In several years i will be in my late 20’s, wherein i would like to start investing for my future. Can someone give me a quick sketch of how stocks, bonds, etc. work? Financial Investing seems like a complex world but i would just like to know the basics of this and that. For example, i have no idea what a mutual is, or if it is good for long-term investing, or how IRAs work. Much Much thanks for any info!
A really terrific site for this stuff is Investing for Beginners and Mutual Funds from About.com (beware of popups.)
Here’s a really short summary:
When you buy shares of stock you are buying ownership in a company. The value of the stock will rise and fall depending on the company’s performance and how people perceive it. The shares may also pay dividends, which are a percentage of the company’s profits. (The more shares you have, the bigger chunk of profits you get.)
When you buy bonds, you’re buying someone’s debt. You can buy bonds directly from the company or government issuing the debt, or from someone else who doesn’t want it any more (perhaps he thinks the debt is worthless because the venture will go bankrupt.) Bonds are paid off with interest after a specified period.
Mutual funds are funds run by a manager who chooses several stocks to invest the fund’s money in. You can buy shares of the fund in much the same way as you would buy individual stocks. The advantage is that it allows you to diversify your investments very easily.
you should add real estate to your list of long term investment ideas.
Check out Greed is Good by Jonathan Hoenig for an overview of investing aimed at the early-20’s investor.
And also The Motley Fool has tons of good information.
-
Buy a house. The debt is paid off by the time you retire, leaving you with virtually free housing in your later years; either that, or a vast source of money for when you take off in an RV. Best of all, the interest on the loan is tax deductible, and most of the benefit comes early, when you really need it, so that you can sock away cash in your…
-
401(k) or other tax-deductible retirement plan. 401(k)'s, Roth IRA’s, and other plans allow tax savings that outstrip the earnings potential of the investments themselves. Especially attractive if your employer offers matching contributions. Depending on the sort of plan you choose, the tax savings can come at the beginning (contributions are not taxed) or at the end (distributions are not taxed).
-
If you plan to have children, college funds, medical savings acounts, and childcare cafeteria plans all offer ways to save money. college funds let you invest money now to be paid to Stanford (or the college of your little darling’s choice) later. Cafeteria plans let you deduct pre-tax dollars from your salary to reimburse out-of-pocket expenses during that year (downside: the excess is non-refundable).
I strongly recommend the sites friedosuggested, as well as the book “Personal Finance for Dummies” – I can’t recall the author’s name, but he knows his stuff.
Just to nitpick an otherwise good post: bonds pay a stated rate of interest on the amount loaned, usually twice yearly. At the end of the term of the bond, be it 5, 10, 20 or whatever years from issuance, the company is obligated to return the principal (the amount of the loan) to the bondholder.
Houses are not for everyone, although they can be a very good investment. Nametag is correct if you don’t refinance or relocate and instead regularly pay your mortgage and don’t incur any new debt on your house (such as a home equity line of credit). I heartily agree with all of Nametag’s other suggestions.
I strongly, strongly, strongly urge you to run, not walk, to your local book seller and plunk down the $25 needed to purchase The Four Pillars of Investing: Lessons for Building a Winning Portfolio. This is an absolutely wonderful book for a new investor – it might look like you have to slog through some math, but you really don’t.
Here’s the point of the book:
People are paid 6 and 7 figure salaries to pick stocks for all the various mutual funds and pension plans in the US – people for Fidelity, T-Rowe Price, Dodge and Cox, etc. But the fact is, when you include taxes and management fees, 95% of the funds in today’s newspaper have underperformed the market index over the life of the fund.
It gets worse.
The above figure factors in “survivorship bias” – it doesn’t include all those funds that started, piddled around for 3 years, and then closed up shop. If you include all the failed funds, you find that over 99% of all funds underperform the market index.
If people with 6 figure salaries, their membership in the local country club, and their prestige at stake can’t beat the market, then how can you?
You can’t. So you join the market.
You buy a diversified range of the lowest cost index funds that you can find – I have some Vanguard funds that have an expense ratio of .18%. You set up your asset allocation so that 70% of your money goes into equities, while 30% goes into bonds (if you’re in your early 20s, you can go 80/20 if you wish). You start buying into the funds using your 401(k) (max that contribution out as far as you can!), and you make sure to rebalance the allocations at least once a year – any more than that is fiddling and will waste (your!) money.
It’s boring. You’re not going to get excited, watching it grow or shrink, because you are only going to rebalance it once a year. And rebalancing sucks – you have to sell what everybody is buying and buy what everybody is selling, so you’re never into what is “hot”. But you’ll buy low and sell high, and that’s the entire point.
I’m serious: the book is a must read. Check it out.