can help you deal with the expense of a personal crisis or emergency. They can help you to make a down payment on a home you want, pay for the education and training you need, start a business, or make an important purchase, such as a car or a computer.

In the first section, you learned how your knowledge and skills could help qualify you for the job you want or prepare you for the business you want to start. In the second section, you learned about how to gain the best job that is within your reach and the other supports that can boost your income when earnings fall short. Once you are far enough along the path, your income may be large enough so that you can think about setting some aside for the future.

The gains from building your savings and investments are not just valuable to you. Communities are stronger when residents have a financial stake through ownership of a home or a business. Communities can thrive when families have the economic security that a nest egg of savings and investments can afford. Communities can grow when households have the financial means to invest in their future.

For these reasons and many others, it has long been considered in the interest of the community to help people build savings and investments. Tax policies can provide incentives for people to accumulate them. For example, homeowners who owe income tax can pay less tax based on the cost of paying off their mortgage. People who save for retirement can reduce or delay payment of taxes on the income they earn from their savings. People can also reduce or delay payment of taxes when they save for the college education of their children or other family members. This kind of help makes a real difference in the lives of millions of Americans. But others, including those with low income, are not able to benefit from these tax policies.

In this section, we will look at ways you can save, invest, and manage your money, and at policies and programs that can help you and others advance along the path to financial security. We discuss four topics:

• Starting simple: Savings
• Saving for the long haul: Investing in a home
• Saving for the long haul: Investing in other ways
• Managing your savings and investments wisely

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Starting simple: Saving up

In the last section, you learned ways to increase your income from a job or your own business to pay your day-to-day expenses. Now let's talk about the money you have left once the bills are paid. You may not have a lot left over, but sometimes all it takes is a little here and there to get you on the road to better financial security and opportunity. So, budget well and commit yourself to putting aside something on a regular basis, and then try hard to stick to your budget. To learn about different ways to save, visit http://www.consumerfed.org/66ways.pdf.

The first money you set aside, you may need for important purchases or emergency expenses, so you need a secure place where you can keep it and have it available right away. At the same time, you want to take advantage of the chance to earn more money from what you have saved. The extra money is called interest. For example, if you open a basic savings account at a financial institution, like a bank, you can earn interest on your money. Over time, your savings and the interest you earn can build up.

Let's say you save $20 every week in a savings account at your local bank. Chances are that your bank will pay you interest on your money of 1% to 3% annually. The table above shows what your account would be worth over time at 3% interest compounded monthly.

Weekly Savings
	1 Year	5 Year	10 Years	15 Years	20 Years
$20 with 3% Interest	$1,056	$5,608	$12,125	$19,686	$28,492
$20 without Interest	$1,040	$5,200	$10,400	$15,600	$20,800

As you can see, if you leave your money in the account you earn more and more interest as the amounts you have already earned build up. This is called compound interest. The key here is saving regularly. This means trying hard not to touch the money you have.

Basic Savings Account
Having a savings account at a bank or other financial institution that is covered by the Federal Deposit Insurance Corporation (FDIC) will allow your savings to grow and be insured up to $100,000. To open such an account, you might have to pay a monthly service charge - typically $3 - if your savings account goes below a certain amount (a "minimum balance"). You may also have to make a minimum deposit to open an account. Having an account may give you access to Automatic Teller Machines (ATMs) to access your money more easily, although there may be charges to use some ATMs. The service charges, opening deposit, and minimum balance may depend on where you save - at a commercial bank, credit union, savings bank, or small community bank. To comparison shop for savings accounts, checking accounts, and other financial services available in your area, visit http://www.bankrate.com/brm/rate/atm_chk_home.asp.

Saving can be easier and more regular if you "direct deposit" your wages, government payment, or other sources of income. You can also avoid high fees for cashing your paycheck when you use direct deposit. Ask your employer or a financial institution that you deal with about direct deposit.

