Quite often, I’ll get emails from readers saying that they’re looking to invest their money and that the money they want to invest is currently sitting in a savings account. What these readers often overlook is that the money in their savings account is already invested.

An investment simply means that you’ve put aside a resource for future use with the hopes of gaining a return on that money. A person can invest in anything from baseball cards and stamps to real estate and stock investments.

I usually look at three big factors when thinking about an investment.

Rate of return How much of a return on my money can I reasonably expect with this investment? For example, over the long term, a reasonable rate of return to expect from a broad stock market investment is 7%. If you invest in a savings account, a reasonable rate of return is about 1% right now.

Risk How likely is it that I’m going to get the return I expect with this investment? With stocks, there’s a significant amount of risk, particularly over the short term. If you bought heavily into stocks in early 2008, you probably lost 40% of your money. On the other hand, if you put your money in a savings account in any year, you had a small positive return, just like clockwork.

Liquidity How easy is it for me to get my money out? Savings accounts are incredibly liquid – all you have to do is visit an ATM. Stocks are a bit less liquid, but you can usually sell them quite easily through your broker. Other things, like real estate or CDs, are not very liquid, as you incur losses for cashing out a CD early and real estate sales require a buyer before you can get your money out.

As you can see, a savings account registers on all of these factors. A savings account is a highly liquid, very low risk investment with a low expected rate of return.

You can make similar statements about a lot of investments. An index fund of all American stocks is a highly liquid, moderately risky investment with a medium expected rate of return. Vintage baseball cards are a fairly illiquid, moderately risky investment with a medium expected rate of return (based on my experience). A CD is a fairly illiquid, very low risk investment with a fairly low expected rate of return.

The question then becomes how do you decide where to put your money? Again, I use a few simple rules of thumb to compare the investment types.

The sooner I need the money, the less risk I’m willing to accept. If I’m saving for retirement, I’m fine with significant risk. If I’m saving for a car I intend to buy in six years, I’m fine with some risk. If I’m saving for an air conditioner repair in five months, I don’t want much risk at all.

If I’m going to possibly need the money quickly, I need it to be pretty liquid. In other words, I would not put my emergency fund into real estate or collectibles, nor would I put it all into a certificate of deposit. These investments have their place (a long-term goal), but they’re certainly not for everything.

If I absolutely must hit a certain dollar amount at a certain time, I’ll lower my risk and focus on raising contributions. For example, if I have to have $100,000 to pay off my ARM in four years, I’m not going to want to put that money in a risky investment where the balance can unexpectedly slip away from me. I’d rather put it in something with a lower rate of return with much lower risk and focus on increasing the amount I can save.

Rate of return rarely plays a role in these decisions. I generally focus on liquidity and risk first and foremost, and when I have those figured out based on why I’m investing, I try to find the best rate of return for that amount of risk and liquidity.

Thus, quite often, savings accounts are my preferred investment vehicle.

Every Sunday, The Simple Dollar reviews a personal finance or other book of interest. Also available is a complete list of the hundreds of book reviews that have appeared on The Simple Dollar over the years.

A week or two ago, I was scanning the radio dial while on a road trip, looking for something interesting to listen to, when I stumbled upon a guy talking rather excitedly about investing. It was Adam Bold, and he was hosting a program called The Mutual Fund Show.

While I didn’t necessarily agree with his show on every point, I did agree with him on most things, and I did appreciate the enthusiasm he was bringing to investing. He made it seem incredibly approachable and even fun, while also keeping in mind the fact that it was quite important to your future.

After listening until the station faded out, I decided to see if Adam Bold had a book available to read, and he does. The Bold Truth About Investing is a thin little volume where Bold lays down his ten commandments for building personal wealth.

It is worth keeping in mind as you’re reading that Bold got his start by founding a financial advising firm, The Mutual Fund Store. While encouraging advising is naturally going to be part of his perspective (more so than mind), most of the advice in the book is quite good.

Know Yourself
Some people are aggressive in how they like to invest. Others are conservative. Some people tend to spend what they have. Others can barely stand the thought of their investments not growing. We all have different personalities. The trick is being able to put the elements of our personalities that limit us aside when making investment choices. You have to be able to follow sensible principles when you invest, some of which may override your personality’s default.

Know When to Invest
Bold suggests holding off any investing until you’ve achieved two things: pay off “bad” debt (meaning those with high or variable interest rates) and build a “rainy day”/emergency fund. I completely agree with this perspective. If you’re on a sinking ship right now – which is where you’re at if you have “bad” debt or don’t have an emergency fund – putting money into investments won’t right that ship. Investments help with the future, but they can’t help if things aren’t right today.

