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Financial Planning for Scientists, Part 4: Spending Your Savings

So far in this series, we've discussed why it is important for scientists to think about their financial situation, and we talked about some "tips" to make saving money a little bit easier. We also looked at some very simplistic methods of determining how much money you need to save to achieve your goals. Today, we're going to take our first look at what I call "spending your savings." (Most people call this "investing.")

Cash is pretty much useless if it's tucked away in your mattress. That's because, almost universally in today's world, money is worth more today than it will be tomorrow. Another way of saying this is that the cost of living is almost always rising. The key to saving is to try to make your money grow at a rate faster than the cost of living. Or at least make it grow a bit, to combat the increasing cost of living. Hopefully last month's article will have convinced you of this.

So the key to financial success is to save enough, and to invest it in things that will appreciate in value faster than the cost of living. And things that you can easily resell at a later date.

People "spend their savings," or invest, in many different things. We will be discussing some of the more conventional investments, such as stocks and bonds, in much more detail in the rest of this series, but there are many other investment choices. Some people chose to invest in works of fine art. Others purchase collectible coins or stamps. Even comic books are occasionally thought of as an investment.

So let's take comic books as an example. If you decided, for some strange reason, to invest your life savings in comic books, you'd do a few things before you spent your money. First, you'd learn as much as you could about comic books. Who are the important action heroes? Who are likely to be recognizable, or (more importantly) valuable in 30 years? Then, you'd probably learn as much as you could about the comic book market. Is it important that they're in mint condition? Who's buying and collecting comics, and will they be around in 30 years? In other words, you'd want to know the parameters used to assess value--quality, condition, age, brand of comic--and the market forces driving the industry--liquidity (how many people collect), market makers (who's buying and setting prices), etc.

I've picked comic books as an example for two reasons. First, to emphasize that when you're investing your money, you're really just spending it (but on something you think you can sell later on), and second to emphasize that, before spending your money on anything, you should educate yourself as much as you can about what, exactly, you're purchasing.

While this may seem preachy, or even self-evident, it's an important lesson. Many people will spend hours pouring over spec sheets and price lists before buying a simple piece of lab equipment (when it isn't even your money you're spending!), but will throw away half their life savings on a stock tip they got from a friend. The main reason behind this, I think, is that people see investments as something mysterious, and something that is always good to do. If you don't know anything about the stock market, but you know, vaguely, that it's better to invest than to not invest, you're going to jump in prematurely. But if you think of investing as spending, you'll hopefully do some "shopping around" before you buy something.

In the next several months, we're going to be taking a close look at some of the typical ways of spending your savings. Not comic books--they're a bit beyond my level of expertise--but more conventional investments, like stocks, mutual funds, bonds, certificates of deposit, hard assets, insurance, and derivatives. For the moment, though, let's just define each of these investment types.

A stock is, quite simply, a stake in a company. When you buy a stock, you literally buy a small piece of a company. Anyone can buy a stake in a public company, and as a typical scientist-investor, you're only going to be looking at public companies. Stocks are probably the most complex of the investment options we'll be discussing--there are all sorts of choices to make when picking individual stocks, and you can mix and match stocks to suit your personal goals.

Mutual funds are baskets of stocks, of various different companies, bought and sold by someone that does this for a living. Basically, when you purchase a mutual fund, you're giving someone else your money and saying, "Here. You know what you're doing. I'll pay you to buy stocks with my money." Mutual funds have many advantages, as well as some disadvantages that we will discuss.

Bonds are someone else's debt obligation. When you purchase a bond, what you are doing (at it's most basic) is lending someone your money. That someone could be a government or a company, but basically you're saying: "You need money, I got money. I'll lend it to you for 30 days if you pay me 5% interest on it." It's a bit more complex than that, but we'll be talking about bonds in depth later.

A certificate of deposit is basically an ultrasafe investment. They are sometimes called "Guaranteed Investment Certificates," and they are exactly what they sound like--an investment you've made that is guaranteed by the bank (or another party). Because there is virtually no risk in these certificates, the interest rate given is usually quite low.

Hard asset investments may include purchases of land, buying a home, or even (in some countries) buying a hunk of gold, silver, or other precious metal.

If you think about it, an insurance policy is something you pay monthly payments on, that accumulates, and pays off a dividend either when you die or when you cash out of your policy--so many people treat their insurance policies as a form of investment.

And finally, derivatives such as forwards, short positions, and hedge funds are extremely complex financial instruments that take a whole lot of time to explain, so we'll be dealing with them last.

We'll be looking at each of these "spending" choices in turn over the next several months. Then we'll think about how to mix and match these different spending choices to minimize risk. So 'til next time, keep on saving. You'll be spending soon!