If you receive one of certain kinds of federal government payments, you may be able to open up an Electronic Transfer Account (ETA), a low cost account into which the payment will be deposited. To see if you qualify, call 1-888-382- 331 toll-free or visit the web site, http://www.eta-find.gov. Also, under the federal government's First Accounts program, organizations in over 25 states have received grants to enable people to open low cost savings and checking accounts. To learn more, visit the U.S. Treasury's web site at http://www.ustreas.gov/firstaccounts/grantawards.html. If you live in Illinois, Massachusetts, Minnesota, New Jersey, New York, Rhode Island, or Vermont, you may be able to sign up for a low-cost "lifeline account" that banks in those states must offer.

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Improving connections with financial institutions Having an account at a financial institution gives you ways to save and means to manage your finances - such as cashing checks and paying bills - that are less costly, so you have more to save. There are choices about how to help people get "connected" that are worth considering. For example, employers could be encouraged to get their employees to sign up for direct deposit of their paychecks and provide financial education at work. Financial institutions could be encouraged to offer more reasonably priced accounts and basic financial services. For example, the First Accounts program that is noted above could be expanded. Alternatively, financial institutions' obligation to serve all in the communities where they do business could be increased under what is called the federal Community Reinvestment Act. Or other states could follow the lead of the seven that have already required banks to establish "lifeline accounts." Two articles at the Brookings Institution's web site, http://www.brookings.edu/metro/capitalxchange/article10.htm andhttp://www.brookings.edu/metro/capitalxchange/article4.htm, offer information and ideas about how more people can get connected to financial institutions.

Removing "asset test" barriers to saving Important government programs such as Food Stamps, Medicaid, and Supplemental Security Income, help fill in the gap with cash or other benefits when people don't make enough from work to meet their basic needs. But some people who need help from these programs can't get it because they have built up modest amounts of financial assets or own a car worth too much money (even though they need it for work). As a result, they have to "spend down" their savings to get in or may not bother to save in the first place. But those savings may be just what they need to move on and move up once the program helped them get back on their feet. Also, people who have certain kinds of employment pension plans risk losing some benefits, if they have too much money in the plan. For more information about how "asset tests" affect asset building for lower income families, check the website of the Center on Budget and Policy Priorities at http://www.cbpp.org/9-20-00tax.htm and http://www.cbpp.org/4-13-01wel.htm.

Encouraging saving Reports so far suggest that Individual Development Account (IDA) programs are popular and genuinely help participants build a financial stake for themselves. As of 2003, there are IDA programs in almost every state. Many are privately supported by foundations and other organizations. In many states, the state government also contributes relatively small amounts of money in a variety of ways. The federal government has created a pot of money for IDA programs, only some of which has been spent so far. But the need and demand for IDA sseems much greater than current state and federal government support for it. For more information and ideas about IDAs visit http://gwbweb.wustl.edu/csd/ and click on "IDA" or "State Policy." The Family Self-Sufficiency (FSS) program has had success not only in helping people get on and up the job path, but also in building a financial stake that they can call their own when they complete the program. But many public housing authorities across the states could do even more to help the program work. In some areas, additional funds pay for more staff who assist people in reaching their goals through case management and by tapping into more resources that exist in the community. To find out about the FSS program, visit http://www.cbpp.org/4-12-01hous.htm.

Certificates of Deposit and Money Market Accounts
Certificates of Deposit (CDs) generally pay higher interest than regular basic savings accounts, usually because you must invest a minimum amount of money (say $500) and won't have access to it for a minimum amount of time (for example, 6 months). Money Market Accounts (MMAs) also pay higher interest - though not so much as CDs - because you must also invest a minimum amount of money and you are limited to six withdrawals per month. Most financial institutions offer MMAs and CDs; those offered by banks are federally insured, just like ordinary savings accounts. Shop around for the best interest rates and terms. You can learn about these options at http://www.bankrate.com or from your local bank.

