In a few years, barring accidents, sudden death, and continued procrastination, I will be making enough money to start thinking about saving some. However, I have very little idea about how to go about it. I understand that younger people are encouraged to invest more heavily in stocks to tap into long-term growth, but as my parents are wary of such investments (having immigrated from a country formed amidst chaos about 80 years ago does that to your faith in the markets), I don’t have a grasp of the logistics of such a move. Is it common for individuals to use the big-name investment companies, and if so, how? If not, what am I supposed to do? And are mutual funds pretty much the way to go for your average investor, or is it common for people to make their own (or agent’s pressured) choices?
The dispensing of financial advice is a heavily regulated field in the US, and I’m not a member of that field. But here’s my take on the consensus advice:
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Start saving as early as possible, with 10% of your income as a minimum target goal.
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The younger you are, the more of your investments should be in high-return (and therefore higher-risk) investments. This is typically the stock market, but…
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Untrained folks are generally bad at picking stocks. You can learn the basics pretty easy, but you don’t need to any more, because of index funds. An index fund is a way of investing in a whole “sector” or “market” by buying a single fund. These are often ETFs (Exchange Traded Funds), which you buy and sell “shares” of the fund as though they were stocks, or they can be conventional mutual funds in which you invest by (typically $1000 or more at a time) dollar amount. Common ones are SPY (for the S&P 500) and QQQQ (for the Nasdaq)
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Make sure you’re taking full advantage of things like company matches on 401ks, by contributing at least the matched amount.
Whether you’re better off with ROTH (pay tax now, take money out tax free later), tax deferred (buy with pre-tax dollars now, pay taxes on all the money you take out later), or standard investments (pay taxes now, pay taxes on just the increase in value later - at a lower rate than your base income tax), depends on factors you’ll need to learn for yourself (you’ll probably want a mix), but good advice abounds on the Internet (a statement you won’t hear me make very often.)
IANAFA, but reading some good books might be a start. Bobbrinker.com suggests these, but some of them are a little dry. I’d also suggest The Millionaire Next Door, one or more of Suze Orman’s books (if you can keep your food down, they actually have some good advice), and Real Money by Jim Cramer.
IIRC the basic rules are:
[ol][li]“Pay yourself first” – i.e., the first money out of your paycheck should go directly to your retirement savings, the best option of which is generally a 401K.[/li][li]Contribute to your 401K up to the point where the company match stops (generally in the 2% to 6% range).[/li][li]Contribute to a Roth IRA, if your salary qualifies you to contribute to a Roth.[/li][li]Bump up your 401K contributions until you hit the yearly limit ($15,500 or thereabouts).[/li][li]After those monies are allocated, if you have anything left over, put it in a money market account until you have three to six months’ expenses as an emergency fund. I hear ING is good for money market accounts, but I haven’t done business with them.[/li][li]If you have anything left over, you could join Sharebuilder to buy incremental shares of some stock such as SPY (the S&P 500 ETF). (Or just go to any low-priced broker).[/li][li]After you’re satisfied that you’re investing enough for emergencies and retirement, the money left over, should there be any, can be used to start building wealth. For that, I’d start looking for more aggressive mutual funds or start doing research and buying individual stocks.[/ol] [/li]
For your first 401K investment choice, I’d suggest an S&P Index fund; they have low expenses and track the S&P 500. That’s if you want to “set it and forget it.” There are more aggressive funds available, but I’m still plowing everything into S&P Index funds and SPY shares. I’m about to start step 6 and am a little intimidated by the whole process. However, defaulting to a SPY (or QQQQ or DIA or IWM) is at least doing something useful with the money.
If you don’t have a 401K (or similar plan for teachers & gov’t employees), get the Roth, then send as much as possible into a self-directed IRA ($4000 per year, I believe). In that case, I’d sock away an extra $10000 per year (or whatever you can spare) into an after-tax brokerage account buying SPY shares.
