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.

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.

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.

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.

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.

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!

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.

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!

You often tell people to put money in their savings account if they’re just saving for a year or two, but then you tell people to put money into stocks or other stuff if they are saving for lots of years. Why?

It’s probably easiest to explain this with an example.

Savings Accounts
Let’s say that, at the start of each year, you put $1,000 into a savings account. This savings account keeps your money safe and pays out 1.5% interest per year.

After the first year, you’ll have $1,015 in the account.
After the second year, you’ll have $2,045.23 in the account.
After the third year, you’ll have $3,090.90 in the account.
After the fourth year, you’ll have $4,152.27 in the account.
After the fifth year, you’ll have $5,229.55 in the account.
After the sixth year, you’ll have $6,322.99 in the account.
After the seventh year, you’ll have $7,432.84 in the account.
After the eighth year, you’ll have $8,559.33 in the account.
After the ninth year, you’ll have $9,702.72 in the account.
After the tenth year, you’ll have $10,863.26 in the account.
After the eleventh year, you’ll have $12,041.21 in the account.
After the twelfth year, you’ll have $13,236.83 in the account.
After the thirteenth year, you’ll have $14,450.38 in the account.
After the fourteenth year, you’ll have $15,682.14 in the account.
After the fifteenth year, you’ll have $16,932.37 in the account.

What’s worth noting here? First, the money is growing all the time. There is no point where the money’s not growing. There is no point where the growth is less than the year before. It’s steady, positive growth.

At the same time, it’s slow growth. You’re not seeing a skyrocketing increase in price over time. It’s going up steadily, but slowly.

Stocks
Let’s assume you put $1,000 into the Vanguard 500 (a broad-based stock market index) each year on the first trading day of the year, starting on January 1, 1996, and choose to reinvest the dividends. Here’s what happens with your money.

At the end of the first year (1996), you’d have $1,299.68 in the account.
At the end of the second year (1997), you’d have $2,996.43 in the account.
At the end of the third year (1998), you’d have $5,402.76 in the account.
At the end of the fourth year (1999), you’d have $7,231.63 in the account.
At the end of the fifth year (2000), you’d have $8,260.74 in the account.
At the end of the sixth year (2001), you’d have $7,862.39 in the account.
At the end of the seventh year (2002), you’d have $6,946.30 in the account.
At the end of the eighth year (2003), you’d have $10,862.61 in the account.
At the end of the ninth year (2004), you’d have $12,851.47 in the account.
At the end of the tenth year (2005), you’d have $15,573.23 in the account.
At the end of the eleventh year (2006), you’d have $19,308.22 in the account.
At the end of the twelfth year (2007), you’d have $20,217.50 in the account.
At the end of the thirteenth year (2008), you’d have $12,748.24 in the account.
At the end of the fourteenth year (2009), you’d have $18,745.44 in the account.
At the end of the fifteenth year (2010), you’d have $24,531.96 in the account.

While the overall growth upward is better than with the savings account, the stock investment is wildly uneven. There are individual years that are devastatingly bad, and the problem is that you can’t predict those devastating years. Your first year of investment might have been 2001, where you would have put $1,000 in at the start of the year and seen a balance of substantially less than $1,000 at the end of the year. You might have been planning to pull the money out at the end of the thirteenth year, except that thirteenth year saw a 40% drop in the balance and finds you in significantly worse shape than a simple savings account.

What Does All This Mean?
It’s actually pretty simple. If the date at which you’ll need the money is a long way off (say, fifteen years or more), the overall growth of things like stocks is the best route. Because you’re looking so far down the road, those individual bumps really don’t matter too much. You can live through another 2001 and 2002 or another 2008 if you’re looking fifteen years down the road or more.

On the other hand, if you know you’re going to need a certain amount in the next few years, you should have it in a savings account (or something else that’s highly reliable). It won’t provide rampant growth for you, but it will provide stability. You won’t lose your balance this way and you won’t find yourself in a situation where you need the money and it’s lost in a stock market collapse (in fact, people often need money when the stock market is down, as that’s a time when the economy is trending down, too, and there are job losses and so forth to worry about).

What if you’re in the middle? Have some of your money in each. As you get closer, move your money from the risky investment (stocks) to the less risky one.

Another vital point is that you should never try to time the market. Base everything on when you will need the money. If it’s a long time off, ignore what the market is doing this year. As your goal inches closer, slowly move the money into something more secure, regardless of what the market is doing at that moment.

Our question then becomes what can we do with that difference to secure our financial life in the future?

We have several avenues, of course. For one, we could simply accumulate cash in savings accounts and CDs. For another, we could buy highly secure investments that would return a bit more than savings accounts. We could also seek to simply maximize returns by investing in stocks that would give us a large return over the long haul.

However, after a lot of discussion, our biggest interest is in turning that money into a passive income stream while also using that money to support companies we believe in. We’d take our money and put it into a handful of companies we believe in – or at least ones that aren’t involved in businesses we find unethical or problematic – and then use the dividends paid by those stocks as an income stream. Our goal would be to avoid selling those stocks for a very long time, if ever, as the purpose would be to have a steady stream of income via the dividends.

Personal finance 101 here: dividends are small payments given to the holder of each and every share of a company on a regular basis. Many companies do this as a method of encouraging investment in that company and returning value to the people who own the company (the shareholders).

So, how would this work?

Let’s take a look at, say, Coca-Cola (stock symbol: KO). Coca-Cola’s stock pays approximately a 3% yield each year, which means that if the stock is valued at 100 steadily over the course of a year, you would receive $3 over the course of that year in dividend payments. So, if I bought one share of Coca-Cola today (at 67.40) and it held that value, I could reasonably expect to receive $2 over the coming year.

Let’s say, right now, we bought $20,000 in Coca-Cola stock. That would net us about 297 shares of KO, which we would then sit on for the time being. Each quarter, we’d earn a dividend payment of around $0.45 per share or so, based on the historical data, and that amount will likely inch upward over time. That’s a payment, each quarter, of $133.65.

$133.65 every three months? That’s not much, it seems. However, there are a few important things to remember. First, those payments will go out as long as the Coca-Cola Corporation exists and continues to pay dividends. Second, if I want my initial investment back, I can get some significant component of it back by simply selling the stock. If the stock is up, I could make some money just from selling the stock. If it’s down, I still made money from the dividend payments.

