Creating Wealth with Dividend Income Investing

I was recently asked by a large personal finance website to write a series of articles about "advanced" trading strategies, including trading options, currencies, and commodities. I politely declined.

Why would I decline a lucrative offer to write what would almost certainly be popular articles, as the demand for information on advanced "hedge fund" type trading strategies are all the rage?

Simply put, I do not believe in the viability of these types of investments (if you can call them that) for the average person who seeks to build wealth in the equity market.

Let me explain. I define building wealth as creating assets. An asset is something that creates income, that provides compounding returns over time, growing your money at a steady and predictable rate that allows you to sleep at night knowing that your principal investment is safe and your long term steady growth rate is, if not guaranteed, at least likely. 

"Advanced" Trading Strategies:

"Advanced" trading strategies do not create wealth. They are not investments. They are speculative in nature and do not compound your returns. At best, speculative trading strategies create the circumstances allowing traders to make a quick buck and retreat to the shelter of underperforming assets like cash until another speculative opportunity arises. At worst, speculative trading strategies will cost you everything; and if you have incurred debt in the form of leverage or "buying on a margin", speculation can cost you as much as you own and more. 

Do people make money trading currency, executing leveraged options calls, and speculating on commodities? Sure. 

Are these people creating wealth? No. Read my post on Money Crashers about The Difference Between Income and Wealth for more information. 

Building Real Long Term Wealth:

At compounding returns, we seek to create a community of people oriented to building a robust, long term portfolio that will provide returns in good markets and bad, with a portfolio of equities that provide cash flow that keeps pace with inflationary periods, and provides a modest return during market downturns. Does this sound too good to be true? Its not. 

We believe that through steady, long term investment in dividend growth stocks, the average American investor is capable of building real, long term wealth in the equity market. 

Investing in Blue-Chip Stocks:

Essentially, we at compounding returns advocate a blue-chip stock investing strategy. I know, I know... Blue chip stocks are not exciting. They rarely provide the 100% annual returns of the sexy secular growth stocks. But what do blue chip stocks provide?

Below is a list of the 15 Reasons compounding returns loves blue-chip stocks. (And why you should too)

1. Security: How often have you heard of someone losing 100% of their investment in a major dividend paying American corporation? Rarely. Yes, there are exceptions to this rule. Many blue chip stocks were crushed during the recent financial downturn, some of whom are just now reemerging from bankruptcy and reorganization. But generally, healthy, dividend paying slow growth stocks will provide security in the form of a consistently increasing dividend which confirms the corporation's profitability. Unlike paper returns that can artificially increase a company's P/E ratio, dividends don't lie, and are the "proof in the pudding" of economic success. This is the same reason that when a corporation slashes a dividend, investors run for the hills. 
2. Growth of Share Price: Dividend growth is essential for a blue-chip dividend paying company. Many income investors count on the dividend growth of blue-chip stocks to keep pace with inflation. Corporate management is aware of this, and generally ensures that the company continues paying out a steadily increasing dividend. This growing dividend has the added benefit of bumping up the stock price itself. Let me explain: If a company pays a consistent 3% dividend yield, as the dividend increases, the share price generally increases to keep the dividend yield relatively the same. 
3. Passive Income: Dividends are an excellent source of passive income. Historically, dividend stocks were known as "Widow and Orphan Stocks" because of their ability to provide the unemployed or retirees with a source of income that did not require working for a living. 
4. Growth of Passive Income: Lowell Miller's book The Single Best Investment: Creating Wealth with Dividend Growth, insists upon several aspects in a dividend stock. Chief amongst these is a healthy long term growth rate that is sustainable and allows a healthy growth of dividend. This growth of dividend should at least keep pace with inflation, providing inflation adjusted growth of passive income. 
5. Long Term Compounding: No one can deny the effect of long term compounding on a dividend growth stock, especially when dividends are reinvested. Read the story of Grace Groner to learn more about the huge effects that long term compounding can have on your stock returns. 
6. A Limited Downside: Among the reasons to love a dividend is that dividends limit the stock's dive in bear markets. How often do you see a stock with a 10% dividend yield? Not very often. In a healthy dividend paying company, a dividend usually limits how far the stock can fall, as yield seekers will snap up shares when the price makes the dividend yield too attractive to pass up. 
7. An Unlimited Upside: Unlike fixed income investments, investing in dividend paying blue-chip stocks can have as significant of an upside as any other equity on the market. When circumstances change in favor of a dividend paying long term stock, their share price can shoot through the roof just like any other equity. 
8. Huge Yield on Cost: Yield on cost is essentially the amount of income your initial investment is producing on a quarterly or annual basis. With dividend paying stocks, when dividends are reinvested, the result is additional shares. These additional shares create even more income, which in turn creates more shares, and so on. The fact is, this is the best case scenario for accelerating stock returns that you can experience. In many cases, your yield on cost after several years can be a significant boon to your portfolio. 
9. Ownership: Dividend investors are true investors. You are reaping the long term rewards of investing with a company, who is paying you to hold their shares. 
10. Favorable Tax Treatment: Dividends and Long Term Capital Gains taxes are being kept low for the next 2 years thanks to congress' extension of the Bush era tax cuts. Unlike short term profits taken by traders, these tax rates amount to only 15% rather than ordinary income.
11. Low Trading Costs: Why do you think there are so many advertisements for stock investing platforms and financial advisors. This industry doesn't care if you make money. They want you to trade as much as possible. Their commissions depend on it. Buying stocks long term keeps your money where it belongs: with you and your portfolio.
12. Compounding Dividends: Yield on cost and compounding dividends are the best kept secrets in the business, because with dividend reinvestment, you get more shares, but do not pay trading costs. How's that for keeping your own cash.
13. A Slice of the American Economy: Who doesn't want to own a piece of the strongest and wealthiest economy on earth. Owning a share of stock amounts to a piece of a very real, powerful American corporation, and with dividend paying equities: one that pays you to own it. 
14. Inflation Beating Returns: Fact is, over the long haul, bonds and other fixed income assets will not beat inflation. Dividend growth stocks are almost guaranteed to, based on research by Dr. Jeremy Siegel in Stocks for the Long Run, 4th Edition: The Definitive Guide to Financial Market Returns & Long Term Investment Strategies. 
15. A Good Night's Sleep: Stop trading already... and invest! Chances are you will sleep better at night, knowing your money is not subject to the whims of a flash crash or the Federal Reserve.