Know Your Advisor
This chapter provides some good basic advice for finding a financial advisor. Bold talks about fee-based and commission-based advisors (I’d pretty much insist on a fee-based one if I were ever choosing one) and covers some basic questions to ask advisors. I treaded pretty lightly on this chapter because of the fact that Adam runs his own financial advising shop, so there was at least a little promotion of The Mutual Fund Store here.

Have a Plan
A plan starts with a goal. What do you want to do with your money? Do you want to have a very secure retirement? Do you want to build a house in ten years? Do you want your children to be able to go to college in fifteen years? A goal helps to establish a timeline and also helps to establish how much risk you should take on – without a goal, you’re flying blind. From a goal comes a plan – risk, diversification, updating your investments regularly, and so on.

Be in the Best Funds Possible
By “best funds possible,” Bold does not mean the ones that had huge returns the last few years. He means funds that have a long history of having solid and reliable returns. For me, this usually means index funds, but Bold doesn’t really look at those too much. Instead, he encourages looking at all funds and find ones with a mix of risk level that all have consistency in their returns over the long haul.

Avoid Any Hidden Costs
Here’s where I agree with Bold wholeheartedly. When you buy an investment, know every single fee involved before you buy. What’s the mutual fund’s expense ratio? More importantly, is the fund carrying a load – and if it is, avoid it like the plague. Bold does come out a bit against index funds in this chapter, arguing that although they cost more they tend to have a better return over the long haul. That might be true in some funds, but their year-over-year variability makes them more volatile. I’ll stick with my low cost index funds.

Don’t Buy What You Don’t Understand
If you don’t know what exactly an investment is, don’t invest in it. That’s simple enough. How deep does the knowledge have to go, though? Bold basically encourages people to be wary. If you can’t explain how the investment works in a sentence or two and can’t easily find out what the investment is made of, then you shouldn’t put your money in there. A black box managed by someone else is not something to trust your future to.

Be Proactive About Managing Your Retirement Investments
If you’re not investing for your retirement yet, start now. Start immediately. You need to be on the ball with your retirement, and the earlier you start, the less you’ll have to save (yes, seriously – if you start now, you won’t have to save as much as you would if you started in a few years). If you’re not sure what to do, just use your company’s 401(k) and choose a target retirement fund – you can always change it a bit later on. If you don’t have a 401(k), start a Roth IRA. The key is to start saving now.

Stick to Your Plan
You can’t react emotionally to what the stock market is doing. If you do that, you’re going to make investment mistakes. Markets are going to go up and down. That’s just what they do. When you invest in stocks, part of that investment means enjoying the years when the market is up 15 or 20%, but holding on for dear life during years like 2008 where the market is down 40%. If you jump off when things are flying downwards, all you’re doing is locking in your losses, because when you move to something more conservative, you’re giving up the “bounce” that stocks get when they hit bottom and rebound.

Live Well, For You Cannot Take It With You
When you’ve reached your investing goal, that means it’s time to start spending it. A 401(k) or a Roth IRA is meant to be used when you reach retirement age. It can be scary to see that total start to go down, but if you don’t start spending it, all you’ve done is create a very valuable asset to hand down to your kids.

Is The Bold Truth About Investing Worth Reading?
This is a short book, one that’s clearly written for people who are thinking that they ought to invest but are very nervous and unsure about the prospect. Bold uses very clear and straightforward language when talking about these things. I can easily see this book being exactly what a person might need to get over their nervousness about jumping into investing.

While I don’t agree with Bold on every point – for example, I think most people can manage their investments themselves using online tools and I think that index funds are the best way to go for investing – I agree with him on the vast majority of the principles outlined in this book. This is a great book to read for anyone who is trying to make up their mind about getting started with investing.

Check out additional reviews and notes of The Bold Truth About Investing on Amazon.com.

Saving Pennies or Dollars is a new semi-regular series on The Simple Dollar, inspired by a great discussion on The Simple Dollar’s Facebook page concerning frugal tactics that might not really save that much money. I’m going to take some of the scenarios described by the readers there and try to break down the numbers to see if the savings is really worth the time invested.

Kelly writes in: My husband I have lots of hobbies/interests and finances do not excite either of us so we are not savvy. We are great savers but don’t really know what to do with the money. We have our retirement accounts through work (Fidelity) and an emergency fund in a high interest checking account. In addition we had about $60,000.00 (that we don’t have plans for) in Vanguard money market funds until the rates dropped and we were not earning any interest. Because there is not a Vanguard office near our home (and we did not know where to put the money) we met with an advisor at Fidelity. We moved the money into stock market accounts and have made a significant amount of money. I have heard and read that Fidelity has higher fees than say, Vanguard, but if we can meet with an advisor yearly and are making significant money on this money do you think it is worth it? Or, is there a way to figure out what funds to put the money in at Vanguard? Are we talking about saving pennies or dollars?