There’s also the question about future savings. If I were to continue to invest future savings in other dividend-paying stocks, I could eventually reach a point where the dividend payments are producing a significant portion of my personal income. This is exactly how many older and retired businessmen live – they earn income from the dividends on their stocks, and if you have enough, you can easily live off of them.

Let’s say, for example, we bought $2 million worth of Coca-Cola stock – 100 times as much. That would give us a dividend payment every three months of $13,365.00. That would be a very nice income stream, indeed, especially considering we would just sit back and collect the checks.

Now, what about the future? There are two factors to look at here.

First of all, will the actual stock value of Coca-Cola go up or down? Over the last ten years, the stock has held fairly steady. Even during the stock bubble bursts of 2000 and 2008, the value of KO didn’t drop as much as the overall market, and it’s up about 30% over the last decade. If you go back even further, it’s held steady value for a very long time. Why? People like to drink Coke. It’s reasonable to think that it will continue to hold value. Even more important, the company has been in good financial health for a very long time, with little debt and lots of revenue. It’s stable and steady for the long haul.

Second of all, will the dividend for Coca-Cola go up or down? This is much harder to tell, but one of the big shareholders of Coca-Cola, Warren Buffett, predicts that the yield for KO will go up about 7% per year over the next decade. In other words, Buffett believes that the yield will gradually slide upward from about 3% (where it is now) to about 4%. There’s also the fact that Coca-Cola’s dividend history is very long and very steady.

A final question for Sarah and myself would be whether we would want to invest in Coca-Cola. Are they in a business that ethically bothers us? Do they have business practices we support? That’s still an open question, but it’s a key part of the thought process we would have about any company we would invest in. We want to find dividend-bearing companies that aren’t engaged in businesses that ethically bother us and, preferably, do at least some things that we ethically support.

Is this an avenue we’re going to take? It’s certainly an avenue that’s a part of our discussions right now, along with eliminating our mortgage and focusing on maximizing our savings to buy a home in a different location. All of these have various appeals and, as with most things in our life since we’ve turned our financial situation around, we’re looking at each one before making a big leap.

Since we simply don’t live a lifestyle that involves spending all the money we take in – nor do we have an interest in that – we’re left with the great problem of deciding what to do with the remnants. This is the reward of living frugally and within your means. This is the reward for not buying stuff just because you happen to lightly desire it today.

Really, in the end, their questions come down to one issue. Can I beat the stock market and earn a greater return for my money than I might get in an ordinary index fund?

The answer is yes, of course you can, but the ability to do so isn’t that simple.

Here’s how I like to explain it. Let’s take 1,000 random people who have at least some money invested in the stock market, whether in their retirement funds or otherwise, and give them each $100,000 to invest in the stock market.

At the end of the year, if you added up the market value of all of those investments and compared it to the total amount you started with ($100,000,000), the amount of total growth would be about the same as the overall stock market.

That makes sense, right? Some of those investors will do better than the market. Others will do worse. A lot of them will tread water and roughly match the market.

It’s really not all that different than filling out an NCAA basketball tournament bracket. Very few people will miss all of their picks, and very few people will pick the Final Four completely right. Some of the picks will seem easy (a 1 seed versus a 16 seed) while others will be very tricky (an 8 seed versus a 9 seed). Most people will end up somewhere in the middle, getting some picks right and missing on others. The ESPN Tournament Challenge demonstrates this quite well (I was at the 53rd percentile, by the way, with none of the Final Four picked correctly).

Those people that do beat the market, just like the people who pick the Final Four correctly, show that it is possible to beat the odds. If you know how to do this well, you can certainly make a lot more money than the average investor.

The problem is that very few people can do this consistently over a long period of time.

There certainly are people who have done it in stocks. Peter Lynch and Warren Buffett immediately come to mind.

The problem is that if people have a knack for doing this, they’re often scooped up quickly by the hedge fund or private equity businesses and make an obscene amount of money plying their trade. Individual investors – you and me – don’t have access to their expertise without paying a lot of money, and if you’re like me, you don’t have that kind of money to pay someone for advice. The fees for the attention of someone on that level would obliterate the amount I actually have to invest, leaving me with very little.

Thus, for me, there’s really only two options: doing it yourself or simply buying an index fund and playing the average.

Doing it yourself can be very rewarding. You know exactly what you’re investing in and have control over it. You have the freedom to choose companies to invest in that you actually believe in instead of just pieces of lots and lots of companies. Having the right handful of companies can certainly beat the market – just ask anyone who bought Google in 2002.

One problem is that doing it yourself can also be a big time sink, especially if you’re trying to maintain some degree of diversity, which you should be (Diversity simply means that you own lots of stocks of companies in unrelated sectors, like owning stock in Coca-Cola, Nike, and DuPont all at the same time, which is good because if something affects Coca-Cola’s bottom line, it shouldn’t have much of an impact at all on Nike or DuPont). You have to invest the time to study a lot of companies, make the decision as to which ones to invest in, and then keep a constant eye on them.

Another problem is that with those rewards comes risk. The smaller the number of stocks you’re invested in, the greater the risk of being hurt by a slump in one particular economic sector. The larger the number of stocks you’re invested in, the more time you have to devote to simply managing your stocks.

My advice generally is this: if you’re passionate about stock investing and are willing to take on some additional risk for some additional reward, individual stock investing can be worthwhile and you can sometimes do better than the stock market. However, if individual stock investing isn’t something that excites you, don’t. Invest in an index fund and you can just ride the average due to owning a little bit of lots of companies.

Of course, no one says you can’t do both. An old friend of mine has most of his money locked up for retirement, but he keeps about 5% of his paycheck aside to invest in individual stocks. He mostly buys stocks that he understands that pay a high dividend. His stocks rarely shoot up in value, but he does receive some nice dividend checks. Plus, it’s a great hobby for him that isn’t sinking his future.

That’s the biggest win of all, perhaps.

So, let’s back up. An income stream just refers to any source of regular financial income in your life. Your job is one. Your pension is another. Rent from an apartment building you own is yet another.

Of course, I don’t have the regular time to invest in another job or another high-content website at this time, so, for me, the best route to look for new income streams is to evaluate passive income streams.

What’s a passive income stream? A passive income stream is one where, once you’ve done the initial investment, there’s little or no upkeep to that investment required to maintain the income stream. Writing a book is a passive income stream, for example – once that book is complete and on its way to the publisher, you just sit back and wait for the proceeds.