So there you have it. I'll get off my soap box. I'm sure there's plenty of people who disagree with this strategy. If this describes you, let me hear about it in the comments below!

Photo By: MoneyBlogNewz

Finance and Investing for Active Duty Military Members

Military life comes with its own peculiar set of risks and challenges. One of the biggest challenges that military members face is learning to take advantage of the financial benefits that they are offered by their chosen profession. As military members have chosen a different path than most of their friends and colleagues, many haven't been adequately advised as to the personal financial factors that come with a career in the military.

Below are just a few of the things that military members should be aware of and act upon to ensure a comfortable lifestyle while serving at home and abroad.

Tax Advantages for Military Members:

One significant factor for military financial planning is that the military offers much of their compensation tax free in the form of allowances for housing and subsistence. In addition, many states do not tax military pay; and when you are deployed to a combat zone, you pay no federal taxes on your earnings whatsoever.

Understanding these tax advantages and taking advantage of every benefit that Uncle Sam has offered you in return for your service is step number one in getting the most financial return out of your military career.

Education, Insurance, and Retirement Benefits: 

The financial advantages offered to military members do not end with tax advantaged earnings. Military members have access to low cost life insurance, healthcare provided free of charge (for active duty), a robust tuition assistance and advanced education program (in the form of Tuition Assistance and the Post-9/11 GI Bill), and active duty retirement eligibility after 20 years of active duty service, which means that a military member could potentially retire at age 38 with a pension worth 50% of their average highest 3 years of base pay.

The Military Debt Problem: 

Despite some of the advantages above, many military members are in tough financial straights. See Personal Finance for Military Members for the results of a recent FINRA Survey that explored some of the ways in which military members have struggled financially. The study indicated that many military members are trapped under the weight of consumer debt.

I can relate. As a 22 year old, single officer in the military, I found myself $62,000 in debt. Much of this was due to student loan debt, and the rest was split between credit card debt and a automotive loan.

Budgeting for Military Members:

It wasn't until I started using Mint.com- free personal finance software, that I started to see where my money was going. Using Mint to Build My Budget was one of the best things I have done for my personal finances. It streamlined the budgeting process and made it easy to track my expenses. It was the first step in my journey to spending less than I make and paying off debt.

Fixing the Military Debt Problem:

If you are like I was, an active duty military member with a debt problem, read A Guide to Paying Off Credit Card Debt. Paying off your debt should be your first step in building an investment portfolio. Nowhere else in the world will you find the opportunity for guaranteed 20% per year returns. But paying off your credit card debt will absolutely yield 20% returns or more depending on your card balances and terms of your loans.