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Individual Development Accounts (IDAs)
Depending upon the state and area where you live, you can get a helping hand in saving through an Individual Development Account (IDA) program. If you qualify for the program, some of your savings in a special account will be matched, often dollar for dollar and sometimes even more, if you stay in good standing. Usually that means you are saving at least small amounts on a fairly regular basis over a year or two. It also means taking classes to increase your knowledge about personal finance and sharpen your money management skills. Generally, you get the benefit of the match when you use the money for a specific purpose, such as buying a home, paying for college or vocational education, or starting a small business. IDA programs typically give you advice and support in making wise decisions about how to use your savings in this way. To find out if there is an IDA program you can join, visit http://www.idanetwork.org, or call the Corporation for Enterprise Development at (202) 408-9788.

Family Self-Sufficiency Program (FSS)
The public housing authorities (PHAs) that run public housing and supply vouchers ("Section 8" certificates) that help pay for private rentals by lower income families also run a Family Self-Sufficiency Program (FSS). This program helps participants with supports and services not only to get and keep jobs with good wages, but also to build a financial nest egg. Ordinarily, public housing tenants and voucher users must pay more rent as their earnings rise. But for FSS program participants, some of their increased payment is put into a special account. All the money in that account becomes available to them when they successfully complete the FSS program. In some states, PHAs run additional programs that work like FSS. If you receive housing assistance, contact a PHA in your area to learn about programs of this kind in which you might participate.

Saving for the long haul: Investing in a home

Once you have saved enough to meet your short-term needs, you can think about putting more money aside and investing your savings over the long term. Investing can bring greater financial rewards, but it also may come with greater risk. You can lose money as well as make it. It can be the right strategy for you if you learn about the different risks and rewards and make wise choices about your investments.

How homeownership works
Owning a home is more than having a house to call one's own. It's also a way to build wealth. According to one estimate, households in America may have as much as $8 trillion of their net wealth in homes. For many, it's the most important part of the net wealth they have. You will need savings of your own (a down payment) and money you borrow (the mortgage loan) to have enough to buy a house. You will have to pay for other fees and expenses to cover the cost of the transaction (closing costs).

Required minimum down payments for conventional loans may be as high as 20% of the sales price, although government loans typically have lower down payment requirements. For example, the Federal Housing Administration (FHA) and the Department of Veteran Affairs (VA) may offer assistance in paying your up-front cash requirements. To learn more, visit the Government National Mortgage Association web site at http://www.ginniemae.gov/1_learn/h_i_c.asp?Section=YPTH. Also, you can check the web site of the Department of Housing and Urban Development (HUD), http://www.hud.gov/buying/localhomebuy.cfm, to find out about other local down payment assistance programs. In addition, visit the website of Fannie Mae, the largest single private source of money for home mortgage lending. (Go to http://www.fanniemae.com/index.html, click on "Find a Mortgage" and click again on "Mortgage Solutions.") There you will find a list of mortgage products designed to meet the needs of different kinds of borrowers and lenders who offer those products.

Turning savings into a home Public policies have enabled many Americans to become homeowners. Most importantly, they have been given a real boost to covering their home ownership costs from the taxes they save when they deduct their mortgage interest and real estate tax from the income they report on their federal tax returns. It's worth considering whether there are ways to give similar help to others who don't get the benefit of such deductions. One way would be to make the deductions "refundable" like the Earned Income Tax Credit (EITC), described in the section on jobs plus. That is, just as some people get a tax saving deduction, others who cannot benefit from it could get a credit that gives them back money to help pay their mortgage. Another way might be to help those for whom coming up with the down payment is a bigger barrier to homeownership. They could be offered a one-time credit that they could use to cover part of the cost.

If the home you want costs $145,000, a down payment between 10% and 20% will cost you between $14,500 and $29,000. The money will primarily come from your savings and perhaps some help from a family member. Once you have the down payment, you will need to borrow the rest (get a mortgage loan). The most important features of a mortgage loan are the amount of the principal, the term, and the interest rate. The principal is the money you borrow from a financial institution. The term is the number of years you have to pay back the loan. The interest rate determines the extra amount you have to pay to the financial institution for borrowing the principal. In 2003, interest rates have been the lowest in decades, well below 6%; during the last few years, they have been has high as 8.3%. Whenever you seek a mortgage, be an educated buyer and shop around to get the best buy! For example, it would cost you over $23,000 more in interest to make all the payments on a 30-year mortgage loan for $100,000 at 7% interest, than for a loan at 6%.