In this instance, you’re comparing apples to oranges. Comparing a Vanguard money market account to a Fidelity stock fund isn’t even close to a realistic comparison. Money market accounts are typically invested in things that would be considered ultraconservative, like U.S. treasury notes. On the other hand, stock funds are invested in the stocks of companies and, by their very nature, are much more volatile, with big gains and big losses within the realm of possibility.

The only way to really gauge the impact of investment fees is to compare identical investments from two separate investment houses, which is extremely difficult since it’s rare for two investment houses to have identical offerings. Even if you compare very similar investments, like the Vanguard 500 and the Spartan 500, it’s still not an exact comparison because of small variations between the funds.

For example, with the funds above, the basic level investor shares of the Vanguard 500 has an expense ratio of 0.17%, with Admiral shares (with a minimum investment of $10,000 required) havving an expense ratio of 0.06%. The Spartan 500, offered by Fidelity, is somewhere in the middle at 0.10% (but has a $10,000 minimum investment). This gives an overall nod to Vanguard based solely on the expense ratios.

How much does that save, though? Let’s say you invested $10,000 in each of those two funds. An expense ratio means that, in a given year, that percentage of the assets is being used to maintain the fund, employ the people running it, and so on.

So, at the end of 2009, a fund with a 0.06% expense ratio might have a face value of $10,000. Another fund with an expense ratio of 0.10% also has a face value of $10,000.

During the year 2010, the assets in those funds gain, let’s say, 2%. At the end of that year, the 0.06% expense ratio fund would have a balance somewhere close to $10,193.88 (depending, of course, when the expenses were taken out) and the 0.10% expense ratio fund would have a balance close to $10,189.80. This amounts to $4.08.

In other words, when the difference in expense ratios is small and your investment amount is relatively small, the amount of money you’re saving and losing is small.

However, let’s say you’re investing $1,000,000. The amount of money due to the difference in expense ratios is much closer to $408, and suddenly you’re talking about significant money.

Even with the $60,000 mentioned in the question, you’re talking about an approximate annual difference of $24.08, which may be less than the value they get from talking face-to-face with an advisor.

What about the difference in expense ratios? Let’s say that one fund has an expense ratio of 0.06% and the other has a ratio of 0.60%. You’re talking about a rough difference of $55.08 per year on an investment of $10,000, and $5,508 per year on an investment of $1,000,000. That’s a big difference.

Again, these types of comparisons only mean anything if you’re comparing very similar investments. The greater the difference between the investments, the less it means in the sense of a direct comparison.

As a rule of thumb, I usually subtract the expense ratio from the annual return numbers on any investment I look at. Although this isn’t anything like an exact comparison, it does give me an idea of how much I’m going to be hamstrung by their expense ratio over the years.

Usually, this leads me to investments with very low ratios. Usually, I find these types of investments at Vanguard or Fidelity, the two places you mention.

It is important to note that you shouldn’t just chase low expense ratios when you’re investing. Putting everything in the investment with the lowest expense ratio isn’t well diversified and will lose you money.

To put it simply, when you’re investing small amounts and the difference between the expenses in comparable investments is small, you’re talking about pennies (or a few dollars). But if either of those factors grows large, you’re quickly talking about dollars – and often lots of dollars.

This is an issue that I’ve discussed a few times in reader mailbags, but I continue to receive so many questions about it that I think it needs to be thoroughly discussed.

Over and over again in personal finance writing, you’ll find references to investment returns on the order of 10% to 12% per year (and sometimes even higher).

Over and over again in his books, Dave Ramsey makes statements like “Invest the $200 difference each month at 10 percent for the next seven years of the car loan. That $200 a month will grow over those seven years into $24,190.” (from The Total Money Makeover Workbook, emphasis added).

Entire books, such as Millionaire By Thirty by Douglas, Emron, and Aaron Andrew, proudly proclaim that rates of return as high as 15% are not only possible but probable over the long haul.

These are just two examples among many. The reason is that there’s a lot of reward in suggesting amazing stock market returns. It makes your financial plan, whatever it might be, look brilliant. You can suggest almost any old ludicrous thing, but if you’re eventually putting it into an investment that returns 12% a year for a significant period, well, your “plan” turns people into millionaires like it’s nothing!

Too bad it doesn’t really work that way.

Over the last decade, the stock market (as estimated by the S&P 500, an index of 500 stocks) has returned about 3% annually. It’s not been the best decade, with two strong downturns in it (2001-2002 and the almost apocalyptic 2008), but it’s an extreme far cry from 12%.

The housing market was producing returns of around 15% per year for the first part of the past decade. The last part? More on the order of -15% per year.

If there’s anyone I’d trust to make long-term calls on the stock market, it’s Warren Buffett. In his own words: “I would expect now to see long-term returns run somewhat higher, in the neighborhood of 7% after costs.”

