In my first post, I'd like to discuss some ways to get started investing in the stock market. I'll focus mostly on US markets because that's where I've got the most familiarity.
Your 401K
Most people get their start with investing because their company offers a 401K. This makes things pretty simple: someone sets up a plan for you and you chose where your money goes!
Every paycheck, a percentage of your paycheck goes into your 401K. If you're lucky, your employer will throw some extra in for you (called a 401K match). Because you are adding a little bit every paycheck, you're taking advantage of a powerful principle called Dollar Cost Averaging. I'll discuss this more later.
Most 401Ks offer different Mutual Funds into which you can put your heard-earned income and hope that it does well. A Mutual Fund is a professionally managed investment vehicle that uses a pool of money to invest in a specific investment class, for example: Stocks, Bonds, Money Markets. Usually, MFs will invest in a specific type of stock or bond, like Utility Stocks, or S&P 500 stocks.
Most 401Ks have someone who can help decide where to put your money. It's usually a good idea to diversify and split your money between several different types of funds. Some funds have names like "Aggressive Growth" or "Balanced" or maybe "Equity Income".
Something to keep in mind as you get started: the long-term trend of the Stock Market is upward, though sometimes there are some dips in the road. Maybe big bumps! Starting in 2001 and ending in 2009, the market suffered 2 back-to-back bear markets (severe downturns).
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| 30 Year History of the S&P 500 |
Over time, the S&P 500 usually returns close to 10%. This is over time. One cannot expect, for example, to put $1000 into an S&P 500 mutual fund and have $1100 in 1 year. Imagine your $1000 investment in mid-2007. About 18 months later, your precious $1000 would have been closer to half that.
For many people, watching their investments hit the skids is a little uncomfortable (to understate the emotion!). This is why diversification is important. If some of your money was going to more conservative investments in 2008, US Treasuries for example, your US Treasuries investment would have increased while your stocks went down.
Remember, above, I mentioned dollar cost averaging? Well, that is a really powerful concept, especially in down markets. Imagine that you are putting $100/month into a stock fund. Let's assume that the cost of the fund is $10/share. Every paycheck you buy 10 shares. Now let's imagine that the mutual fund falls to $9/share. Your next $100 buys 11.1 shares. Remember that the long-term trend of the market is up. Maybe the fund shares fall to $8. Now you're buying 12.5 shares every month. You might not be happy that your share have fallen 20%, but you're buying more and the long-term trend is up. Eventually, the market will recover. If you bought shares at $8/share for 6 months, when that market rises back so your shares are $10 again, those shares you bought at a discount are now work $750 (you paid $600 for them).
The great news is that you bought a bunch of those shares while they were on sale! You looks for sales at your local grocery store. When the stock market is on sale, that's when to buy.
Investing in Outside of Your 401K
Maybe you are not happy with the .09% interest that your bank is paying you. Maybe you know that money in the stock market now will multiply your wealth later on when it's time to retire. Maybe you want to invest for your child's College.
Now it's time to open an account and put some of your extra money (extra?? yeah right) in there.
There are plenty of brokerages out there. They all have different requirements for opening an account. A new brokerage named Robinhood seems pretty cool - there are no commissions for the free version. (Disclaimer: I do not have a Robinhood account, nor have I used the software.)
You can try Schwab (I use Schwab and am generally happy with them), Fidelity, TD Ameritrade, or any of many others.
You can apply online and probably be approved very quickly. Some firms have funding minimums, so you'll want to make sure that the funds that you will use will meet that minimum.
Most major firms offer thousands of Mutual Funds. They also have Screeners so that you can find the fund that is right for you.
I feel like this is a good time to talk about fund loads. A load is an up-front fee. There are some funds that are called "Front End Loaded" funds that charge a fee to buy the fund. In other words, if the fund has a 5% load, then $1000 will buy you $950. These funds usually will charge lower fees, but many studies have shown that investors never "catch up" when paying the front end fee.
There is another type of fee called a back-end fee. Many times, Mutual Funds will charge a fee for selling shares within 3 months (more or less). This is to keep people from trading MFs like a stock.
The other fee is the management fee. Sometimes these can be rather high. The fees are always spelled out for you in a document called a Prospectus. Sellers of mutual funds must make the Prospectus available to you. It's a document that describes important facts about the Fund. It has all sorts of fun facts like expenses, objectives, risks, performance data, etc. It's important to read the Prospectus before buying a fund.
Personally, I prefer no-load (no front-end fee) funds and don't mind the back end fee. I've rarely (if ever) sold a mutual fund within 3 months of buying it.
What kind of fund should you buy? That depends on your goal, your timeframe, risk tolerance, if you are going to dollar cost average this investment and many other factors. Many firms offer index funds with really low fees (Schwab offers some index funds that only have a .03% fee. That's really low).
One interesting type of fund is a Target Fund. It automatically rebalances your account based on the target date. What does this mean? Financial theory states that the closer you get to your goal (usually retirement), the more conservative your account should be. In other words, a younger investor could have 70% stocks and 30% bonds while someone a few years from retirement would have more bonds - maybe 70% and only 30% stocks. Rebalancing means that the manager will sell and buy securities to keep this ratio. For example: a 2035 target fund (18 years as of this writing) might have a 70%/30% stock/bond mix. Let's assume that the ratio will remain the same for 5 years. If the stock market outperforms bonds next year, the ratio could become skewed and become 80%/20%. In this case, the fund manager will sell some stocks (taking a profit for you) and buy bonds. If bonds do well the next year, then the manager will sell some bonds and buy stocks.
Once the year of a target fund is reached, the rebalancing will continue. You're not forced to sell.
We've covered a lot here, so maybe it's time to take a break. To summarize, Mutual Funds are a very powerful way to diversify your portfolio without buying individual stocks. Watch out for fees! They can add up. There are many types of mutual funds: stocks, bonds, income, money market...make sure that you buy the ones that meet your goals.
We've covered a lot here, so maybe it's time to take a break. To summarize, Mutual Funds are a very powerful way to diversify your portfolio without buying individual stocks. Watch out for fees! They can add up. There are many types of mutual funds: stocks, bonds, income, money market...make sure that you buy the ones that meet your goals.
Disclaimers here: I am not promoting any product or firm here. I mentioned Schwab only because I've got an account with them and I'm familiar with their products. I'm not promoting or endorsing any fund, stock, bond or any other security. Please do your own research and make your own decisions.