Most passive income streams require some sort of significant investment up front. Generally, that investment breaks down into two distinct groups: an investment of money or an investment of time.

I’m going to stick with discussing the types of passive income streams that I’m interested in developing.

Investing Time
Most time investment usually pairs with an investment of ideas and energy as well. Generally, you’re turning spare time into some sort of item that will provide a steady stream of income over time.

Books, electronic and otherwise I’ve already written two books – 365 Ways to Live Cheap and The Simple Dollar. Both are working for me as passive income streams, but the stream from each book is quite small. Unless you’re J.K. Rowling or John Grisham, the passive income stream from writing books is not going to sustain you. The solution, of course, is to write several books so that the streams add up to something significant.

Another factor when it comes to writing books is that the options for self-publishing just get better and better. Self-publishing is a double-edged sword. When you self-publish, you tend to retain a much greater percentage of the proceeds for yourself, but your distribution tends to become more of a problem, as it’s hard to get your book on the shelf at Barnes and Noble. The growth of great self-publishing platforms and the rise of e-readers like the Kindle have mitigated these worries somewhat. If I write another book, I will most likely self-publish it.

Static websites Another approach is to simply develop a static website that provides information on a specific topic, then add some sort of revenue-generating mechanism to it – affiliate links to Amazon, a portal to buy a product of some kind, direct advertisements, or something else. Once that’s in place, spend some time developing links to it so that Google can find it. After that, you’ll keep generating a steady trickle of advertisement and referral revenue.

At some point, this is the route that The Simple Dollar will take if I ever choose not to keep writing it. I’ll turn off comments, make the site static, and go on with my life. It’ll still earn some revenue for a very long time.

Investing Money
On the other hand, one can simply invest money with the purpose of generating a passive income stream. This, of course, requires a chunk of money up front and an expectation that each year will only return a small portion of that initial investment. Usually, though, some significant portion of that initial investment can be recouped through selling the investment or waiting for it to fully mature.

Dividend-bearing stocks If you bought $10,000 worth of Coca-Cola stock one year ago, you would have bought in at roughly 53.60 a share, which means you would have purchased 186.5 shares of KO. You would have received four dividend payments of $0.44 per share during that period, so each dividend payment would have been $82.09, for a total of $328.36 over that year. It’s a 3.28% return, plus you still have the 186.5 shares of KO stock.

If you choose a very stable company that pays out a very steady dividend, this type of approach can earn a very reliable income for you. On the other hand, you are invested in a single stock, so you would probably want (over time) to invest in a variety of dividend-bearing stocks. You might also want to invest in an index fund that spreads out your investment over a lot of stocks (less risk), but also waters down your dividend (less return).

Treasury inflation-protected securities TIPS are bonds that you can purchase from the government that return at a fairly low rate, but their face value adjusts according to the rate of interest, so that when the TIPS matures, you will be able to sell it for more than the initial purchase price.

TIPS return at a very low rate, of course, but they have the advantage of being rock-solid investments that will match inflation growth when you sell them.

Savings accounts and CDs This is a similar rock-solid investment that is also very liquid (meaning you can pull out the money whenever you need it), but the interest rates (right now) are very poor. There are times when a savings account or CD is very solid. This is not one of these times.

Annuities Annuities are investments you can purchase, typically from an insurance company, that will pay you a certain amount each year for the rest of your life. The younger you are, the smaller that amount is, of course.

Let’s say, for example, that you purchase a $10,000 annuity, one that the insurance house quotes at 4%. That would mean you would receive $400 each year for the rest of your life from that company.

The risk here, of course, is that the insurance company may eventually become insolvent, leaving you with nothing at all. If I were to purchase this, I would seek out an insurance company with a long history of stability and a great bond rating, and even then, I’d diversify across multiple insurance houses.

What approaches am I considering? I’m still investigating several of these approaches, but I can say that I am moving in a direction where more passive income is a part of my life. As I actually begin to make moves in these directions, I’ll post about the moves on The Simple Dollar.

Passive investing is a strategy that has a great deal of appeal to me, so I was quite eager to read this book that discussed passive investing as a broad strategy with great depth and reasoning.

So, what’s passive investing?

To put it simply, passive investing refers to an investing strategy that doesn’t require any kind of forecasting or predictions and thus requires very little effort to manage (thus the name “passive”). Because of that, the costs of such a strategy are quite low, meaning savings in the investor’s pocket (and thus more money to invest rather than dump into brokerage fees). Usually, this means either investing very broadly (usually meaning buying index funds that are essentially large collections of different stocks, commodities, bonds, or other investments, meaning if one fails the whole ship doesn’t go down) or investing in things that offer a very steady return (like savings accounts, CDs, treasury notes, highly rated bonds, or stocks that pay a very reliable dividend). Sometimes, you can do both at the same time.

This book, by Richard Ferri (a writer for Forbes and the head of Portfolio Solutions) and with a foreword by John Bogle (founder of Vanguard, the company where I keep much of my investments), simply makes the case for why passive investing is a very good choice for many investors, particularly those who do not have the time or financial expertise to compete with Wall Street professional investors.

The Active Versus Passive Debate
Although this section is called a “debate” between active and passive investing, it largely just makes a great case for passive investing as compared to active investing.

Let’s step back for a minute and state what active investing is. Active investing occurs when you invest in something with the goal of selling it at a profit at a later date. Doing this means not only forecasting what will happen in the market as you choose what to buy, but watching the market and deciding what the right time to sell is. You have to be actively involved with the investment.

That, of course, has a time cost. Many people choose to pay brokers and fund managers money to take care of that time cost, which would be great if such people could consistently beat the market.

But they can’t. The market is simply the average of what all of the investors out there are doing. Sometimes, a particular fund manager or broker might beat the average, but the next year, they very well might not. When you consider that you’re paying for this type of performance, why not just try to seek a way to find the average on your own?

That’s essentially what indexing does. The idea behind it is that you buy some of everything without doing any active investing at all. Then you sit on it until you’re ready to sell it. Over that period, it will have tracked the average very closely and the costs associated with it are really low.