Investing for Military Members:

Fact is, if you aspire to turn your military paycheck into a robust investment portfolio, you have to use the Power of Compound Interest to your advantage. This means paying off your credit card and other high interest debt, while investing for the future. For military members, the best forms of investment vehicles available for retirement are the Thrift Savings Plan and Roth IRA.

Contributing as much as possible to these accounts early in your military career can make you a military millionaire by the age of 59 1/2, when you can withdraw the earnings from these tax deferred accounts without penalty. (This assumes average stock market returns of approximately 10% as indicated by research in Stocks for the Long Run, 4th Edition: The Definitive Guide to Financial Market Returns & Long Term Investment Strategies, by Jeremy Siegel).

If these types of accounts seem mysterious to you, as they did to me just a scant 3 years ago, visit the following posts about Understanding the Thrift Savings Plan, and learning more about Roth IRAs. Amazingly, by harnessing the power of compounding returns and defferred gratification, you can learn how to become a Millionaire On A Military Salary.

Advanced Education for Military Members:

Getting promoted in the military will greatly help increase your earning power. One key way to be competitive for promotions within the military system is to further your education.

Whether in 4 years or 40, however, your military career will eventually end, so when considering getting an advanced degree, you may want to consider hedging your bets by studying the Top 10 Highest Paying Jobs to see what might be the best major or degree field.

Online education may also be a great option for you if you are a military member on deployment. If you are wary of online education, check out 10 Affordable and Respected Online Colleges where you can get an affordable degree that will get your foot in the door at a new job whether your military career ends with your first enlistment or after 20 or 30 years.

The Military Retirement System:

With the 20 year retirement carrot dangling before you as a military member, if you are looking to call it quits for good at the ripe old age of 38, you will definitely need to consider a taxable brokerage account, since you will not be able to tap your retirement accounts without penalty until age 59 1/2.

High Yield Savings with the Orange Savings Account may be a good place to start a taxable brokerage account, as ING Direct now offers a program called ShareBuilder that can help you build a portfolio little by little with options such as scheduled monthly or weekly transfers into your investment account. This strategy will let you dollar cost average into investments, purchasing shares in both rising and falling markets. Probably the best part about ShareBuilder is that it allows you to purchase partial shares or stock and to participate in dividend reinvestment.

For your taxable brokerage account, you should probably lean heavily towards Dividend Growth Stocks for the Long Term as they offer both long term capital appreciation, and a nice supplemental source of dividend income for your early retirement dreams. For more information on dividend growth investing, consider buying the book The Single Best Investment: Creating Wealth with Dividend Growth.

Planning Your Next Career:

If you are like many military members, however, you will not be ready to fully retire at 40, or you may not stick around long enough for retirement eligibility. In that case, the military offers some great tuition assistance programs and the Post 9/11 GI Bill that can help you get an education which can greatly increase your earning power as proved by Bureau of Labor and Statistics research as indicated in Education: The Key to a Rich Future.

Real Estate Investing for Military Members:

One big question that comes up in military life is the old question of whether you should Buy or Rent a home. For most military member, it probably makes a lot of sense to rent, especially in the wake of the real estate downturn, although if you can find a distressed home or property and visit RealtyTrac for homes at half price. It may make sense to buy a home at your next duty station, since worst case scenario, you could at least rent the home as a nice source of passive income (provided you purchase a home near a military installation and in a good neighborhood and can find a military renter).

Military Financial Considerations:

This list is not all inclusive. Are you a military member? What other considerations would you like to see discussed in reference to military investing and financial planning?

10 Ways Social Security is Like a Ponzi Scheme

The most recent and world renowned case of a Ponzi scheme came at the hands of the American Bernard (Bernie) Madoff, who was convicted of running a $65 Billion Ponzi scheme within the hedge fund that he managed for many years. Madoff was convicted of numerous counts of securities fraud in 2009 and sentenced to 150 years in prison.

A Ponzi scheme, a la Bernie Madoff, is a fraudulent investment scheme in which investors are promised returns based on their initial investment, and are subsequently paid not from the legitimate investment returns of the fund or investment itself, but rather with the influx of money from new investors. In the end, the money that comes in is embezzled, spent or otherwise squandered by the management. The money that flows in from new investors who are promised a return on their investment can keep the scheme afloat sometimes indefinitely. But when new investors dry up and there is no longer sufficient money coming in to pay the investors who are seeking to cash out, the scheme is revealed.