Here’s the truth. You can sometimes stumble on investments that return 10-12% – or even better – for a few years. Eventually, however, there’s a correction. Speculators get out. People head for the hills. The reason is that the investment becomes overpriced.

(Warning: economic theory approaching. If you’re uninterested, skip this paragraph.) Things increase in value because it produces more than it once did. Most of the time, this is due to an increase in productivity. According to an awful lot of metrics and studies, human productivity does increase over time, but it doesn’t increase annually at a rate of more than 7%. If anything, it increases at a slower rate. (Productivity is difficult to accurately measure.) If you add productivity and inflation together in a very stable economy, you’re probably getting somewhere close to 7%, maybe a bit higher. In other words, the natural value of something fueled by human ingenuity’s actual value increases at a rate less than 7%. When something begins to gain value at a faster rate than that, you’re witnessing a bubble in action. There are speculators involved and, by the time you’ve heard about it, the speculators are usually itching to take a profit.

Add all of these factors together and I think Buffett’s long term prognosis is accurate. I would use 7% annual returns as my long term estimate for an investment with the risk level of the stock market. You might be able to beat that annual return over a short period due to luck, but volatility will eventually eat that return up. You might even be able to beat it over the long term, but you’re taking a lot of risk to do that.

Because of this, I’ve recently started sticking to 7% annual returns for my long-term financial estimation. I calculate a 7% annual return on my retirement portfolio for a long while, eventually going down to about 4% as I move it into secure stuff at retirement age. I use a 7% annual return for every bit of long term savings. I use less than that for short term savings, usually basing that on my current savings account rate, with the advantage that short term savings is essentially riskless. I would suggest you use similar estimates in your long term calculations and be very wary of people proclaiming plans with much higher returns involved.

A few weeks ago, I put out a call on Twitter and on Facebook for detailed posts that people would like to see. I got enough great responses that I’m going to fill the entire month of July – one post per day – addressing these ideas.

On Facebook, Edita asks a simple question: “Among diffrent 529 plans.. which one to choose?”

First of all, let’s talk about what a 529 plan is. A 529 plan is “a tax-advantaged investment vehicle in the United States designed to encourage saving for the future higher education expenses of a designated beneficiary.” (source) In other words, it’s an account that you put after-tax money into (meaning ordinary money out of your checking account). That account has a stated beneficiary (often your child, but it might be you if you’re saving for your own future graduate education or something to that effect). When money is withdrawn from that account for educational purposes, you do not have to pay taxes on the returns that money earned while sitting in the account.

There are two distinct types of 529 plans: prepaid plans and savings plans. Prepaid plans are less common (only 11 states have them), but they usually mean that you’re directly “pre-paying” for tuition at public universities within that state by buying tuition credits at that school. These credits are based on current tuition rates and thus are a bargain if your child is going to go to that school. Savings plan 529s are much more common. They function much like a savings account, where you deposit money, it grows within that account, and then you can withdraw it to spend on educational purposes.

Finding the right 529 plan is tricky because so many different states offer them and individual states have differing tax rules when it comes to 529 plans. For example, some states have rules where you have to pay taxes if you withdraw money from another state’s 529 plan.

The first step I would take is identifying the “must-have” features. This depends a lot on your situation and each situation is different. For me, there are four “must-have” features.

It must be a “savings”-style 529. I do not want to lock my children into a specific university or small set of universities.

Other family members must be able to make contributions. I want grandparents to be able to easily contribute to their grandchildren’s 529 accounts.

I must be able to transfer account ownership at any time. This ensures that the account will be there for my children no matter what happens in my personal life between now and when they need the account.

I must be able to meet the minimum contribution level. This can certainly be a big concern for some families who have to really stretch to make payments into the 529 account.

There are actually quite a few plans that meet these criteria. So, the first step I would take is to look at my own state’s 529 plan. Using your own state’s 529 plan minimizes the chances that you’ll be docked by having to pay income taxes on the plans in other states (of course, this is a non-issue if you live in a state without state income tax).

For me, the search ended here. I’m a big fan of College Savings Iowa, as it met all of my needs quite well while also offering strong investment choices (they’re backed by Vanguard). Which brings me to my second factor…

If you’re not completely sure about your own state’s 529 plan, start comparing them. This is particularly true if you live in a state without income tax and plan to live there for a while.

The biggest issues you’ll need to look at are the quality of the investments offered in the plan. I would not base this comparison on past performance. Past performance is not an indication of future results – it’s one factor among many. Not only that, many 529 plans have a relatively short history, meaning the past performance data is limited and not particularly valid for comparison.

Other factors that are more important (from my perspective) include the diversity of investments offered within that state’s plan (the more the better), the availability of “targeted” funds that mature when your child graduates from high school, and low fees (such as investment fees, program fees, and other expenses).