Why doesn’t everyone do that? People often want to – or believe they can – do better than that. They tend to believe they’re above average and thus will get above average results. The problem is that simple math shows it doesn’t happen. Only half of the group actually can be above average, and with everyone competing, that above average group is constantly shifting, with people moving up and people falling back. The book estimates that at any given time, one in three investors will be able to beat the average after costs, and that one in three is constantly changing. If you’re paying a huge fee to be in this contest, why not pay a small fee and just bet on the average?

Chasing Alpha and Changing Behavior
Alpha refers to the excess return an investment bears for the risk borne. An investment with a higher alpha is one that returns very well for the risk involved, while something with a low alpha has poor returns for the risk. Loaning money to your deadbeat cousin is an investment with low alpha, for example, while finding the “perfect” stock pick has a high alpha.

Obviously, active investors are seeking alpha. They want investments that offer a return that far exceeds the risks involved. The problem is that everyone is hunting for these investments. High alpha investments don’t last very long because investors jump on board rapidly when it’s found, causing the price to go up and the advantage to disappear.

The truth is that very few people have enough investing skill to actually find investments with a high alpha before everyone else does. Those that do are usually quickly gobbled up by hedge funds or the family fortunes of the very rich. Unless you’re extremely lucky, your personal broker is not one of those people who can effectively find alpha.

Why don’t more people passively invest, then? Passive investments aren’t highly advertised and promoted like active investments are. Active investments (like managed mutual funds and brokerages) get television ads; passive investments do not because, by their nature, they’re trying to minimize costs.

The Case for Passive Investing
The final section of the book is interesting, as Ferri essentially rewrites the excellent case spelled out in the first two sections of the book and boils it down to a handful of pages targeted to various specific groups: the individual investor, charities and personal trusts, pension funds, and advisors. In each, Ferri pulls out the specific facts that are most relevant to the investing needs of that particular group.

For example, when making the case for individual investors, he argues that the best way for individuals to invest is to seek out investments that maximize return within the risk that they’re allowed to carry. So, for example, some personal investments may want no risk at all (retirement savings when close to retirement), while others can take substantial risk (your “dream house” fund).

Once you have a firm grasp on this, you simply select index funds on your own that match the level of risk you can accept. This is actually exactly how my wife and I started our “dream home” fund. We knew that we could afford some significant risk on this since it wasn’t a life-or-death situation, so we’ve put our money into a pair of diverse stock index funds that carry some significant risk (one is purely international stocks).

Is The Power of Passive Investing Worth Reading?
If you’re unfamiliar with passive investing, this is probably the best one-stop-shop book on the subject that I’ve yet read. It’s detailed enough to really teach you things, yet easy to read enough that you don’t need constant assistance in getting through the pages.

The only real weak spot of the book is specific advice – in other words, if you know how you want to invest, how do you translate that into specific funds? You’re somewhat left on your own there, but thankfully there are many online resources that will carry you on home from third base. Simply poking around the website of a reputable passive investment house (like Vanguard) will take care of what’s missing, for the most part. This book is not a book for hand-holding – it focuses on the “why,” not the “how.”

I thoroughly enjoyed this book and felt that it laid out the case for passive investing very well. Pick it up if you want some great food for thought.

Check out additional reviews and notes on The Power of Passive Investing at Amazon.com.

Dear Trent,

My husband and I are finally on the path to financial freedom. We have only a debt or two remaining and have built up an emergency fund. We would like to start investing. Please tell us how.

Signed,
Sally Saver

When I read this email, I know what they’re looking for. They have money beyond what they feel that they need in an emergency fund that’s just sitting in a savings account and they’d like to feel as though they’re doing something more useful or productive with that cash.

The thing is, they’re overlooking the fact that they’re already investing that money. Simply having cash in a savings account is an investment!

Investing simply means that you’re utilizing a resource that you own or control with the intent of having that resource provide additional gains to you (or to someone else). Loaning $20 to a friend who is very thankful and promises to pay you back is an investment. You’re utilizing a resource you own or control (the $20) with the intent of having that resource provide additional gains to you or someone else (helping a friend through a pinch and perhaps accruing some social capital for yourself).

Money in a savings account is also an investment – you’re putting cash (something you won or control) in there with the intent of earning interest and keeping that money safe.

Most investments offer some amount of liquidity (the ease of which you can get back the resources you invested), some amount of risk (the likelihood that you’ll lose some portion of the amount you invested), and some amount of return (the resources you hope to gain from the investment).

Money in a savings account is an investment that’s very liquid (meaning you can withdraw and deposit largely at your heart’s content), very low risk (it’s FDIC insured and doesn’t put any of your balance at risk), and earns a very low return.

Because of this, when I see someone saying that they already have savings but that they want to invest, I have to assume that they’re seeking some form of diversification. They want an additional type of investment that’s in some way different than the savings they already have.

Usually, that means an increase in return, which usually comes with an increase in risk or a reduction in liquidity. Because they already have some amount of money in a low-risk form with low returns (that savings account), they want to add something with more risk to the equation in hopes of getting a greater return.

Thus, my answer to Sally Saver, after encouraging her to figure out why she’s wanting to invest, usually pushes her towards stocks or other higher-risk and higher-reward investments. In most economic conditions, I would include a suggestion to prepay on her mortgage as well, since that is also an investment from the perspective of someone who has already signed on the dotted line.

(Right now, though, a mortgage prepayment means that you’re only getting a bit better return (4% versus 1% or so in a savings account) for much worse liquidity (you’re only getting that money back at the end of the mortgage during those months when your house is paid off early or via a home equity loan). Although that’s still a solid deal, that’s not what people are often looking for.)

So, what’s the take home message here?

The fundamental act of saving is the key to all investing. By simply choosing to spend less than you earn, you wind up with a surplus. The more you choose to spend less, the greater your surplus.

As soon as you have a surplus, you’re now investing. What’s next? Goals. What are you investing for? Without that, investing is aimless – there’s no reason to choose stocks over a savings account because risk and reward have no real meaning if you’re not investing with purpose. You can only choose rationally and usefully among investment types if you know why you’re investing, when you’ll need that investment to come to fruition, and whether you can tolerate risk.

For example, if you’re saving for a summer home in ten years and your life won’t be a disaster if you have to put it off for a year, you’re probably well advised to invest in something with high risk and high return, like stocks or real estate. On the other hand, if you need to invest for your car replacement in 2012 and you know you’ll need a certain amount as a bare minimum by then, a savings account is the way to go so that you’re not risking what you’ve already got.