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Building Equity in a Home
Over the years, the net wealth you have in a home - the equity - can grow. This equity can be important to even more wealth creation and economic stability because you may be able to use the higher equity to improve your home, start a business, or pay for your education or that of your children. At any time, the equity you have is represented by the following formula:

Equity = Down Payment + Payback of Principal + Sale Price - Purchase Price (The Purchase price is what you paid for the house. The Sale price is what you can sell it for.)

First, you start with your down payment, the amount of your own savings that you invest to buy your house. Next, each month that you pay your monthly mortgage loan, you not only pay interest to the lender for borrowing the money, but also lower the amount you borrowed - the principal - for the following month. The more you pay back, the more your stake in your house grows. Also, over time, the price of your house may increase above what you paid for it. If it does and you sell your house, you get more than you started with. For example, suppose you buy a new home for $145,000, make a down payment of $14,500 and get a 30-year, 6.5% mortgage for $130,500. After five years the principal your mortgage payments pay back will increase your equity by $7,338. This will bring your total equity to $21,838 ($14,500 down payment plus $7,338). If the price at which you can sell your house goes up by 9%, from $145,000 to $158,050, your equity will increase by an additional $13,050. Of course, the price at which you can sell your home doesn't always go up - it may even go down - so you must make your choice for investing in a home wisely. If you join a block or neighborhood association, you may be able to improve the quality of life where you live and protect or perhaps increase the value of your home. Also, other things affect home values. If you don't take care of your home, its sale price may actually go down. To find out more about the advantages of buying a home, visit the website for Ginnie Mae at http://www.ginniemae.gov/rent%5Fvs%5Fbuy/rent%5Fvs%5Fbuy.asp.

Make Sure Home Ownership is Right For You
Whether owning a home is right for you depends on the kind of expenses you have and your ability to manage these expenses. Homeowners must prepare for the typical costs such as mortgage payments, taxes, and utilities. Also, if you are allowed by your lender to make a small down payment (generally less than 20%), you may have the additional expense of mortgage insurance. Managing your mortgage will be very important. You should consult with your financial institution loan officer and homeownership counselor to make sure that you stay on top of your monthly payments. Remember, too, that you will have one-time expenses when you buy - and sell - your home. Also, if you become a homeowner, you must be able to cover unexpected costs, such as repairs to the furnace, or other things that can break. So having a savings account with enough money to pay for such expenses is important.

There are programs that assist with the down payment you need to make and help lower the interest rate you must pay. Whether you qualify for these programs may depend on your income. For more information, contact your state housing finance agency through the National Council of State Housing Agencies. Call the Council at (202) 624-7710 or visit the Council's web site at http://www.ncsha.org/section.cfm/4/39. Or to learn more about the homeownership process, visit the web site of the U.S. Department of Housing and Urban Development at http://www.hud.gov/buying/index.cfm.

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Watch out for predatory lending
If you want to buy a home, you need to do a careful investigation and gather lots of information. You need to be aware of loan scams, what some people call predatory lending. How can you spot a predatory loan? Watch out for high interest rates (several percentage points higher than what your local bank might charge for a loan of the same size and term). Be on the alert for "balloon" payments (a payments schedule that offers low payments for a while but then requires you to pay off a big balance in a lump sum). Keep an eye out for monthly payments you can't afford, loans higher than the value of your home, and penalties for early payoff of the loan. Be on the lookout for extra loan fees and costs, such as credit insurance, that are very expensive.

Most important, be a smart borrower. Shop around. If you have poor credit, be wary of those who say that's not a problem. Don't take the first loan you are offered. Never sign any blank forms. If you don't understand the forms, don't be shy - ask questions and if you still don't understand, get advice from a third person who is in the know and whom you can trust. For more information, visit the web site of the Mortgage Bankers Association of America at http://www.stopmortgagefraud.com.