Other key factors I would look for in a 529 include easy online access to accounts (most states have this, thankfully; it’s almost a make-or-break feature for me), a good customer service reputation (Google for reports from users), and the ease with which they make rollovers into other 529 plans possible (in case I move or some other change occurs).

There are a lot of tools online that will help you compare the features of 529 plans (like this one), but the big factors in choosing a plan aren’t strictly investment based. They have more to do with you and your child’s future than anything else.

A few weeks ago, I put out a call on Twitter and on Facebook for detailed posts that people would like to see. I got enough great responses that I’m going to fill the entire month of July – one post per day – addressing these ideas.

On Facebook, Shannon asked “What book/blog/resource do you recommend as a dummys guide to learning about investments? I’m not sure where to start.”

Over the past several years, I’ve read piles and piles of books and websites and other materials related to investing. Here are the gems I’ve found, focusing particularly on resources most useful for learning.

But first…

Where Not to Start
While there are quite a few great resources out there for learning about investing, there are also many resources out there that are pretty poor tools for learning for various reasons. Until you’re very familiar with investing topics, I would avoid these information sources and take the words they say about investing with a grain of salt.

Any source using a lot of terms you don’t understand This is true in any field, and investing is no different. If you tackle information that’s too full of the terminology of that field without naturally understanding what that terminology means, the information you absorb isn’t going to have much meaning. If you can’t get through a sentence without having to hit a reference book once or twice, just disregard the document for now and wait until you have a firmer grasp of the terminology. In fact, trying to read such a document should be a sign that you need to study up.

Publications directly produced by investing houses I’m not talking about investment prospectuses (the documents that investment houses have to give out that outline the specific details of a certain investment), as those are heavily regulated. I’m talking about general investing guides. Quite often, these guides are marketing materials in disguise, designed to slant you toward the investments offered by that investing house. Avoid them, particularly if you’re just getting started.

Financial magazines and newspapers This might be surprising to some, but I would avoid financial writing in such places. Most of the time, the mainstream financial press simply uses representatives from investment houses as their sources for articles, meaning that the investment advice you’ll find there often focuses heavily on whatever new investment the investment houses are pushing. Some articles in the press are legitimate and well-researched, but there are enough questionable things floating in the water and enough useful resources elsewhere that you’re better off just avoiding all of it until you have a sophisticated understanding of investing.

Websites that include opportunities to buy There are a lot of subtle hints that online information might be shady, but the biggest one is that the website eventually encourages you to buy whatever investment they’re talking about. When you see this, it’s almost always a sales pitch placed there by someone who has money to gain as a result of you buying that investment, which usually means that it’s a bad idea for you to buy it.

So what resources can you trust? The first place I’d start is at the library.

Print Resources
There are a handful of books I really trust as great introductions and references for investing information.

If you’re a complete beginner, Investing for Dummies by Eric Tyson is a strong choice.

It’s one of those books that you read once and the foundational knowledge it gives you enables you to understand most things you’ll read about individual investing, but by itself it’s not a particularly vital book on investments. I would absolutely suggest it to someone who looks confused at the word “bond.”

The single best all-around book I’ve found is The Boglehead’s Guide to Investing by Taylor Larimore, Michael LeBoeuf, and Mel Lindauer.

Why is this book so strong? It does a fantastic job of explaining the ideas behind investing. While it does make recommendations of various kinds, it faithfully explains the ideas behind those recommendations. It sticks to the conservative side when discussing and recommending investments, too, so you’re not going to fall into any risky investment traps.

If you’re looking for more on specific investment types, the Little Book series by Wiley do a great job of covering specific investment types in terms that a layman can understand. Most of the books are excellent.

Over the years, I’ve reviewed most of the entrants in this series: The Little Book of Behavioral Investing; The Little Book of Big Dividends; The Little Book of Bull Moves in Bear Markets; The Little Book of Bulletproof Investing; The Little Book of Commodity Investing; The Little Book of Common Sense Investing; The Little Book of Economics; The Little Book of Main Street Money; The Little Book of Safe Money; The Little Book Of Value Investing; The Little Book That Beats The Market; The Little Book That Builds Wealth; The Little Book That Makes You Rich; and The Little Book That Saves Your Assets. Virtually all provided a worthwhile explanation of their specific topic.

If you manage to read through all of these books, you’ll find yourself with a very strong background in individual investing.

Online Resources
The best online resource for learning about investing that I’ve found thus far is Investopedia’s Investing 101. It does a great job of briefly and clearly walking you through the basics of investing. If you wish, you can also download the whole thing in PDF format.

If you prefer to learn in audio form, there are some wonderful audio resources that do a great job of teaching investment basics. Among those, the far and away best option is Money 101: Retirement and Investing by Marketplace (American Public Media), which is a wonderful series of audio recordings that explain investing in rich detail.

