We all know that we should invest for our future and we all have different reasons why we do; our children’s future, early retirement, to build wealth, etc.
We have been told that saving and investing for retirement is one of the smartest things we can do in life. The trouble is many of us who are not in the finance and investing community do not know the first thing about investing. So many questions run through our minds:
- Who do we invest with?
- What is the difference between stocks and bonds?
- What are the advantages and disadvantages of 401ks and mutual funds?
- How will your investments be taxed?
- What are the expected fees?
- Most importantly, where do we start?
Where do you start? Well here is some advice from me, a fellow young investor.
The first thing that all young investors should do is make an honest evaluation of where they stand financially. Do they have a job? Are they in debt? Do they have student loans to pay off? Do they have health insurance? Answering these questions honestly will help determine the best amount of money to invest and how to invest it.
If your debt level (credit cards, student loans, car loans) is low, then you are in a perfect position to start investing a significant portion of your money. If you are in a lot of debt, or if you do not have any kind of health coverage, it is important to get a handle on these things while you are getting into the world of investing. If these issues are not addressed right away, then they can lead to even higher levels of debt later in life, and make it even more difficult to invest when investing is most important.
Now that you have figured out how much money you can invest every month, lets start looking at some basics. Before we discuss some of the various investing options, lets make sure we have a good grasp of the terminology.
Brokerage – is a company that will actually manage, your money. It is essentially a bank for your investments. As an investor, you will have an account at that brokerage where all of your money is recorded and tracked.
IRA and a 401k – are examples of types of investment accounts. These account types are defined by the government to help you manage your retirement money. We will go into these different account types later, but the important thing is that you understand that they are defined in a certain way to help you (and the government) take advantage of the best possible tax scenarios. With some exceptions, these account types can be invested in any type of fund. Funds are baskets of investments that your money is allocated into. Most brokerage accounts will not have all of your money in one company stock or bond. The fund will have certain goals that it is trying to achieve, and based on those goals, the people who manage the fund for you, will allocate the fund’s money (your money) into certain company’s stocks. The collective performance of all the companies in the fund, will dictate how the entire fund (and your money) performs.
Stocks, sometimes referred to as equity, are small pieces of ownership of a company. If the company performs well, the value of the stock increases and when you sell the stock down the road, you make a profit. On the other hand, if the company’s stock that you own, does not perform well, the value of the stock will go down.
Bonds are essentially a loan to a company. They are more conservative than stocks because, assuming the company is financially stable and not about to go bankrupt, the company signs a promissory note saying it will repay the bond with a certain (or stated) amount of interest. If a company were to perform poorly, the good news for bond holders is legally they have to be paid back before the holders of the company’s stock. This is why bonds are considered to be more stable and less risky than stocks. Just because they are less risky, does not necessarily mean they are better than stocks however. Because bonds are relatively stable, their investment return is not very high and probably will not deliver the returns that young people need by retirement. Bonds and bond funds are a better investment for older investors.
Stock fund (Mutual funds, IRAs, Index funds) – It is not too important to know what makes each of these funds different. It is important to know, however, that most young investors will have some type of fund, rather than pick individual stocks. If you pick stocks, you have to be good at reading a company’s financial statements, understand the sector it is in and have the time to research the company on a regular basis so you know how it will perform. Most of us do not have the time, or desire, to do this.
This is why it is best to choose some sort of fund to invest your money in. A mutual fund, for example, is a diverse group of stocks that have been picked for your money to be invested in. If you talk to a brokerage such as Charles Schwab, about their mutual fund options, they will tell you about the different mutual funds that they offer and what they are designed to do. Some are designed for aggressive investment in speculative ( or young) companies. Others are more conservative and allocate your money into older companies that operate in well-established industries. As a young investor it is important to look for a fund with a reputable brokerage. You want to use a brokerage that has low fees and known for good performance. Since you are still young, you have plenty of time for the market to grow your money. As you put more and more money into your investment account over time, the market will go up and down, but the market is known to grow on average of about 10 to 11% over a 29 year period. In other words, even if you lose some money in the short run, you will gain it back soon enough. The reason it is important to invest aggressively is so you have the chance to actually earn some real return when the market performs exceptionally well. Don’t worry though, as long as you use a fund from a reputable brokerage such as Charles Schwab, TIAA-CREF, Fidelity, or another one that a trusting friend recommends, the fund’s managers are constantly looking at the market to make sure your money is in the right place.
Hopefully this will give you a decent introduction into investing. If you are struggling with any of the concepts in this article, remember, Google is your best friend. Investopedia, the Wikipedia of finance, will always come back in the results from a Google search of financial terms. In the next article, we will discuss the different retirement account types and some of the strategies of investing.
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