Are your Social Security contributions funding an even bigger Ponzi scheme, run by none other than the US government? Well, I sure hope not. But the two do share 10 scary similarities, listed below.

1. Strong leadership. The name Ponzi scheme itself is derived from the first major American embezzlement of this kind, which was executed by Charles Ponzi in the early 1920s. With any Ponzi scheme on record, you will find a strong, passionate, and charismatic leader capable of convincing his victims not only that their money will be safe, but also that the investment's leadership is singly capable of outperforming any other type of investment. Although the Social Security Administration doesn't promise singularly outstanding investment returns, who is more powerful or able of convincing the populace of anything than the government itself. Our strong, charismatic leadership is our elected leadership. 
2. Promised investment returns. Ponzi schemes are well known to promise investment returns. Many Ponzi schemes are reputed to issue promissory notes to investors stating that they are ensured returns of 10%, 15%, or 20% per year. Any time an investment manager guarantees returns, this is a red flag for a Ponzi scheme. But the Social Security Administration has promised us returns on our "investment", in the form of guaranteed lifetime payments starting at a designated age. This payout is not dependent on economic factors or investment returns, but rather on an obligation made to the American worker. 
3. No actual assets. Numerous Ponzi Schemes have been accused of not only squandering the investments of their clients, but also not even having invested the funds in the first place. Although the Social Security Administration has invested your contributions, you will no doubt be interested to know in what the Social Security Administration has chosen to invest your contributions. Government Bonds. The Social Security fund is invested in bonds issued by the US Treasury. Granted, the US government still has a AAA credit rating, but essentially, the government has written an IOU to itself for your contributions.
4. High levels of debt. Ponzi schemes are normally run by management teams that take on a high level of both personal and corporate debt. The Social Security Administration is one of the United States' single largest bond holders. This means that the Social Security Administration owns a great deal of the debt that the United States has entered into in order to pay the bills. To put it simply, the government has taken your tax dollars, written itself an IOU to replenish the money you have contributed, and spent your contributions supporting social programs and funding two wars.
5. Unknown investment strategies. Although there are numerous legitimate hedge funds, which have super-secret investment strategies involving high levels of leveraged options trading, commodities, or currency trading techniques, many Ponzi schemes are found dressed in the garb of a hedge fund. The Social Security Administration takes your contributions and invests them in Government bonds. This we know. But what does the government do with the influx of funds from selling debt? Whatever it wants. 
6. No or insufficient oversight. Especially with the Bernie Madoff scheme, the Securities and Exchange Commission (SEC) was roundly criticized by average Americans and government officials alike for their lack of oversight of Madoff's hedge fund. The amazing thing about Social Security is that because it is overseen by the government itself, there is an assumption of credibility, and less oversight than comparable investment funds, pension plans, and annuities.
7. Investors loyally contribute over time. Because investors are paid out consistently and paper returns are often very impressive, Ponzi scheme investors often contribute consistently throughout their lives, pouring more and more money into the investment portfolio run by their Ponzi scheme management. With Social Security, investors do not have a choice to opt out of the program. The funds are withdrawn from your paycheck before the money even gets deposited. How is that for a loyal group of investors?
8. Investors count on the fund's promised returns. Ponzi scheme investors count on the money and assets that are tied up within the fund or group of funds managed by the Ponzi management. Without this money, they will not be able to retire as comfortably or as soon as they plan on, they may not be able to fund their kid's college tuition, or take a nice vacation. The money invested within a Ponzi scheme may just be a slush fund to the management, but to the participants, it is a very important part of their long term financial plan. Think about how many "retirement calculators" factor in the value of your Social Security payout to determine if this fits the bill. I think it just might.
9. Managers get rich while investors are made poor. High level government bureaucrats make a good deal of money managing the Social Security Administration. Not to mention how much money the average US Congressman/woman makes on an annual basis. Our civil servants, in most cases, are making considerably more money than the average American taxpayer, just as Bernie Madoff lived a life of luxury by squandering the contributions of his investors.
10. Paying investors out with future participants' contributions. Social Security is well known to be unsustainable. With the bulk of the fund invested in US Government bonds, it is no secret that each year's Social Security payroll tax is actually the source of the funding for current Social Security payouts. The money goes out of your paycheck, and directly back in the form of a US government check to Social Security recipients.