I think the idea of a savings account being a “default” investment is a good one. If you don’t have a goal but you do have a surplus, put it in savings – it’s low risk and highly liquid. This way, when you do figure out your goal, you know you can rely on what you’ve been saving and you know you can easily access it and put it to whatever ends you decide.

The fundamental pieces of investing are spending less than you earn and setting goals. Everything else is secondary.

Quite honestly, if I were going to invest my nickels and dimes into peer-to-peer lending, I’d probably do it with Kiva and not worry that much about a return.

From what I’ve seen, on such peer-to-peer sites, the returns on the few good loans they offer are really low, while the failure rate on the higher risk loans are so high that you’re going to have a challenge making a good return through all that noise. From my eyes, it becomes akin to gambling at that point, since you really have limited information on who or what you’re investing in.

If you like the idea socially and conceptually, go ahead and use them, but view it as a very speculative part of your portfolio.

Since then, I’ve received a deluge of emails from readers who have experienced different flavors of success with peer-to-peer lending, and these emails have encourged me to re-evaluate my response a little bit.

Let’s back up. P2P lending means that a website or organization, such as Lending Club or Prosper or Kiva, facilitates an arrangement where you directly lend money to another person who needs money. They do a lot of the footwork for you in terms of evaluating the risk of that person, but you’re the one that puts the money forward.

First of all, I will say that in terms of dollars and cents, I would not invest my whole portfolio into such lending sites. They are unquestionably risky and you simply don’t have the loan support structure that lending companies have. While the sites, by all accounts, do a good job of keeping the sharks out of the water, it still doesn’t stop a specific individual from deciding not to pay the debt back, much like some people charge their credit card to the limit and walk away from it.

Investments such as these inherently come with significant risk. Most people are honest. Some people are not. In the end, what you’re really betting on is that another person, given a debt repayment structure, will repay that debt. Most of the time, that will happen. Some of the time, it won’t.

Any good portfolio will not have all of their money in one single risky investment. Even those heavy on risk will typically have their money spread across different types of risk (the exception being someone who intimately knows every detail of a specific investment, like someone going heavy on a specific stock because they know the company).

Second, generally the lower risk investments on such sites have a lower rate of return and the higher risk investments have a higher rate of return. Such investments have a pretty clear balance of risk and reward. If you’re seeking a lower risk investment, you’re going to have to settle for a lower rate of return. The same is true for high risk and high return. There isn’t much to exploit here – you can’t get a high rate of return for low risk. That’s due to the evaluation that such lending sites put potential borrowers through.

The biggest reason that many people invest is not the return, but the sense that this type of investment is a socially beneficial thing. Rather than making money off of large corporations or governments, such loans help out individual people – the little guy. For many, this is an enormous social benefit that outweighs some of the uncertainty of the investment.

This, in fact, is the big reason I tend to encourage people to try Kiva, which encourages microlending to potential entrepreneurs in highly impoverished places, rather than loaning $500 to someone who just totaled their car. This is more a reflection of my own perspective, which is an acceptance that a global economy is simply a fact and the greatest good for both preserving an American standard of living is to raise the global standard of living as quickly as possible.

In short, there are a lot of good things about peer-to-peer lending. The weakest aspect of it comes purely from the perspective of “dollars in, dollars out,” where you could argue that it’s not the best investment opportunity in the world. However, it does offer social benefits that go far beyond the simple dollars and cents.

I’m no different. I have a Roth IRA through Vanguard, as well as an individual investment account there with which I’m investing with the goal of eventually buying land in the country and building a home. My money is sitting there in those accounts. It’s the product of a lot of hard work and it represents a lot of dreams for the future.

What happens to those dreams, though, if Vanguard were to fail? Lehman Brothers failed. Bear Stearns failed. What happens if your investment house of choice buys into the next bubble for whatever reason, sits there while the bubble collapses, then finds that they can’t cover the withdrawals that people are making?

What happens to your money then?

Enter the SIPC
The SIPC is the Securities Investor Protection Corporation, whose website you can visit at sipc.org. The SIPC’s mission is to step in when a troubled investment house has missing assets – meaning they took the assets held by individual investor(s) like you or me and used them to cover other expenses in a desperate hour, which was then followed by a complete collapse of the investment house or a near-collapse in which people attempted to withdraw assets that were not there.

This might happen, for example, if there’s a “run” on an investment house when there are rumors that they are having trouble (where lots of people simultaneously try to clear out their accounts), or if an investment house does not have the assets available to keep their doors open.

These investment houses purchase insurance from the SIPC on the accounts that they manage as a service to their customers, and you can usually find information about their SIPC affiliation on their website. Vanguard, for example, discusses their SIPC insurance on their brokerage FAQ page.

What the SIPC Is Not
“If that’s the case, why isn’t this just part of the same FDIC insurance that banks offer on savings accounts?” you might be asking yourself.

The key difference is that SIPC insurance does not protect you against investment losses. If the stock market loses 90% of its value next week, SIPC insurance on your account will not help you one whit. Instead, it merely reimburses you for the value of your account at a moment when you would try to withdraw it and the investment house could not comply with your withdrawal.

Most investment types have some risk of investment loss. Your stocks might lose value. Your home might depreciate. Your bonds might not retain as much value as you hope. Porkbellies might become soft. SIPC insurance does not protect you against investment loss.

What SIPC insurance protects you against is investment house fraud and mismanagement, not poor investment choices.

What You Can Do
First, make sure that your investments are in an institution that carries SIPC insurance. Visit their websites and click around a bit to find out, and if you can’t, send them an email asking about it. Virtually all large investment houses are covered by such insurance.

Second, manage your money with respect to SIPC insurance. Keep in mind that if you exceed SIPC insurance limits (often $500,000), your excess would disappear in the event of your institution’s failure. While it’s a tiny risk, it is one worth noting, particularly if you’re considering diversifying your money across multiple investment houses.

Finally, avoid investments that don’t have SIPC insurance. I would generally feel as though an investment firm without SIPC insurance might not have my best interests in mind, and thus I would avoid them.

For most of you, SIPC insurance is mostly an extra dose of security that will help you sleep a little sounder at night.

I have a small collection of vintage baseball cards from the 1930s that have a list value of about $30,000. I started collecting when I was a kid and my grandpa gave me some to start with, but over the years I’ve bought many more, almost completing a Goudey Heads Up set. I have had them all graded. What I’m wondering is whether I should continue holding on to these or not. I know you’re not a baseball card dealer or trader, but I do know you know something about baseball cards and you’ll give me your honest take on the situation.

