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The Five Stages of Investing

Key Economic Concepts:

• Benefit
• Cost/Benefit Analysis
• Economic Security
• Investing
• Money
• Money Management

Description:

The practice of saving and investing is definitely a good thing, but there are many ways to save and invest. In thinking about the options, it is important to consider the degree of risk involved and the potential for return. Typically, the higher the risk, the higher the potential return. The key is to work up to the riskier investments, where you stand to earn the most money, but only after you've successfully established some safer holdings. This lesson walks students through the stages of investing, demonstrating why that sort of sequential order is important. At the end of the lesson, students are asked to serve as financial advisors and give advice to people considering investments at different stages of the investment ladder.

Lesson Objectives:

Students will:

• Become familiar with the stages of saving and investing.
• Apply that information to real-world situations.

Introduction:

Sometimes the order in which you do things is very important it can make or break the process. You wouldn't apply to be the head chef of a gourmet restaurant before you had learned to cook noodles, right? The same is true of saving and investing money: there are lots of good ideas out there, but if you try to use them in the wrong order you might find yourself in over your head (or worse, out of money for groceries!). In this lesson you'll learn about the five stages of saving and investing, what happens at each stage, and why it's important for investors to make use of the stages in a specific order. Then you'll use that information to provide advice to prospective investors at different points along the way in their financial journeys. Happy investing!

Resources:

Students will refer a description of the five stages of investing. Depending on your preference, they may access it online only or they may print off copies for their notebooks and future reference by selecting the following link, The Five Stages of Saving and Investing, (from Joan S. Ryan, Managing Your Personal Finances, 5th edition, 2006).

Process:

Activity 1: To introduce the five stages of saving and investing, have your students read the attached description:

The Five Stages of Saving and Investing

• Step One: Put-and-Take Account
  This is the first savings instrument you should establish when you begin making money. For most people, the put-and-take account is a checking account. A checking account holds the money that you're going to need immediately (or soon) plus a little extra for emergencies. You can take money out of this account by writing checks for car payments, clothes, etc. Experts recommend that you set aside three to six months' net pay in your checking account. So if you're making $50 a week working at the movie theater, your goal for the put-and-take account should be $600 to $1,200. This first stage is very low-risk; that's a good thing, because you don't want to gamble with the money you're counting on to pay the electric bill!
• Step Two: Beginning to Invest
  After you're established a stable put-and-take account (meaning that you're NOT running out of money in your checking account each pay period), you can move on to beginning investments. These first investments should be low-risk instruments that you're not very likely to lose money on bonds or mutual funds, for example you probably will earn a relatively low rate of return on these investments, but giving up the potential of higher returns for more security is worth it at this stage. Most people begin this stage in their twenties or thirties, when their budgets and spending are stable and they begin to have excess cash. Getting an early start is important. If you start early, your money will have more time to earn more money for you! That's why it's important to get your put-and-take account established as soon as you can. If you are a 17 year-old and have your put-and-take account under control, you can get a head start on the next stages and and a head start on other investors!
• Step Three: Systematic Investing
  When you have established your beginning investments, you can move on to investing on a REGULAR and PLANNED basis. For most people, this is a commitment to invest a set dollar amount every pay period, usually in stocks, mutual funds, or annuities. Goals for this stage are long-range; you're going to see the best return from this kind of investment if you continue with it for 20+ years. Typically, people enter this stage in their thirties and forties, when their earning potential is the highest. Here again, starting early is important. The 17 year-old who has a stable put-and-take account and begins investing early might be ready to jump into systematic investing at age 20.
• Step Four: Strategic Investing
  The fourth stage is for investors who have set up a stable put-and-take account, dabbled in safe beginning investments, and established a systematic investing plan. When you have extra money above and beyond those your money for those commitments, you can begin strategic investing, which is managing your portfolio (your collection of assets) with an eye on balancing out losses and gains in different investment instruments. The key here is diversification: making sure you're not keeping all your eggs in one basket. Since stocks and bonds often respond in opposite ways market conditions, many people invest in both to balance out potential losses. Goals in this stage are medium-term: five to 10 years.
• Step Five: Speculative Investing
  The fifth and final step is speculative investing in penny stocks, junk bonds, or collectibles, for example. Speculative investing involves high levels of risk, but it also has the potential to yield high returns. (You've probably noticed the relationship between risk and potential return in the world of economics the greater the risk you take, the greater your potential return.) Some people never do engage in speculative investment, preferring to avoid the heightened level of risk that is involves.

Activity 2: To check your students' understanding of the five stages of investing, give them this mini-quiz

Conclusion:

Note: Summarize the main points of the lesson for the class:

As you start to earn money, it's important to remember that there's a smart way to invest that money and a smart sequential order to follow. Of course, you don't want to gamble with money you can't stand to lose, and you also don't want to jump into very complicated investments when you don't have any experience as an investor. It's important to start investing in low-risk choices only to protect your money but also to help you learn about what investing is all about. The best way to make your money grow and thus earn enough money to do what you want is to follow the five stages of saving and investing.