I’m a little leery of mutual funds because of expenses and weird capital gains distribution rules, but if you get something whose name starts with “Fidelity” or “Vanguard” you’ll probably be doing okay. The reason I fixate on ETFs (and SPY in particular) is that they have miniscule expenses and by definition do exactly as well as the market; it just depends on which market you’re focusing on. SPY, QQQQ, DIA and IWM track the S&P, Nasdaq, Dow Jones and Russell 2000, respectively.
Don’t be afraid to open a passbook savings account. Your first several thousand dollars should be somewhere where you can get to it in a hurry. You are not being a sap.
Keep two or three month’s income in a bank. You will need it is you need to replace a car or fly to California in a hurry. You can get the money out of your long-term savings, but what if you investments in Fidelity Crack Cocaine Fund are down at the moment. Do you want to sell just because you wrecked the car?
Start with a savings account.
Note to nitpickers: this isn’t exactly true. First of all, ETF just means exchange traded fund, it’s not quite the same as an index fund, although most of them are.
Second, while these funds attempt to track their indices, at any given time the mix will be a little different, because they don’t buy and sell continuously. I have seen SPY’s daily gain/loss differ from the S&P index gain/loss by as much as four or five percent from time to time. And remember that those “minuscule expenses” (usually in the 0.2%/year range) will still add up to hundreds or thousands of dollars over a lifetime of investing.
But these are both nitpicks; I agree with the point that index funds are the way to go if you don’t know or care enough to pick individual stocks (and even if you do, they’re an easy way to get diversification for the money you’re not putting into individual funds).
One additional comment, and please realize this is just my opinion, and I’m not a financial advisor: If you’ve got options (401K/Roth IRA) where the taxes don’t get complicated by foreign investments, you may want to consider investing in fund that trade outside the US. Both China and India are supposed to have larger economies than the US within the next 10-20 years, and by definition there is more room for growth in countries with smaller starting economies, especially those poised for industrialization. This will cause some pain for people in the US – no reason why we shouldn’t profit from it, too. Several ETFs track foreign markets. (Remember that foreign investments, particularly developing nation ones, are risky, so diversify, diversify, diversify!)
I agree with your first point, but respectfully disagree with your second. Most savings accounts these days are paying interest rates *much * less than inflation (and many of them pay zero). You’re basically losing money on anything you put into them.
Find a money market or similar account instead – most of these have the same liquidity as a savings account (give or take 24 hours) – many you can even just write a check off of. And they generally pay several percentage points more. For the “emergency fund” in particular, (you hope) the money will be there for years – make some interest on it.
Shows you what I know. TimeWinder is probably right in terms of US banks (how I hate them) and small savings accounts.
I am not a financial advisor (but I am a successful saver!)
Start saving early. Get into the habit, then you will be ready for the long haul of saving for e.g. a house deposit.
Take professional advice. My UK bank offers free advice, though they state that they only recommend a few products outside their own.
Know the risk. Some people think it’s fun to play lotteries. Others like the futures market. Some prefer Government bonds.
Decide what you want to save for. Once your housing living and pension costs are covered, you have the choice to spend the rest or save up for a dream item.
Equally important to the “how to invest”, is to learn how to avoid going into debt. Without the latter, you’ll never have the opportunity to learn the former. In general, avoid borrowing money to obtain a depreciating asset. (automobiles) Credit card debt remains a most effective way to remain poor as well. Live within your means, stay out of trouble, and maintain if at all possible, some type of catastrophic care health insurance.
Refer to the thread about ING Direct. I am not familiar with all your options in the US, but the respondents in that thread indicate that you can get what amounts to a savings account with pretty decent interest as long as you don’t mind the possibility of waiting a couple of days to withdraw money (and that’s only a possibility, depending on whether the account comes with a bank card).
Like most of the posters have been saying, Index funds are the only way to go. When you buy individual stocks you are competing with huge investment companies that have information you could only dream of getting. By the time you hear about a great stock to buy, its probably a good time to SELL it.