I’ve received so many emails from people writing to me wondering why their giant pile of 1988 Topps cards are worthless, so this baseball card related email was actually a breath of fresh air. It also has given me a good reason to spell out my perspective on collectible investing.

First of all, I would never rely on the long term future value of a collectible. The problem with such items is that they rely entirely on supply and demand, and with collectibles, there’s no real need for the item. Demand rests on the cultural interests of other people, which can shift over time. Fifty years ago, sports besides baseball were barely a blip on the national radar. Twenty five years ago, Garbage Pail Kids were in such hot demand you couldn’t find them on store shelves. How things change.

Similarly, I would never invest in any collectible where there is a large supply. Any time there is a “collectible” out there in large supply, the only reason that “collectible” has any value at all is due to a huge demand in that moment, and the public is fickle. Instead, focus on seeking out the truly rare items and don’t spend your time on the rest if you’re “collecting” for profit.

Second, even if you’ve covered the rarity issue, the future value of any such items relies on a continual interest in the phenomenon being collected. If that phenomenon decreases significantly or goes away, your collectible value drops dramatically. I once had a set of fairly valuable Star Wars trading cards whose value dropped precipitously over the past decade because that trading card game was on longer supported.

Having said those things, the best reason to be this kind of a collector is that the items you’re collecting have some personal value to you.

I can think of two distinct examples of this from my own life.

First, I, too, have a small collection of vintage baseball cards that have largely held their value over the last decade. They’re PSA graded, like yours are. For me, though, they have more value than what I could get for them on eBay because of the memories and stories associated with them. They make me remember family members and times watching baseball with them when I was young. They remind me of the first time I went to Wrigley Field. They’re aesthetically appealing to me and scratch that itch I have for vintage baseball every time I look at them.

That has value. I get value from those cards every time I look at them. Even if I sell the cards for a dollar loss at some point – and I don’t think they’ll ever be worth less than the pittance (or the gifting) that I originally paid for them – it’s still not really a loss because of the many instances of joy they’ve brought into my life.

Another example is with a small handful of original Magic: the Gathering cards that I own. These cards come from the very first set of this game, a game that’s selling more and attracting more players now than it ever has.

I enjoy these in a much different way. Rather than keeping these items in a PSA-graded case, I just keep them in protective sleeves and … gasp … actually play with them. These cards still come up on my kitchen table when I play with my wife or my friends and thus they still bring me quite a bit of enjoyment.

Are they losing value because of the play? They’re sleeved. I’ve played with them many times in sleeves and their condition seems identical to when I first sleeved them.

On the other hand, I am getting consistent enjoyment out of the use of these cards. It’s an item with collectible value that I also get to directly enjoy on a regular basis.

To me, regular enjoyment of a collectible item that retains at least some of its value makes the collectible item worth it. I’m reminded of a friend of mine who has an uncut sheet of pre-1970 Topps cards on his wall – I think they were 1965 Topps, but don’t quote me on that. They’re framed and hanging in his office. That sheet has some significant collector value and he could re-sell it for some cash any time he wanted to. Instead, it hangs in his office and gives him value almost every day.

So, here’s what it comes down to. Invest in – and keep – collectibles if they provide some additional value to you personally. Do they make you feel happy when you see them? Do you get to actually use them in some fashion? Do they serve as a home decoration? Those are great additional values that a collectible can provide.

Of course, without that additional value, I would suggest flipping the item as soon as possible unless you know the market for that collectible cold – and anyone outside of collectibles dealers doesn’t know it cold. Why? Collectibles are notoriously unsteady items to invest in, so if you have one that you’re not getting personal value from, I’d move those invested dollars into something at least a little more stable.

What about as a pure investment? I’d frown on it unless you are sure you can turn a quick profit or you’re picking it up with spare money for the personal value it’ll give you. Do not rely on a collectible as an investment that will support you in the future. Instead, do rely on it as something that has a good chance of retaining value while bringing regular joy into your life.

Commodity investing is one of those areas of personal finance that I simply don’t know much about. When I think about commodity investing, I think of listening to an AM station where a dry-voiced announcer is saying, “February soybeans two thirty two and a quarter up two and a quarter…” with small variations for half an hour.

Still, the idea of investing in something tangible holds some interest for me. Commodities are tangible, material things, often used in the manufacture or production of other things. Instead of owning a share in a corporation that exists on paper only, you own a thousand bushels of soybeans. That has direct appeal, even if it’s not something I deeply understand.

This week, I decided to correct that lack of understanding by reading The Little Book of Commodity Investing by John Stephenson, the latest book in the wonderful Little Books, Big Profits series. I like the series because it offers gentle introductions to specific investing topics from individuals who are actually involved in that field. John Stephenson is a very experienced portfolio manager who has been in commodity investing for a very long time – he knows his stuff.

This book largely boils down to a sequence of short chapters each dealing with a particular flavor of commodity investing – oil, foodstuffs, natural gas, precious metals, and so on – with a chapter on each end to bookend these pieces.

One | Calling on Commodities: Why Commodity Investing Is a Savvy Bet
The big argument in this opening chapter is that the coming years are going to be a boom for commodity investors as the tendrils of globalization dig deeper into nations like China, India, Brazil, Russia, and so on. These nations are going to be building infrastructure like mad and the ingredients to build that infrastructure, such as steel, oil, and natural gas, are going to be in high demand. This will also give rise to a huge global middle class which will result in consumer goods being produced and purchased at a huge rate, and those goods will be made from – you guessed it – commodities.

Two | Gettin’ Goin’: Companies or Commodities?
Unfortunately, directly owning commodities really isn’t a convenient option for most people. Do you have a place for 1,000 bushels of soybeans or 500 50 gallon drums of oil? For most people, the answer is a resounding “no.” The solution is to invest via a futures contract, in which a producer agrees to sell you some amount of a commodity at a certain price on a certain future date. So, for example, you might agree to a contract for 100 barrels of oil today for $30 a barrel, with the oil to be produced in six months. In six months, you then have 100 barrels of oil which you can sell to someone who will actually use it for the going market rate for that oil – it might be $35 or it might be $25. The chapter describes this market in detail with a tone that makes it quite understandable.