Ok, so now I've got your attention. Do I think Social Security is a Ponzi scheme? The fact is, I don't know. And that scares me. It scares me because too many Americans are counting on Social Security payouts as the major source of retirement income. It scares me because I do not want to see a generation of Americans destitute in their golden years. 

I know one thing. As a younger American, I decided long ago that Social Security will most likely not be there for my generation. As such, the impetus of saving, investing, and making arrangements to provide for my family and yours after retirement have become that much more important. Roth IRAs, TSP and 401(k) accounts, saving for the future, and investing in dividend paying stocks become so much more important when you assume your social safety net will not be there to catch you. And I think that's a safe assumption. 

What are your thoughts? Is Social Security doomed to fail, or do you have faith that it will be around for you and yours in some form or another?

Spend Wisely: Itemized Savings Accounts

Some people call it conscious consumption, others call it setting your financial priorities. But regardless of the name it goes by, one of the best things you can do for your wallet and your sanity is to allow yourself some fun every once in a while.

At compounding returns, we advocate slashing expenses, paying off debt, saving, and investing in your financial health and yourself. We believe that these four simple steps can prevent many of the financial hardships that confront the average American.

But when does one get the opportunity to go to an amusement park, eat at their favorite steak restaurant, or take a nice vacation? It seems like the things that make life worth living often get pushed off as unimportant or frivolous.

This is at once a patently false and dangerous long term mindset. Let's compare financial health to maintaining a healthy weight for a moment. Numerous studies of dieting have shown that over the long term, diets do not work. People may lose weight quickly, but invariably, on a calorie restricted diet, people gain weight back when their willpower begins to break down. This tells us one important thing. Going on a "debt diet" is also likely to fail over the long term.

So how do we get out of debt and stay out of debt while saving for the future? It requires a long term commitment. A lifestyle change. See our long term financial checklist for more information.

A huge part of your lifestyle change is beginning to plan for not only the necessities of life: food, water, shelter, clothing; but also the things that keep you psychologically healthy and happy.

One of the best financial decisions that my family has made in the past few years has been the creation of several itemized savings accounts within our online savings accounts with ING Direct.

We use these accounts for designated purposes. These consist of a number of long and short-term financial goals that we are looking forward to. We have, for instance, a vacation fund, a new car fund, and even a fund for a new leather chair.

Each month we divert a trickle of money into these accounts: $50.00 here, and $25.00 there (the amount depends on our most pressing "frivolous" goal of the moment). Interestingly, even though the monthly amount is small, it has built up to a respectable amount. It is also a great feeling to know that as we are paying off debt, saving, and investing, we are also setting ourselves up for future enjoyment of the fruits of our labors, while setting the footwork for spending responsibly.

Creating itemized online savings accounts is not only easy to do, but can make a huge difference over time in both your budget and your ability to spend responsibly on the things you care the most about. To keep yourself sane as you tackle your debt, save for the future or consider investing, maybe it's time to establish your own itemized savings accounts.

So what are you saving for?

7 Ways to Save on Your Next House Party

The following is a guest post by Marc Brown on 7 smart ways to save money on your next in home party or get together.

Have you just recovered from a debt crisis? 

If the answer is yes, then you might be contemplating frugal living, and chances are that you are not willing to part with your money easily these days. That’s all right! With recollections of your debt-stricken days still fresh in your memory, you may not want to go through the same nightmare again. You never want to have to look look for debt relief companies or feel the crushing weight of debt again. Does that mean you have to live a miserable, boring and secluded life? The answer is no! It is possible to enjoy life without getting financially ruined, as long as you make smart and thoughtful choices.

You have had your share of invitations to house parties and now it’s your turn to host. However, you hesitate because you are not well off. Hey, do not worry! Here are some tips which can help you host a great party without draining your wallet:

1) Make a proper plan. Get your plan ready. Prepare a guest list. If possible, chop off a few names no matter how heartless that sounds.

Do not order food from an expensive restaurant. Charm the guests with homemade food showing your personal touch in the kitchen. To keep the budget small, make a list of the dishes to be prepared, and stick to it when grocery shopping.

2) The simpler the better. Who said only expensive food is delicious? Simple dishes can be equally tasty if they are prepared with care. Also remember that too many ingredients can mess up a dish. Search online for cheap yet delicious dishes. Get ideas from websites like BBC Recipes. Try simple recipes such as Ribollita, for instance, which is a pure Tuscan soup that is both easy to prepare and delicious.

