Do you have any advice for a teenager with a steady job who would like her savings to grow. I have paid for my college education without taking out student loans. I contribute to an RRSP and I carefully keep track of all my income and expenses. I am not sure what to do with my savings. I set aside 10% of my income, but it is currently in a basic savings account because I don't know what to do with it. I was wondering what the best investment strategy would be for someone of my age. Any help you could give me would be great! -- Anita

Wow! Anita sure is off to a good start. Contrary to what a lot of people think, the young adult years are often the easiest time to save money. They often see their income grow faster than their financial responsibilities. That gives them an excellent opportunity to save.

Anita has already started down that path. So what's the best place for her to park the 10% of her salary that's she's saving? The answer to Anita's question has less to do with her age than what she plans on doing with that savings. The decision making process is the same for any age. The first thing Anita needs to do is to decide what she's saving for.

Why is that true? Her use will determine how quickly she might need it. And, that urgency will affect her investment choice.

Let's look at two simple rules of investing. First, you earn a higher return by assuming more risk. For instance, stocks are riskier than savings accounts.

The Journal of Financial Planning cites studies that show the real rate of return for the S&P 500 (stocks) from 1950 to 1999 was 10.3%. At the time this was written, a short term CD (6 months to a year) would pay about 4.0% and a five-year CD closer to 4.5%. An interest bearing checking account earns 1.0% while money market funds are about 2.8%.

So the earnings difference can be significant. To illustrate, suppose that Anita puts away $1,000 each year for the next 50 years (ages 20 to 70). If she earns 2% on the money, at the end of that time, it will be worth $89,000. But, if it earns 10%, it will grow to $1.4 million. Quite a difference!

That means we need to learn about the second rule of investing: risk can be minimized. Either by diversification or through a longer time frame.

Diversification is a fancy word that means owning more than one stock. If all of your money is in one company and the stock goes down 50%, you have a disaster. But, if you spread your money among 10 different stocks and one drops 50%, you've only lost 5% of your investment. Not nearly as bad. In fact, it's possible that one or more of the other stocks could go up and offset the loser.

The longer time frame reduces risk much the same way. The stock market does have bad years. Sometimes even two or three in a row. But, for the last 100 years, if you took any 10-year period, the return was positive. So you might have lost money in one year. But if you could afford to wait awhile to sell, you would have gotten the losses back. Combined, time and diversification allows Anita to get the higher returns without increasing her risk.

Now let's apply all of this to Anita's situation. We'll assume some life events. The first reason that she might need to access her nest egg is for an unexpected bill (think auto repair). For that she needs money that's accessible immediately. Like in a savings or checking account.

Once she's saved more than enough to cover immediate needs, she's ready for a second investment account. Suppose Anita is also planning on buying a new car or making a down payment on a home in two or three years. Savings earmarked for those purposes would earn more if they were put into CDs.

Longer term, Anita will want to save for her retirement. She already has an RRSP account. For our U.S. readers, an RRSP (Registered Retirement Savings Plan) is a Canadian account very similar to an IRA. A mutual fund investing in stocks would be an appropriate selection here.

Anita is off to a fine start. All she needs to do is to decide why she's saving, how much she needs for that purpose, and then select the type of investment that matches her goal. At the rate she's going, in a few short years, she'll be giving others advice on how to accumulate money!

I'm 35 years old and have the option to pay off my mortgage and be totally debt free. After paying off my mortgage, I'd still have approximately $68,000 to invest for retirement. I'm really confused about whether it will be best for me to pay off my mortgage or invest all of the extra money ($98,000) instead. My financial advisor and professor from a Personal Finance class I just completed are telling me it's not in my best interest to pay off my mortgage because I will no longer have the tax benefits. Some financial experts say you should pay off your mortgage as soon as possible. I'd really like to hear your opinion on this subject. -- Julie M.

Good question! And, a common one, too. When you have some extra money, is it wise to pay down the mortgage or is an investment a better choice? Let's begin by understanding the mortgage interest deduction and then work on a framework for comparing options.

Interest paid on a mortgage for your home is generally deductible on your federal income taxes. To use the mortgage deduction, you must file an itemized 1040, be legally liable for the loan, and the debt must be "secured" by the home.

The IRS defines home mortgage interest this way in publication 936: "any interest you pay on a loan secured by your home (main home or a second home). The loan may be a mortgage to buy your home, a second mortgage, a line of credit, or a home equity loan."

There are some limits to the mortgage deduction. We won't get into the formula here, but in most cases, it won't be a problem as long as the money borrowed was used to buy or improve your home.

The biggest problem with the mortgage deduction is that many people use the standard deduction. In 2004, it was $4,850 if you were single or married filing separately. Filing married on a joint return? You got $9,700.

The rules for what's eligible for deductions are beyond the scope of this article. The safest way to figure out your status is to see what you did on last year's and expect to do on next year's tax returns. The biggest items are typically state/local income taxes, property taxes, medical costs and charitable contributions. Before making any decision, see how your specific tax situation would play out.

One way to look at the mortgage interest deduction is that you're paying someone $1 in interest to get 25 cents back in tax savings. That's what would happen if Julie were in the 25% tax bracket. I suspect that most of us would be willing to give Julie a quarter for every dollar that she gave us. The point is that the interest deduction by itself probably isn't a good reason to have a home mortgage.

Now for Julie's choice. Can she get a better return by putting $30,000 into paying off her mortgage or by investing it for her retirement? We'll need to do a little math so hang on tight! And, we're going to simplify just a little. But, that's ok. This decision doesn't require three decimal places.

What does Julie's mortgage really cost her? If her mortgage were 6% and her tax rate were 25%, she'd pay $1,800 interest during the year (.06 x $30,000). But, that $1,800 in interest would be worth $450 reduction in taxes if she itemized ($1,800 x .25 tax rate). So the true cost of borrowing the money is really $1,350 ($1,800 - $450). That works out to an interest rate of 4.5% ($1,350 / $30,000).

Everybody still with me? Ok, next Julie can calculate what she'd earn by investing the money elsewhere. If Julie were to invest the money, she'd earn the investment return minus the tax rate.

Julie could invest in a lot of different things. And, they have different potential rates of risk and return. We won't get into that today. Let's simply assume that Julie found an investment that she thinks will earn 7%. In the first year, she'd earn 7% minus the amount paid in taxes. So she'd see $2,100 ($30,000 x .07) minus $525 ($2,100 x .25) or $1,575. Or a rate of 5.25% ($1,575 / $30,000).

In this particular case, Julie mentions investing for her retirement. If she's able to use a tax-sheltered account, it's possible that she won't have to pay taxes on the investment earnings for years.

So given these assumptions, the investment looks better. Remember though that predicting future investment returns, tax rates and the ability to use mortgage interest deductibility aren't precise.

Julie also needs to be aware of any biases that her investment advisers have. We're not saying anyone is dishonest, but it is easier for mortgage and investment advisers to see the benefits of taking out a mortgage and investing the money in other places. Julie shouldn't ignore what they say, but she should be aware of the context of the advice.

Finally, there's an emotional side to be considered. Some people feel more comfortable without debt. They sleep well knowing that no one can take their home. Others have a more adventuresome nature and like the thought of picking investments and earning a higher return.

If Julie takes the time to work through her choices and how she feels about them, she's likely to make a decision that she won't regret later.