If you start moving outside of these resources, though, beware. Be very careful that the “learning” resource you’re reading isn’t just a cleverly disguised sales pitch from an investment advisor or an investment house. Know what the source of the information is. Is that person or organization, in the end, trying to sell you a product? If they are, then be very, very careful.

Good luck!

A few weeks ago, I put out a call on Twitter and on Facebook for detailed posts that people would like to see. I got enough great responses that I’m going to fill the entire month of July – one post per day – addressing these ideas.

On Facebook, Silver requested a post on the topic of “Investing in precious metals – worth it?”

This is a question that doesn’t really have a straightforward “yes” or “no” answer. It has to do with a lot of other factors, risk tolerance being a big piece of it. Let’s walk through the whole picture.

How One Invests in Precious Metals
Usually, when people discuss investing in precious metals, they’re talking about buying and selling gold, silver, and/or platinum.

This investment takes two forms. Sometimes, people will buy the physical metal and store it somewhere privately. For example, people will often purchase gold and/or silver coins and keep them in their safe or in their safe deposit box at their bank. One person I know has several pounds in old gold coins sitting in their safe.

Another option is to buy a precious metal ETF. Essentially, this means you’re buying a stock whose price is tied to the current value of that precious metal, usually meaning that the ETF represents ownership of some small amount of that metal. If the value of the metal goes up, the value of the ETF goes up.

There are also ETFs that represent precious metal interests, such as ownership of silver or gold mines or refiners. These often track roughly with the rise and fall in value of precious metals, but not perfectly (they tend to be a bit less volatile, in my experience).

The Upside
There are several big pluses to investing in precious metals that many people point to.

One, it’s a physical commodity. If you own gold, you actually own a piece of that precious metal. This is opposed to things like a share of stock, which only exists on paper (as the company it’s a share of only exists on paper, in the end).

Two, it’s a limited commodity. There’s not an overabundance of any precious metal in the world. Yes, there is more mined all the time, but the total quantity isn’t growing at a very rapid rate.

Three, the price of precious metals often runs in the opposite direction of the United States and other Western economies. The recent enormous increase in the value of gold has come during a period of great weakness in the United States economy. The last big run-up in gold prices came during another period of great weakness in the economy. Many people once argued that the value run-up was a response to high inflation, but this most recent run-up has come during a period of very low inflation. The repeating pattern mostly seems to be a weak United States economy.

This means that people often move into gold when the United States economy looks weak (driving up the price) and they move out of gold when the United States economy looks economically strong (causing the price to drop). This is an extremely rough approximation.

Obviously, right now, people point to the tremendous recent jump in value in gold and silver as an example of how strong an investment in precious metals is. This is both a good and a bad.

It demonstrates that, yes, there are huge value jumps in precious metals that you can get rich off of. If you had bought gold at $300, you’d be rich now.

The Downside
In the short term, however, the big run-up in value in precious metals has already happened. If you’re looking to get rich quickly in precious metals, that ship has sailed. There may still be value increases, but the rocket ship ride that occurred in precious metals happened already over the past few years, and if you didn’t own precious metals during that period, you missed the rocket ship.

The huge upwards jump and the many recent rollercoaster-esque rises and dips in the values of precious metals demonstrates clearly the biggest flaw in investing in precious metals: they’re incredibly volatile investments. Jumps of 50% in value in a single year aren’t unusual over the history of precious metals, nor are drops of 50% in value.

In other words, right now we’re (at the very least) sitting fairly far up along the run-up in value of an extremely volatile commodity. This is not a place I want to be unless I’m truly hedging against something disastrous, and the only situation in which I’m doing that is if I’m convinced that other investments are going to lose the majority of their value in the very near future.

Thus, often, gold is sold alongside a healthy dose of paranoia. Much of the recent popularity in precious metals has come with gold sellers advertising on apocalyptic talk radio shows. Those shows spend a lot of time convincing people that the American economy is about to collapse and other apocalyptic facts so that the sales job for gold becomes much easier – which is exactly why gold sellers are happy to pay good money for these apocalyptic radio hosts to do the gold sales pitch for them. They both make money and the listener who buys in is left holding a very volatile investment near the top of its value.

(An aside: you would be shocked how often gold sellers want me to pitch their products to you. Often, they’re offering good money to do so.)

Another factor is that in a limited market like this, speculators run rampant. Every significant commodity market has speculators – people who are more interested in turning a short-term buck than earning money on a lasting investment. I don’t see anything wrong with speculation, but in order to compete with speculators, you have to really know what you’re doing in that market and very few individual investors do.

So, When Should One Invest?
I think that if you have a large portfolio of investments that includes a lot of other asset classes – domestic and foreign stocks, bonds, cash, foreign currency, real estate, and so on – precious metals might be another element you might want to include. Obviously, this element would be a very volatile piece of your investment picture, but you can balance that with other stable investments.