Non index mutual funds charge way too much to invest your money. By the time the fund managers are through buying and selling stocks with your money, the fees for all these transactions have eaten up your profits. Index funds for the most part buy and hold stocks. This keeps transaction fees down and your profits up.
Vanguard invented index funds and have some of the lowest fees in the industry. The S&P 500 is good, but their Total Stock Fund invests in basically the whole stock market. You can’t get much more diversified than that! You should also invest in countries outside the US and also real estate or REIT funds. Vanguard has index funds for both these.
Three thousand dollars is the minimum to buy into a fund.
Stay away from banks. They boast of paying 2.9% or less. Stocks average over 10% a year; in 2006 stocks were up something like 16%! Just keep reinvesting the profits every year and you’ll be surprised how fast your money will grow.
This is a time to mention dollar-cost averaging. (Not to worry it is easier than it sounds.)
Ideally you ought to invest every day (week, month, year). Lots and lots of little steps. Here is why.
When you buy a 100 bucks of something every week, and ignoring transaction costs, you buy more of that stuff in weeks when the price is low, less when the price is high. It is always a hundred dollars, but some weeks you get three shares, some weeks only two and a half.
So over time, you are getting a lower price per share than you most likely would if you just tossed the whole glob into the market at once. So once again, the easy way is the smart way.
It’s very simple. Go to either your banks website or a mutual fund site like www.vanguard.com and open up a brokerage account. Usually you can link it right to your bank accounts so you don’t need to deal with checks.
Pretty much.
Start with your rainy day money. Keep about 3-6 months worth of expenses in an liquid asset like CDs or a savings account for emergancies. Some banks offer No Risk CDs that have higher returns than a savings account but allow you to withdraw money without penalty.
Next, max out your companies 401k. Set aside at least what is matched by your employer (it’s free money). Plus it’s all pre-tax so it lowers your tax burden.
If your company offers an ESPP (employee stock purchase plan) take andvantage of it. They generally work by setting aside money each paycheck and then using the money to buy company stock at a %15 discount every 6 months. Once you have purchased the stock, you can then decide to hold on to it or sell it.
No-load index fund. Vanguard has some pretty good funds that don’t even charge you fees if you have over certain amount ($10,000 IIRC). They are tied to the S&P or some other index. The reason you want an index fund is that you generally can’t diversify your portfolio enough on your own.
If you have money left over, maybe dabble with individual stocks. Generally you’re better off investing in Blue Chips and it’s a bad idea to chase hot tips. And most people without a financial background don’t really know how to value stocks. Still, you might get lucky.
There’s a lot of good advice for beginners here:
CDs are not very liquid. You can borrow against them, though, but I don’t recommend it.
As for index funds, I’m a big fan of Vanguard. You can set up your account in minutes and transfer cash from your existing bank account. I have a recurring transfer set up to my Vanguard S&P500 and NY Bond funds.
Bank of America has one where you can withdraw money with no penalty.
Says who? Is this just your personal preference? I own a few hundred dollars worth of several funds, one of which is VTI (Vanguard Total Stock Market Index) through Sharebuilder. You don’t even have to buy full shares (currently trading at $139.12), you can own fractions of a share.
Yeah, but that “ignoring transaction costs” bit is the clincher. Transaction costs can be significant, and ultimately eat into your profits.
What I do is put away a little at a time into a high-interest savings account (ING direct), and when I have at least $500-1000 saved, then I’ll buy a stock/fund for a $4 transaction fee (Sharebuilder). If I was buying $100 worth every week, I’d still be paying $4 per transaction - which would be 4% of my investment, compared to < %1.
I suppose it depends on the type of investment you’re making. With no load funds, dollar cost averaging works out great. If buying individual stocks, ETF’S, etc…, saving like you said and then buying a chunk to avoid a lot of transaction fees would be ideal.