Saving for the long haul: Investing in other ways

Investing in a Microenterprise
You can use your savings to start a small business, even a very small one (what some people call a microenterprise). The hot dog stand, the corner book cart, the small ice cream shop, and the single landscaping truck are all examples of microenterprises.

You may be able to start a very small business with several hundred or a few thousand dollars. Generally speaking, microenterprises require $35,000 or less. Financial institutions typically will not provide business loans worth less than $50,000, although there are some that have special programs that do. Shop around! Many microenterprises are started with people's own savings, loans from family and friends, and, often, money borrowed on a credit card (although that is expensive and can be risky).

Many people who own a microenterprise have a job as well. They start the microenterprise to gain extra income to pay bills, save for a home or for retirement, or purchase a computer or car. But a microenterprise can grow. Your business may employ one or more individuals. If so, you may need technical assistance on how to run your business and spend more time managing it. For more information and resources to help you set up and run a microenterprise, see the human capital section. For additional information, including facts about business start-up costs and start-up loans, visit the web site of the Small Business Administration at http://www.sba.gov/starting/; for micro-loans see http://www.sba.gov/financing/frmicro.html.

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Stocks, Bonds, and Other Kinds of Investments
You can invest your savings in many other ways. You can buy individual stocks (that represent a share in the ownership in a corporation) and bonds (that represent a loan you make to a corporation, a state or local government, or the federal government). You can also invest in mutual funds. A mutual fund is a company that pools together money from many people and invests it in stocks, bonds, and other investments. The company typically will have a manager who directs all the investing. Before you invest in anything, you should educate yourself about these and other choices for investments that you might have. You should learn what the risks are and the rewards you might gain by investing in any one of them. For example, government bonds are no or low risk, while corporate bonds can be medium or higher risk, depending upon who issues them. When you make your choices, take into account the amount of safe and secure savings you need to meet critical needs when emergencies occur or if your income from a job drops unexpectedly. Even if you don't make such investments directly, if you have one of the retirement accounts described below, you will likely have a chance to choose your investments, so the knowledge you acquire is still important. You can test yourself on your investment savvy at http://www.sec.gov/investor/tools/quiz.htm. Learn more about what it takes to invest for success at http://www.icief.org.

Saving for the next generation's future State-promoted 529 plans help some families set aside money for their children's education. Families that save in this way do not have to pay federal taxes on income they earn on contributions to the plan. In some states, families can also deduct what they set aside from their taxable income in the year the contribution is made. Other families could get similar help, if the government directly matched their contributions to such plans. Or people in IDA programs could be allowed to put their savings and the match money in a 529 plan. More generally, it might be important to make sure that all children have a "stake" that can put them on the path to real opportunity when they become adults. This money could be used to pay for their college education or start-up of a business when they become adults. To learn more about ideas of this kind, visit the websites http://csd.wustl.edu/Publications/Pages/default.aspx or http://www.cfed.org/focus.m?parentid=2&siteid=288&id=2220 for the Center for Social Development and the Corporation for Enterprise Development.

Retirement Accounts
Planning for retirement is important. When people retire from work, they no longer have a steady stream of earnings they can use for expenses and saving. Even though retirement seems far off in the future, you have to start building now the assets you will need to live comfortably in retirement. There are three key components.

Social Security: Social Security provides you with very basic government guaranteed benefits when you reach retirement age. (It also assures you, your spouse, and your non-adult children of income in the event of your death or disability before retirement.) Whether you qualify for Social Security depends upon the number of years you work. What benefits you and your family members receive depend upon how much you earn during those years. So having a longer work and better earnings history can give you basic economic security in your later years. The money to pay these benefits comes from deductions from workers' pay and matching contributions from employers. To learn more about Social Security, visit the Social Security Administration's Web site at http://www.ssa.gov.