I would not buy precious metals unless I already had a significant amount of investments to counterbalance the volatility. If you don’t already have a lot of investments, buying precious metals means that you’re making the sum total of your investments incredibly volatile. You might wake up in three months to find that your life’s savings has lost 50% of its value.

I would absolutely not try to “play the gold market” (or the silver or the platinum market) unless I knew exactly what I was doing. In other words, if I had studied the markets extensively for years and had experience in short-term investing, I might try it. This excludes the vast majority of investors out there and most likely excludes you.

Kelly writes in:

I’m reading about retirement and I see terms like Traditional IRA and Roth IRA and 401(k) thrown around without really explaining what they are or what the differences between them are. Do you have a summary of these plans and how they work?

There’s no better time than the present to offer up some great fundamental personal finance information like this. I’m going to ask a series of basic questions about retirement plans and provide the answers for each type of plan so that you can clearly see how they differ in each area.

I myself have had a 403(b) in the past and I currently have a Roth IRA.

One important point to make: this is a summary of the differences between the plans. Plans often change over time as the government alters the tax code and many plans have loopholes that appear and disappear as the years go by. The goal here is to not provide a be-all-end-all reference, but to make clear the big differences between the plans.

Right off the bat, let’s clarify a key point. A 401(k) and a 403(b) are essentially the same thing. The difference between the two is whether or not your employer is a for-profit entity (a business) or a certain type of non-profit entity (such as an educational institution). In terms of the employee, they’re virtually identical in their usage. Some types of non-profit entities also offer a 457 plan, which is very similar to a 401(k)/403(b) except with a few less restrictions on withdrawals.

Who Offers the Plan?
How can you get involved in each type of plan?

A Traditional IRA is offered directly from investment houses. In order to open a Traditional IRA for yourself, you have to open an account with an investment house. Some well-known investment houses that I use (or at least somewhat recommend) include Fidelity and Vanguard.

A Roth IRA is offered in the same way as a Traditional IRA. You have to set up your account yourself with an investment house (like Fidelity or Vanguard).

A 401(k)/403(b) is offered through your employer. Your employer sets up an arrangement with an investment house to provide individual 401(k)/403(b) accounts to their employees. Rather than having a choice of investment houses, you are stuck with using whatever investment house your employer provides.

Which has the advantage? The IRAs have the advantage here. Because you have the freedom to choose which investing house to use and can move from investing house to investing house, these companies have good reason to offer you strong investment options. With a 401(k)/403(b), you’re locked into whatever investment house your employer negotiates with, which may or may not provide you with the best investment options. This doesn’t mean that the investment choices in a 401(k)/403(b) are terrible; usually, it just means that the fees are a bit higher than they would be with your own IRA.

Who Is Eligible?
Which people are eligible for each type of plan?

You are eligible for a Traditional IRA if you are under the age of 70 1/2. You must also earn some sort of income from work or be married to someone who earns income from work.

You are eligible for a Roth IRA if you are eligible for a Traditional IRA. The requirements are the same.

You are eligible for a 401(k)/403(b) if you are employed by an organization that offers such a plan to its employees.

How Much Can You Invest?
How much money can you invest in each plan each year?

In a Traditional IRA, you can invest $5,000 per year if you are under 50, or $6,000 per year if you are over 50. These numbers are accurate for 2011 and may go up in future years (they’ve gone up in the past).

In a Roth IRA, you can invest the same amount as in a Traditional IRA. However, there are income caps for investing in a Roth IRA. If you are single and earning between $107,000 and $122,000 or if you’re married and earning between $169,000 and $179,000 per year, your upper limit is less than $5,000 or $6,000 per year. If you’re over the top end of that range, you can’t invest money at all into a Roth IRA this year.

In a 401(k)/403(b), you can invest up to $16,500 per year as of 2011.

Obviously, in this regard, 401(k)/403(b) plans are the big winner as you can invest more in them.

What Tax Advantages Are Included?
The purpose of a retirement plan is to take advantage of tax breaks. What tax breaks do you get with each of these plans.

A Traditional IRA offers the ability to make contributions that are fully tax-deductible. In other words, if you contribute $5,000 to a Traditional IRA in 2011, you will be able to subtract $5,000 from your taxable income when you file your taxes early next year. This results in a smaller tax bill right now.

A Roth IRA contribution does not offer the tax deductibility of a Traditional IRA contribution. Instead, once you contribute to a Roth IRA and have the account for at least five years, you can withdraw any money in the account tax-free (gains or otherwise) once you’re 59 1/2 years old. This results in a smaller tax bill later on, as Traditional IRAs require you to pay taxes with all withdrawals from the account.

A 401(k)/403(b) operates much like a Traditional IRA in this regard. You make contributions today that are fully tax-deductible with regards to your taxes for the coming year. However, there are no tax benefits when you withdraw.