Three | Gusher: Investing in Oil
This chapter and the seven that follow it each give an outline of a particular commodity market, discussing in detail why it works as well as reasons why you might want to (and might not want to) invest in it. I felt that Stephenson’s most compelling case was with oil. He discusses at length how economies around the world are rapidly building infrastructure and moving to automobile transportation at the same time that world oil supplies seem to have peaked. If demand is going up and supply is going down, then prices are probably going to go up. The risk? Nations begin moving to energy sources besides oil for transportation.

Four | Drilling for Dollars: Profiting from Natural Gas
Stephenson doesn’t seem nearly as bullish on natural gas, however. Due to a lot of technological innovations, huge deposits of natural gas can now be accessed that were inaccessible before. While the demand for natural gas seems to be level, the supply has gone up, which means that prices have gone down. This does mean that prices are low at the moment, so an individual who carefully followed federal reports on natural gas reserves could turn a profit, but the general direction here is much weaker than with oil.

Five | Going for Gold: Prospering with Gold and Precious Metals
Gold. It seems to have been the buzzword over the past few years. As with most investing guides, Stephenson points out that gold seems to do best when the United States is having economic struggles – like right now, for example. However, he’s far from a gold bug – he suggests that, rather than hoarding gold and putting all of your money into it, you’re better off just buying a gold ETF (basically, this amounts to buying a stock in gold) as a small part of your investments. He gives short discussions of other precious metals here as well, such as platinum and palladium.

Six | Digging It: Making Metals and Mines Work for You
Here, Stephenson talks about “construction material” metals – steel, copper, aluminum, zinc, and so on. These items fluctuate in line with the global economy, meaning when construction picks up, these items pick up and vice versa. The London Metals Exchange drives almost all of this trading, and traders often keep tabs on supplies of various metals. When the supply drops, the prices will go up.

Seven | Betting the Farm: Bingeing on Food Inflation
I didn’t get a sense of the author’s advice on investing in foods overall. In the chapter, he discussed several trends in foods that point in opposing directions – some pointed towards greater demand, others pointed toward greater supply. I don’t think he was fully bullish on crops.

Eight | Ordering the Breakfast Special: Finding Profits in Foodstuffs
On the other hand, foodstuffs, like fruits, coffee, sugar, cocoa, and so on, are items that he seems to be strongly bullish on. Such crops are simply too exposed to the weather (giving them shaky production bases) and in such high demand that the prices will continue to stagger upwards into the foreseeable future, at least as far as Stephenson sees it. If you’re going to do this, he recommends buying ETFs.

Nine | Gaining in Grains: Investing in Grains
Grains are such a fundamental part of worldwide diets that the demand for such items is pretty strong and pretty steady in terms of growth. The issues come in with supply, wich is affected by lots of things from the weather to crop diseases. Another factor to look at is whether long term changes in diets globally will have any impact, though it hasn’t shown a significant impact to this point.

Ten | Bulk Up: Benefitting from Bulk Commodities
Here, Stephenson discusses iron ore and coal, which are used in huge quantities in industrial production. As with oil in the third chapter, Stephenson seems to be very bullish on these things, believing that the future points to more and more industrial production and infrastructure building as nations like China and India build a more sturdy infrastructure than they have.

Eleven | Capitalizing on Commodities: Why Commodities are Happening
Stephenson concludes the book with a short chapter that argues strongly on behalf of the idea that India, China, Russia, and other Asian nations are growing very rapidly in terms of their economy and will do so for quite a while. Since this idea underpins an awful lot of this book, it’s a key one, and Stephenson makes the case very well.

Is The Little Book of Commodity Investing Worth Reading?
If you want a book that will teach you some of the concepts behind commodity investing, The Little Book of Commodity Investing is probably going to be a very enjoyable read for you. It explains why investors would invest in certain commodities and gives some very general suggestions on how to do it.

On the other hand, if you want a step-by-step guide on what to buy, The Little Book of Commodity Investing will not really work for you. The book focuses on passing along ideas, not instructions.

For me, The Little Book of Commodity Investing gave me quite a lot of food for thought. Will it turn into actual investing? Probably not. Did it give me insight into areas I didn’t understand very well and put enough information in place that I now can understand and incorporate new things? Absolutely.

On September 18, 2009, a share of stock in Verizon closed at 29.59. In the following months, Verizon issued four dividends of $0.475 per share. On September 24, 2010, a share of stock in Verizon closed at 32.64.

Let’s say, hypothetically, that we chose to invest $1,000 in Verizon on September 18, 2009, and chose to withdraw it on September 24, 2010. Our $1,000 would have bought 33.8 shares of Verizon stock. Over the course of the year, then, we would have received $64.22 in dividends. At the end of that year, we sell the stock for $1,103.23. Our total earnings on that investment would have been $64.22 in dividends and $103.23 in stock returns, right?

Not so fast.

First, the dividends would be subject to income tax. In this case, the dividends would appear to be qualified dividends, which means that they would be taxed at a rate of 15% by the federal government and possibly more by state and local sources. $9.63 of that dividend gain goes away.

Second, you’re going to have to pay your brokerage for the cost of buying the stock, as well as the cost of selling the stock. Let’s say, hypothetically, that you’re using E*Trade. The cost of the buy would be $9.99. The cost of the sell would be $9.99. That’s another $19.98 off the top – although that $19.98 is tax deductible.

Third, the gain on the sale would be a long tern capital gain, so 15% of that gain goes to the federal government. Your gain was $103.23, so you’d be paying $15.48 in taxes for that $103.23 gain.

All in all, your expenses for your gain add up to $45.09. Just like that, 25% of your gain is gone.

Even if your investment is a loser, you still lose more. Let’s say that over that same timeframe, VZ went from a starting price of 32.64 to a closing price of 29.59. You’re still out the $19.98 in brokerage fees (it’s tax-deductible, though). However, you only buy 30.64 shares of stock. You only earn $58.21 in dividends and you lose $93.36 on your investment, a net capital loss of $35.15. Add that to your $19.98 in brokerage fees and you’re down $55.13 on that investment.

What’s the point of this story? Investing has costs. You’re taxed if you gain anything and you’re getting hit with brokerage fees whether you win or you lose.

Some forms of investing have lower costs than others. If you invest directly with an investing house like Vanguard, for example, you can essentially invest without fees, meaning you only have to deal with the taxes on your gains. However, you’re limited to the offerings that Vanguard has available, plus there are often stiff minimums for investing.