3) Department stores can save your neck. Department stores offer discounts on bulk purchases, making it smart to shop from a department store when planning for a party. You can also use this opportunity to buy things for the future. If you are buying items like frozen prawns, cocktail sauce and smoked salmon for guests, then you might also buy some for personal consumption, as you can save money by purchasing in bulk.

4) Consider frugal decorations. Sure, you are hosting a party. But that does not mean you have to turn your home into a Beverly Hills palace. Get creative if you have chosen to furnish the interiors with a new look. For a cheap and easy way to decorate, consider the use of mirrors. Placing more mirrors in the room will create the illusion of a larger room and can lend the room a shining appearance.

Fancy candles are another great way to revamp the interior of your home. The use of candles with a variety of shapes and colors can make a room look great. In addition, if you can afford them, a combination of fresh flowers, colorful curtains, fabrics and innovative lighting can change the appearance of your home a great deal without breaking the bank.

5) Beverages can be tricky. Expensive beverages can weigh on your wallet pretty heavily. Stick to homemade cocktails and beverages. Better yet, if you are hosting a day- time soiree, tea and coffee are much more affordable than alcoholic beverages, and when paired with fresh seasonal fruit, can present a frugal and elegant beverage spread.

6) Avoid last minute additions. Understand that you have made enough arrangements. You have a well decorated house, and you are offering some delicious food as well as the pleasure of your company. There is no reason for you to panic and look for new additions at the last moment. Do not end up buying expensive appetizers or hire an interior decorator to groom your living room at the eleventh hour. If you are trying to be a superhost then you are actually asking to overspend.

7) Sharing can be fun. If the get-together is not too formal then it is possible to change the whole thing into a picnic where everyone contributes something. Let one person pay for the beverages, another for the snacks, and so on. Picnics can make the ambience and occasion of your party both special and unique, while also involving your guests.

Human beings are social creatures and cannot live without the company of friends and family. But we need to take care of our wallets as well. So it is very important for you to strike a balance between fun and money. Do invite guests over to a party but also remember the above tips, to keep your social life and your wallet healthy.

Using Quicken to Build Your Budget

Before I built a budget, I had no idea where my money was going.

I knew generally how much I had coming in, but at the end of each month, I kept climbing deeper into debt. Although I thought I was living below my means: I didn't drive a flashy car, live in a huge house, or fill my apartment with consumer goods, I was overspending on other things... sneaky things. Things like going out with friends, food, and other consumables constituted a large part of my spending.

For a great article on how programs like Quicken and Mint.com can help you to better understand your daily expenditures, and a step by step guide to building your first budget, visit Quicken.com.

Until recently, building a budget meant sitting for hours sorting through receipts, balancing your checkbook, adding up columns of numbers, and generally pulling your hair out. I'm sure that for some of us, it still does.

Although you still have the option of budgeting long hand (and more power to you if you have the time, energy and inclination), modern technology has made it so much easier to get expenses under control and start saving for the future.

As I believe firmly that the first step in any journey towards a more fiscally responsible lifestyle includes building your first budget, I think that for many of us, the easier it is to start and maintain a budget, the more likely that we will stick to it. I know that automation has sure helped me meet my short and longer term goals.

Do you have any experience with Quicken? How has it helped you better manage your finances?

Roth IRA, 401(k), and Roth 401(k) Plans

When I made the decision to begin paying off debt, saving, and investing for the future, I began researching the best tax advantaged ways to invest. What I discovered through my research was that there is no one perfect investment for any of us. Each investment vehicle has its own particular advantages and disadvantages that must be understood in order to make an informed decision as to where to park our savings.

The three major types of tax advantaged investment vehicles are the Roth IRA, 401(k) and Roth 401(k) savings plans. Continue reading for an explanation of the benefits and drawbacks to each of these investment plans, as well as which one may be the right choice for your particular situation. 

Roth IRA: 

Roth IRAs and their big sister the Roth 401(k) are, in this writer's opinion, one of the greatest gifts the federal government has offered the small American investor. Basically, a Roth IRA, like a 401(k) account allows you to pay taxes only once on your designated retirement funds. Unlike a 401(k), however, the Roth allows you to contribute after-tax money up front, and collect both principle and interest tax free in retirement!

A Roth IRA, like any other Individual Retirement Account (IRA) allows you to hold your choice of investments within the tax sheltered vehicle. This may include cash, money market funds, bonds, equities, and many other securities or commodities.

As we know, even a small investment can yield huge returns through the power of compound interest. This means that being able to pay tax on your current income and withdraw your accumulated wealth tax-free in retirement is an amazing boon to your portfolio.