Work-Related Pension: Some work-related pensions are provided directly and in some cases entirely by an employer. But these days the most common kind of work-related pension is what is called a 401(k) plan. Not all employers offer them, but many do. Usually, you qualify to start one after working for a certain number of months or several years. If you do qualify, you will usually be expected to make a contribution (through a deduction from your pay) that will be matched in some way by your employer. The money and the match go into your own special pension account that can, over the years, build up (through the contributions and from investment earnings on those contributions). The money set aside in this way is tax-deferred. That means you will not have to pay taxes now on the money you and your employer contribute or on what the contributions earn over the years until you withdraw the money. Typically, you will be able to withdraw funds without penalty after age 59 1/2. Check with your employer to see if you can start a 401(k) plan. Think seriously about starting one!

Special Savings Accounts for Retirement: Whether or not you are offered and choose to have a 401(k) or other work-related pension, you can start one of your own, namely, an Individual Retirement Account (IRA). To start and build such an account, you must make contributions of a percentage of your income, usually no more than 20%. If your income is not too high, the amount of earnings you contribute will not be taxed now. In fact, in some cases, what is called the Small Savers' Credit treats your contribution as a payment against other federal taxes you might owe. In any case, what income your contributions earn over the years is tax-deferred until you withdraw the money. Typically, you will be able to withdraw funds without penalty after age 59 1/2. There are several kinds of IRAs. Roth IRAs can offer you a better deal on taxes than regular IRAs. Education IRAs allow you to use what you build up in the account for college or other higher education for you or your family members. You can open IRA accounts at banks, credit unions, insurance companies, mutual fund companies, and other financial institutions. As mentioned in the human capital section, another way you can save for your children's college education is by participating in a federally authorized, state-promoted 529 plan.

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Saving for retirement Work-related pensions and special accounts for retirement, when combined with Social Security, are important to enjoying a secure and comfortable retirement. Many people build this kind of wealth in several ways. They make their own and often get the benefit of contributions from their employers who offer them a chance to join a retirement plan at work. Many also get a boost because of the taxes they save when they use pension and retirement contribution deductions on their tax returns. It is important to think about how others, especially workers in lower paying jobs, with jobs at small businesses, or who change jobs often, might get a similar chance and boost. For example, the government could help with a jump-starting contribution when they open up an account and, perhaps, match small contributions by those workers to their plans. Employers could be encouraged and supported in offering plans that their businesses can afford and from which their workers can really benefit. To learn about a wide range of ideas on increasing saving for retirement, visit the web site of the Pension Rights Center, http://www.pensioncoverage.net. To find out more about specific ideas about jump-starting contributions and making it easier for small employers to offer pensions, see the Brookings Institution's and the Economic Opportunity Institute's web-sites, http://www.brook.edu/views/testimony/iwry/20030630.pdf, and http://www.eoionline.org/washington_voluntary_accounts/reports/ WAVoluntaryAccountsUniversalPensionAccess-Jun02.pdf.

Even if you are self-employed, you can benefit in the same ways. Self-employed persons are entitled to Social Security benefits because they, like employees, are required to make contributions to the Social Security system. You may be able to set up a Self-Employment Retirement Plan (SERP) (which can either be called a Simplified Employee Plan or a Keogh Plan), somewhat like a 401(k) plan.

To find out about your pension rights and protections, visit http://www.dol.gov/ebsa/publications/wyskapr.html. For more information on IRAs and SERPs, visit http://www.bankrate.com and search under "retirement," or talk with a representative of your local financial institution. To learn more about 529 plans, you can call the College Savings Plans Network tollfree at 1-877-277-6496 or visit http://www.collegesavings.org/.

Managing savings and investments wisely

Once you start on the path to financial security and opportunity, you have to manage what you save and invest. Keep track of your savings and investments, the interest rate or other income they earn or how they have performed during the time you have owned them. Read your monthly bank or other financial statements. If you do not receive a monthly or other statement or find errors in it, contact your financial institution immediately. Even if you have someone you trust who advises you on your savings and investments, you should ask as many questions as you need to understand the advice your receive. Even then, the choices you make should be the ones that you think are right for you.

For information about how to make a financial plan, set goals, evaluate your financial resources, and come up with financial strategies, visit the web site of the AARP at http://www.aarp.org/money/personal/ or of the Federal Reserve Bank of Dallas at http://www.dallasfed.org/educate/pfe.html.

 

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