Assessment Activity:

Note: First have your students take this interactive quiz to make sure they are ready to move on. Then introduce the assessment activity:

You are now an expert financial adviser. The following people have e-mailed you asking for advice on their next step in investing. They're at different stages of saving and investing, and they don't know where to go from here. Using what you've just learned about the stages of saving and investing, give them sound financial advice. First have the students review this interactive quiz to make sure they are ready to move on.

Next have them complete the open-ended activity below:

1. Hello. My name is Erick! I'm looking for some advice on what type of investments to look at. I'm 53, my kids are through college and out on their own, and I have what I feel is a pretty healthy, diversified portfolio of stocks, bonds, mutual funds, and real estate. I'm earning more on dividends and interest payments than I need to support my family right now, so I'd like to find something to do with this money to make it grow. What should I consider?

(ANSWER: Erick should move up into speculative investing with his extra money. The key: he has a diversified portfolio - the goal of step four - and money left over, which means he's ready to move on to the fifth step.)

2. Hi, I'm Monique! I'm a high school senior and I've been saving money from my landscaping job for a couple of years now in a savings account. I've got enough in the account to not have to worry about running out of money at the end of the month, and my parents say that I have enough money to consider investing it in order to earn a greater return. (I'm earning .8% interest on my checking account now THAT'S not going to make me a millionaire any time soon.) What should I do?

(ANSWER: Since she already has her put-and-take account under control, Monique can move on to beginning investing. She should try low-risk investments, and she should be prepared for lower returns than she might earn from riskier investments. This would be a good time to talk about being patient and knowing that not losing this money is more important than reaching for the highest rate of return that you can find.)

3. My name is Felicia McMillian, and I was referred to you by a friend. I have a question about what I should do with my money. I've been working as a pharmaceutical sales representative for just two years now, but I've already started investing a little bit of my money. Right now, I have a checking account, a money market account, and I've started buying small bonds. I am beginning to earn a little more money, and I'm starting to think about future goals, like buying a house, helping my kids pay for college, retirement. . . all things that are more than 10 years down the road. What would you advise me to do at this point?

(ANSWER: She's got her put-and-take account under control and she's already started her beginning investments. Since Felicia's thinking about long-term goals, she's ready for systematic investing, where she chooses an investment and commits a certain percentage of her income to that investment over a long period of time.)

4. Hi! This is James Cook. We spoke on the phone yesterday; you asked me to e-mail you some specifics on my present financial situation so you could give me appropriate advice on what investments I should consider. Right now, I'm 34 years old and I own a local cooking specialty store. Through my credit union, I have a share account (this is the account I write checks out of to pay for day-to-day necessities). I've also dabbled in mutual funds and am currently investing 5% of my monthly income in Tyson stock. I'm starting to have some leftover money from my paycheck and from Tyson dividends; what should I do with it? Thank you!

(ANSWER: James is currently in the systematic investing stage because he's putting 5% of his income into stock. He's ready for the strategic investment stage, where he looks at his portfolio and focuses on diversification. He should look for the investments that are going to give him the greatest return in 5 to 10 years. Since he's currently investing in stock, a great way to balance out risk is to also invest in bonds (remember that stocks and bonds often respond in opposite ways to market factors). Two other topics that would be good to bring up now: reinvesting dividends, and how that helps money grow; and credit unions (where James banks).)

5. Hello! I saw an advertisement for your financial advisement firm in the paper and I need some help getting my money in order. I'm a 30 year-old nurse, and I have a checking account, but I usually end up running out of money at the end of the pay period. I'm trying to invest in things that will make my money grow, but it seems like I've been picking the wrong ones. I find a stock that has gone up a lot recently, and I buy some, but then it usually goes down pretty quickly and I sell it to get rid of it. What am I doing wrong? How can I really make my money grow?

(ANSWER: The problem here is that our nurse has skipped a stage or two that's why she's having trouble. She needs to get her put-and-take account under control before she starts investing. And when she does start looking at stocks, she should avoid the risky ones that are better reserved for the speculative stage. This would be a good time to talk about how to research investments, especially stocks. Many investors believe, incorrectly, that all you have to do is find the stock that has gone up the most in the least amount of time and put your money into it.)

Extension Activity:

This lesson lends itself to several possibilities for extension activities. You might engage students in a discussion of how various investment possibilities fit into the five stages. I think it's especially important to talk about what happens if investors go out of order or try to tackle all the steps at once. You might help your students determine what stage they're in right now (most high school students will be in stage one; some may be in stage two). You might have students make a time-line of their lives from now until age 80, maybe mapping out prospective dates of milestones like retirement, job promotions, having kids, etc. Students then could split the time-line into the five stages of saving and investing. Of course they can't know for sure when they're going to buy their first house, switch jobs, etc., but it's still worthwhile for them to think about a time-line for their goals. Also you might remind the students that not all investors get to stage five, and it's not necessarily a good thing to try to do so. Stage five investing makes sense only for people who are comfortable, financially and otherwise, with high levels of risk.

Links Used:

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