Most people have probably heard this Chinese proverb: the best time to plant a tree was yesterday. The second best time is now. Investing is no different. But how do you start the process? Thankfully, wading into the world of investing on your own isn’t as scary as you might think. Mutual funds and exchange-traded funds are great options for the new investor, and they don’t take a finance degree to figure out. Read on to learn how you can go from being a green investor to a grizzled veteran.
The first thing to lock down is your reason for investing. Do you want to fund a nest egg for your retirement? Do you want to save for your child’s education? Do you want to create wealth to last for generations? Having a clear reason will help determine what you invest in, what your timeline is and how much money you need. Investors should aim to have a diverse portfolio, made up of national and international companies and small and large firms. Some companies provide more growth while others yield income for the investor. A mix of income and growth companies is vital. Most people hear about the stock market in terms of companies like Apple, Google and General Motors. But a better way to gauge the overall economy is through indexes such as the Dow Jones Industrial Average or the S&P 500. These indexes act as holistic snapshots of the stock market, and avoid focusing on specific companies or areas of the market. Don’t let these indexes intimidate you: They’re not as complicated as they may appear. Like with most investment related information, learning the basics will make everything else easier to understand.
Why Mutual Funds or ETFs?
So once you have a basic knowledge of the stock market, what kinds of investments should a newbie look to make? Many people decide to invest by picking single companies, but holding your money in a few corporations exposes your investment to a lot of risk. Mutual funds and Exchange Traded Funds are like baskets that hold a cornucopia of funds. One share in a mutual fund guarantees you more diversity than a single share in Apple, and that inherent diversity makes it a perfect choice for the new investor. By buying mutual funds or ETFs that hold shares in a variety of companies, you lower the chances that the market’s downturns will affect you too much. Plus, many of these funds have low fees, so you won’t lose a huge chunk of your earnings. Find a fund that charges 1% or less in fees – any higher and you’re getting ripped off. For retirement investing, you can choose a 401k, offered by an employer, or an Individual Retirement Plan, which you can open through a firm such as Charles Schwab, Fidelity and Vanguard.
How to Choose?
Funds can be conservative, aggressive or in between, depending on the investor’s needs. More conservative funds are good for seniors getting ready for retirement, while aggressive funds are better for younger people who have decades to save and wait. Some people choose to invest more aggressively or conservatively than the norm. Older people whose risk tolerance is low might stick to income securities such as bonds, while younger people who want to grow their assets will choose more stocks. No matter how you invest, it helps to be rational and calm. Too many investors let their emotions dictate their financial decisions. Many choose to sell when the market is down, panicking at the thought of losing all their money. Remember to stick to your original plan. The market can swing up and down, but continue to invest carefully and regularly. The best investors focus on long-term goals, tempering their reactions to short-term market volatility. When you’re a new investor, the key is to start small and think big. You shouldn’t throw your life savings into the stock market right away; take some time to learn the process and monitor how your funds are performing. Once you’ve mastered the basics, you can start building towards a financial future to look forward to. That’s when investing really starts to get fun.
Financial Planning, Investing
The investment world can be a complicated and overwhelming place to those on the outside, and it doesn’t matter where you fall on the GenY to Boomer spectrum. Not only are there a variety of account types to consider when stashing away cash for the long term (think 401(k)s, Individual Retirement Accounts, Roth IRAs, SEP IRAs, 403(b)s, etc.), but on top of that there’s a slew of investment terms and types to be aware of too! The terminology alone can make someone’s eyes glaze over if there’s no context behind it. One of the big “no no’s” in the financial planning profession is throwing around industry lingo and using schmancy words in front of clients to make them think you’re smart. That doesn’t fly for me. I took Spanish in high school and Italian in college. I know that learning a new language is tough. And I know that understanding your investments shouldn’t make you feel like you have to break out the books and start studying. That’s why I’ll be taking the next two weeks to break down some basic investment terminology for you. Part One will cover basic investment terms and Part 2 will cover account types and considerations. If you’re already finance savvy – consider the below a recap (but feel free to review and share) and if you’re new to the investment world, you’re in the right spot. Read on for a GenYer’s mini-financial dictionary.
One share of stock represents a single share of ownership (equity) in a company. When you purchase a share of stock, you become a part owner in the company (proportionally to the number of shares owned by others) and you can even vote on how the company operates. The price of the stock will fluctuate up and down over time depending on how much an investor is willing to pay for it (or think it will be worth). Fun homework assignment: Visit www.yahoofinance.com and look up the stock prices for some of your favorite companies. You can track the movement in price throughout the day and overtime.
A bond is a debt investment where as the investor, you loan your money to an issuer (a corporation or government) for a set period of time. In exchange for the loan, the issuer promises to repay the principal and a set interest amount over the life of the bond, which is a predetermined time. Think of this as an IOU where you loan a company money and in exchange they agree to a set of terms for repayment. The value of a bond will increase or decrease based on changes in interest rates (increase when interest rates fall and decrease when interest rates increase). They tend to offer more moderate returns and risk when compared to stocks and can sometimes work in a portfolio to even out risk.
A mutual fund pools together money from a group of investors and purchases stocks, bonds and other securities. The fund acts as one investment and as the underlying securities increase or decrease in value, so does the overall value of the fund. Mutual funds help individuals to take advantage of diversification, asset allocation and professional money management when they’re unsure or don’t have the time to do it themselves. Each mutual fund has a manager and a strategy for the fund’s overall objective, which can be found in the fund’s prospectus. Some may be geared towards growth or capital appreciation and others may be geared towards income generation or stability. Even though a mutual fund may own stocks, bonds and other securities, its price does not fluctuate throughout the day, but instead is set at the end of each trading day. This means that if you want to purchase or sell a mutual fund, you will do so at the end of the day after its price has been set based on the value of its underlying securities. Note: You’ll likely see a variety of mutual fund offerings for you to choose from in your employer’s 401(k), 403(b) or TSP plan. Among these options you may see a Target Date Fund, which is a type of mutual fund whose asset allocation is set according to a selected time frame. The allocation becomes more conservative as the “target date” approaches.
Exchange Traded Funds (ETF):
An exchange traded fund (ETF) is similar to a mutual fund in that it pools together funds to purchase a set of stocks, bonds or securities. However it trades throughout the day instead of at the end of the day. The price of an ETF is determined throughout the day and they trade just like stocks. Note: Most ETFs are passive in nature and therefore tend to come with lower internal expense ratios than similar mutual funds. Be sure to check the expense ratios of any mutual funds or ETFs you’re investing in.
Asset Allocation: This is a strategy that adjusts the amounts or percentages you own in certain asset classes in order to balance risk versus reward based on your overall risk tolerance, goals and timeframe for holding investments.
Risk Tolerance: As an investor, this describes your comfort level with certain levels of uncertainty when it comes to fluctuations (large and small) in the value of your portfolio.
The key to understanding your investments is to start off as you would with any other goal. Break it down into smaller goals and conquer one piece at a time. Start by getting clear on key terms, then account types and then work your way up to how they relate to each other and most importantly – to your life. And if you’re ever feeling like your Advisor is talking above you, using words you don’t know or just plain isn’t making things easy to understand – call them out on it. You deserve to have an understanding and education about these things. Make sure to ask for it.