Be aware, there are income limits on who can contribute to a Roth IRA. In 2011 single filers can contribute the maximum of $5,000 a year to their Roth IRAs if they earn less than $107,000 annually. For married couples, the contribution limit is $5,000 a year each, as long as the pair earns less than $169,000.

Who should contribute to a Roth IRA? 

Everyone who is eligible! Uncle Sam doesn't give too many opportunities like this, and every American investor who is eligible for a Roth IRA should take advantage of this outstanding offer for what amounts to almost tax exempt investment returns. 

Who is the Roth IRA best for? Put simply, the Roth IRA is a great investment vehicle for anyone that qualifies. The Roth IRA is a particularly outstanding choice for the following individuals: 

Young Americans. Because of the amazing power of compounding returns, and the huge growth of even a small initial investment, the Roth IRA is the single best place for young Americans to park their long term retirement savings.

Americans who expect to be in a higher tax bracket in retirement. This would apply to people who also have traditional pensions, 401(k) accounts, or other income in their golden years, because unlike traditional IRAs, Roth withdrawals are tax free.

Military members and employees with a traditional pension plan. Members of the US military and those civilian employees fortunate enough to have a traditional pension plan through their employer should definitely invest in Roth IRAs. Because of pensions, social security benefits, and a likely second career (especially for most military members), the chances are extremely high that you will make more money in retirement than during your years of gainful employment. Having tax free income from a Roth IRA will help keep the government's hands out of your pockets in your golden years.

401(k) and other Tax Deferred Retirement Accounts: 

401(k) and other tax deferred retirement accounts such as 403(b) accounts for non-profits and even individual traditional IRAs, are also a great place to park your retirement savings. Most Americans participate in these programs through their employer.

401(k) type accounts, like the Roth IRA, allow you to pay tax only once. In these accounts, you contribute before tax income, and in retirement the principal and interest is taxed as ordinary income. Many companies offer a contribution match to participating employees, making 401(k) and other tax deferred savings vehicle an extremely good deal for many Americans. 

Investment choices for employer sponsored plans are sometimes limited, but these types of plans normally offer diversified choices such as money market plans, bond plans, balanced plans and index plans. In addition, if your employer offers a target date option, this may be a great choice, especially if expenses are low. 

Unlike 401(k) plans, there is no income limit for contributions to a tax deferred account. There are, however contribution limits, which vary depending on your age. For 2011, these limits are $16,500 per year for Americans under 50 years old, and $22,000 a year for Americans older than 50 years old. 

Who should contribute to a 401(k) account? 

Americans who are not eligible for the Roth IRA due to income limitations.  Fact is, you have to stash your savings somewhere. You are much better off saving your nest egg in a tax advantaged account as much as you can, prior to funding a taxable account, where Uncle Sam will slowly chip away at your savings. 

Americans who expect to be in a much lower tax bracket in retirement. If you are like most Americans and are counting on your personal savings and Social Security to carry you through your golden years, then 401(k) type plans are an excellent choice, as your tax burden will likely be lower in retirement then it is during your working years. 

Anyone who works for a company with an employer matching program. At compounding returns, we never turn down free money! Neither should you. If you work for a corporation or any other entity that matches your contributions to your retirement account, not contributing up to the limit is like turning down a part of your salary and benefits package.

Those people who are already maxing out Roth IRA contributions. Like we mentioned earlier, you have to park your savings somewhere. All things considered, most of us would rather pay taxes once on our income, so if you are maxing out your Roth IRA at $5,000 a year, start funneling more into your tax deferred accounts. 

Roth 401(k) Accounts: 

A new development, and another huge gift from congress to the American people, the Roth 401(k) combines the beauty of the 401(k) account with the huge tax advantage of the Roth plan. 

Allowing you to pay income tax up front on your contributions like a Roth IRA, your contributions compound tax free for the rest of your life. Unlike a Roth IRA, however, there are no income limits on who can participate, and you can contribute the same amount to your Roth 401(k) as to a traditional 401(k): $16,500 a year in 2011 if you are under 50 and $22,000 a year in 2011 if you are over age 50. 

Who should contribute to a Roth 401(k) or similar accounts such as the Roth TSP?

Americans who expect to be in a higher tax bracket in retirement. Like the Roth IRA, the Roth 401(k) plans are best for those Americans who expect to earn more in retirement than during their working years, as the withdrawals are tax free.