You could also simply invest in the money market account at your local bank. There are no costs there, either, and your balance isn’t at risk; however, your returns will be low.

The bigger your investment, the smaller the impact such costs have on you. At the $1,000 level, the investment fees described above eat up about 2% of your balance. If you’re investing $10,000, the fees eat up only 0.2% of your balance. If you’re investing $100,000, the fees eat up only 0.02% of your balance.

Thus, for beginning investors, it’s absolutely vital that you know the total cost of ownership of an investment before you even consider it. Because even a small fee can really hammer your total return, such fees are very important to the beginning small investor.

That’s why my advice to beginning investors is this: invest your money in a savings account to start with and spend some time learning first. Know exactly what you’re going to invest in – and what all of the costs of that investment are – before you put your money in. Set up an automatic savings plan that keeps building the balance of that investing savings account so that when you do decide to make your move, you have a solid amount of money to make your first move.

Yes, you might “lose” some gains by only having the cash in a savings account. However, if it’s in a savings account, it’s not at risk of a loss, you’re not paying fees, and it is earning you a return. If you invest elsewhere without studying up, the fees and the taxes can easily eat up a big chunk of whatever you gain – and make a loss more painful than it already is.

Start slow. Don’t subject your money to fees or put it at risk without knowledge. Learn as much as you can and don’t make a move until you know the costs and feel confident about it.

How do you start learning? I suggest starting with The Bogleheads’ Guide to Investing. Read it slowly. Read it again. Move on from there by digging into some of the recommended titles. Keep going until you feel confident and comfortable with investing, then move forward. You’re better off taking it slow and making good moves from the start than flailing about and losing a bunch of your money to fees and taxes.

They look around, watch CNBC, read investment advice online and in books, and still aren’t sure exactly what to do. Should they keep the money in cash, or buy a CD from the bank? Should they invest in stocks, and if so, should they buy individual stocks or put money in a mutual fund? What about bonds? What about real estate?

The options seem overwhelming, as do the potential risks and rewards. I’m going to offer a few ideas that I’ve learned over the years that will help anyone that’s just starting to invest.

First of all, there is nothing that will guarantee you a great return. If anyone is guaranteeing you a large return – and by large, I mean more than a couple percentage points higher than what you’re getting in a savings account – be very, very wary. Such investments usually have some sort of giant drawback, like losing all access to your balance for a very long period, hidden and/or extensive costs, or hidden risks that aren’t being directly revealed. Leave such “too good to be true” investments for people who are actually skilled investors – and they probably won’t be investing either.

Instead, most investments beyond a savings account or a CD offer potentially strong gains coupled with risk. That’s just part of the equation. What usually happens is that the better the estimated returns on an investment, the greater the risk.

Let me spell it out for you in detail using a specific example. The Vanguard 500 is a long-established index fund that essentially invests in 500 of the largest publicly traded companies in the United States. If you look at the returns on this fund, you’ll see that (for the quarter ending June 30, 2010) money invested in the fund has earned 14.33% over the previous year. That’s a very nice return.

At the same time, though, money invested in the fund has earned an average of -9.84% the last three years. Yes, each year (on average), an investor has lost almost 10% over the past three. Even over ten years, the average is -1.67%. Over the lifetime of the fund, though (since the mid-1970s), money in the fund has returned an average of 10.10% per year.

So what does that mean for you? It means that over the course of some years, you’ll have a 15% positive return. Other years will have a -30% return. Over some decades, it’ll average out to a nice positive – 10% or so. Over other decades, like the ’00s that had two economic downturns, it’ll average out to a very low positive or even a negative.

Sometimes you can afford that kind of risk. If you’re many, many years from your goal, that kind of risk is fine. If you’re 25 and investing for retirement, you’re going to get enough great years between now and retirement that you’re pretty likely to make up for the losses of the bad years. The key is to just ignore the year-to-year losses and gains and just be patient.

However, if you’re closer to your goal, you can’t afford that kind of risk. If you’re saving for a goal that’s going to happen in five years and you need to have the balance you’ve already saved up, you’re making a big mistake to put it at this kind of risk. You need to keep it safe, even if you’re losing the potential to have a big year.

You also have to look at your debts in comparison. Right now is a great time to pay down debt. Why? The “return” you get from debt repayments is equal to the interest on that debt. So, if you have a debt that’s costing you 8% interest, an early payment on that debt essentially earns a guaranteed 8% return. Why? If your balance is lower (and that’s what an early payment does), the lower balance will generate that much less interest that you’ll have to pay. It’s important to note, of course, that actually acquiring new debt is really, really bad – I’m looking at debts here as water under the bridge and merely a problem to be solved.

Also, you can never, ever have too much money put away for retirement. It is never bad to over-save for retirement, because you can always use that money during the early years of your retirement for whatever things are most important to you knowing that you’re secure for life.

Thus, here would be my very general suggestions for someone with a chunk of money to invest.

The first thing I would do is aim for debt freedom. Why? Paying ahead on debts is probably the best stable investment that people have right now. Get rid of your debts – all of them.

If you’re debt free, I’d sit down and look at my life goals. Are there any big goals that I want to achieve in my life? Am I going to buy a house? Do I want to start a business, or launch a new career? Maybe you’re really happy with how things are right now. If you have a strong overriding goal, keep the money in savings and have it help you reach that goal a lot sooner. Most likely, the goal will be short term enough that you shouldn’t put it into stocks or other risky investments, for the reasons discussed above.

If you don’t have an obvious overriding goal, open up a Roth IRA and put the money in there. A Roth IRA is a simple retirement account that anyone can open – you just sign up for one with an investment house like Vanguard, much like signing up for a savings account at a bank. You put money in the account from your checking account, then tell the investment house how you want the money in the account to be invested. The best option for most investors is a Target Retirement fund that matches your estimated retirement date. You can contribute $5,000 a year to a Roth IRA – if you have more than that, put it in a savings account and make contributions each year.

There are two things that people virtually never regret: freedom from debt and plenty of money saved for retirement. If you have money just sitting around, you’ve got two good things to do with it, right there.

A final tip: read. Pick up a well-regarded book on investing (here’s my pick) and read it at your own pace. Go slow and make sure you understand every sentence. Use Wikipedia and Google to help you understand terms. This is perhaps the best thing you can possibly do with your time as a beginning investor.