Which is better? It depends strongly on what you think tax rates will do in the future. If you expect them to stay the same or go down, then the Traditional IRA and the 401(k)/403(b) route is better. If you expect them to go up, then the Roth IRA is better. I expect them to go up, so I give the Roth IRA the nod here.

When Can I Withdraw?
I have this money in the account. When can I take it out without a stiff tax penalty?

You can withdraw from a Traditional IRA at age 59 1/2 or any time after that. Withdrawals made from a Traditional IRA will be viewed as income and taxed as such. You must start taking withdrawals at age 70 if you haven’t already started.

You can withdraw from a Roth IRA at any time (once you’ve had the account for five years) as long as you merely withdraw your contributions. You can begin to withdraw your investment gains at age 59 1/2. You do not have to start withdrawing at age 70.

You can withdraw from a 401(k)/403(b) in almost exactly the same way as a Traditional IRA. You may start withdrawing at age 59 1/2. The withdraws you make are taxed. You must start withdrawing at age 70.

The Roth IRA is clearly the most flexible account here. There are no tax penalties for withdrawing contributions early. There’s also no requirement to begin withdrawing at age 70.

How Can I Withdraw Early?
What if I desperately need the cash early? This is usually a bad idea, but it’s worth knowing.

You can withdraw early from a Traditional IRA if you pay a 10% additional tax penalty on your withdraws. This is beyond the normal income tax you’d have to pay on it. So, if you withdraw $10,000 from a Traditional IRA early and are in the 25% tax bracket, you’ll pay $2,500 in taxes on it plus an additional $1,000 penalty. There are some exceptions to these rules for special situations.

You can withdraw early from a Roth IRA if you’ve had the account more than five years. At that point, you can withdraw contributions with no penalty and no tax. If you’ve not had the account for that long, you’ll have to pay a 10% tax penalty on your early withdrawal. If you withdraw above and beyond your contributions before you’re 59 1/2, you’ll have to both pay taxes and a 10% penalty on those additional withdrawals. There are some exceptions to these rules for special situations.

You can withdraw early from a 401(k)/403(b) much like a Traditional IRA. You pay a 10% additional tax penalty on your withdraws beyond the normal income tax you’d have to pay on it. As always, there are some exceptions to these rules for special situations.

Again, the Roth IRA is the best deal here. It offers more flexibility with early withdrawals than the other plans.

A Final Factor
At this point, a 401(k)/403(b) plan looks like the worst option, but there is one huge factor in that plan’s favor. With many employers, the employer will offer matching contributions. For example, one employer that I know of offers one-to-one matching of every dollar an employee contributes to their 401(k)/403(b) up to 6% of the employee’s pay. So, if the employee makes $50,000 per year and contributes 6% of that – which would be $3,000 per year – the employer would match that, giving that employee a total of $6,000 invested each year.

This blows away the benefits offered by other plans. The strength of this kind of multiplying of retirement funds is the best tool you have available to you – if your employer offers it.

What Should I Do?
Here’s my take on the plans as a whole and how I invest for my own retirement.

If my employer offers matching funds on my 401(k)/403(b) plan, I take advantage of those matching funds first. I would contribute as much as possible to retirement to get every drop of matching funds. This is free money that you should never turn down.

After that, I would fully fund a Roth IRA if I were eligible for it. If you make less than $100,000 a year, you’re eligible for it. Find a trustworthy investment house – I use Vanguard, but do your own research – and open a Roth IRA with them. They’ll make it easy for you to open the account and set up an automatic investment plan that pulls money from your checking account.

If I wasn’t eligible for a Roth IRA, I would fully fund a Traditional IRA.

If I was still not saving 10% of my income for retirement, I would invest enough in my 401(k)/403(b) to add up to 10% of my salary. So, for example, if I were making $100,000 a year and I contributed $4,000 to my 401(k) to get matching and $5,000 to my Roth IRA to fully fund it, I’d still only be saving 9% per year. I’d contribute another $1,000 to my 401(k) to get to that 10% threshold.

I would then pay off any and all debts I have. Before contributing more than 10%, I would get myself to complete debt freedom. I would also take care of buying whatever house I wanted to live in for the long term and make sure that I was saving for major purchases like automobiles. Riding a merry-go-round of debt eats away at your retirement like anything else.

If I were completely and securely debt free, I would increase my personal retirement savings to 15% of my income. This might mean fully funding a Roth IRA, contributing more to a 401(k), or even just saving money in a savings account or non-retirement investment account.

That is the plan I would follow at my age (32, as I write this). My only exception to that is that if I were over 35 and hadn’t saved for retirement yet, I’d put the 15% total savings at a higher priority than total debt freedom, as you have some retirement ground to make up for the years you weren’t saving.

Good luck!