Young Americans. Because of the amazing power of compounding returns, and the huge growth of even a small initial investment, any young American fortunate to work for a company or other entity that offers a Roth 401(k) option should jump on the chance to pay a tiny amount of tax early on and reap the huge rewards in retirement, especially if the young person's employer offers a contribution match.

Military members and employees with a traditional pension plan. Again, like the Roth IRA, members of the US military and those civilian employees fortunate enough to have a traditional pension plan through their employer should invest in Roth 401 (k) Because of pensions, social security benefits, and a likely second career (especially for most military members), the chances are extremely high that you will make more money in retirement than during your years of gainful employment. Having tax free income from a Roth IRA will help keep the government's hands out of your pockets in your golden years.

Which plan have you chosen? 

When I began investing, the first thing I did was sign up for the military TSP, which is the federal government's 401(k), through the personnel office on base. Next, I opened a Roth IRA and slowly began to trickle money into this account. Over time, I have increased my contributions to the point where I am able to max out the Roth IRA (my first stop since I'm active duty military), and have increased my TSP contributions to 15% of my income. When the TSP begins offering the Roth option, I intend to participate as soon as possible. 

What strategies and investment plan have you decided to use? 

The Power of Compound Interest

A very famous and apt financial quote goes something like this:

"He who understands interest earns it. He who does not pays it." 

Understanding the role compound interest will play in your financial future is the first step in truly taking control of your finances, of understanding the hidden and insidious wealth crushing power of debt, and in building confidence in the long term prospects of your investment portfolio.

The Basics of Compound Interest:

What is compound interest? Compound interest is a simple, yet extremely powerful financial force. Compound interest is interest that builds upon itself, resulting in compounding returns. Compounding returns can result in huge financial gains over time, when allowed to work undisturbed.

According to Dr. Jeremy Siegel's Stocks for the Long Run, 4th Edition: The Definitive Guide to Financial Market Returns & Long Term Investment Strategies, the long term Compound Annual Growth Rate (CAGR) of US Stocks has been approximately 10% a year over the last 200 years (before inflation, and including reinvested dividends).

Using the 10% benchmark in the chart below, you can see the extraordinary power of compounding returns in action. An initial $10,000 investment is worth $452,593 after 40 years of uninterrupted compounding growth. 

Also take note of the extraordinary differential between the long term compounded returns with different interest rates. 

This very simple chart shows how powerful the effects of compounding returns truly are in the long term investor's arsenal. These returns are not fictional, nor did I conjure this graph or the long term average 10% CAGR of the US stock market out of thin air. The graph is nothing more than simple mathematics, and the 10% CAGR of the stock market is based on exhaustive research by one of the world's leading economists, and author of Stocks for the Long Run, 4th Edition: The Definitive Guide to Financial Market Returns & Long Term Investment Strategies.

So how can you experience returns like in the chart above?

Understand Interest. He who understands interest earns it. Understanding interest will not only act as a catalyst to get you saving and investing for the future as soon as possible, but it will also become and incentive to keep yourself and your family out of debt.

He who doesn't understand interest pays it. When you are in debt, you are compounding your creditor's interest. That's right, the effects of compounding returns work in the favor of the financial and lending industries, so keeping out of debt is the first step to experiencing the long term benefits of compound interest.

Some Characteristics of Compound Interest:

It can work for you or against you. When you are in debt, compound interest works against you. If you are in debt, compounding returns has several resources to help you get out of debt as soon as possible.

When you invest, compound interest works in your favor.

It is the most powerful force in your investing arsenal. No one can guarantee market outperformance, but by purchasing a low cost index fund or ETF, you can keep your investing expenses low while at least guaranteeing you will experience the market average return, which has historically been 10% per year over all periods longer than 20 years.

Small amounts add up. Too many people believe that they don't have the money to invest. I believe these same people don't have the money not to. 

Even a small amount invested monthly from a young age will result in incredible returns over time. Think about this: If your parents had invested $1 per day from the time you were born until your 18th birthday in a low cost Index ETF, and you never touched the investment account, by the time you were 60 years old, you would have over $1,000,000. That's a pretty decent return on $1 a day, which brings me to my final point...

Time is your ally. If you are lucky enough to have learned about compound interest when you are young enough to experience the full effects of long term compounding returns, congratulations! You are in a position to earn compound interest, and hopefully quit paying it to your creditors as soon as possible. 

There are numerous financial resources available through web based sources, forums, and blogs like this one. Finding a community of like minded people is essential in the long term wealth building process.