Although investing your money is completely optional, it is also a critical part of any financial plan. That’s why the main goal of this two-part series is to help you develop a healthy, realistic and informed attitude toward investing.
In part one of our conversation, Personal Finance Specialist Kelley Long was nice enough to break down the basics of how investing works and some of the theories behind it. Hopefully this made you feel a bit more comfortable. I know it helped me!
Now in part two, Kelley is going to provide some ideas for how to get started. She’ll also tackle some of the investing topics and buzzwords you’ve probably heard about, but maybe don’t totally understand yet – don’t worry, you’re not alone!
For example, is real estate really a smart investment for young people? What is a robo-advisor and should I be using one? What are these “index funds” I keep hearing about? Is it safe to invest in stocks and how much risk is too much?
These are all great questions to get answered before you actually start putting your hard-earned cash on the line!
So let’s start from the beginning:
Q1: Once you’re ready to start investing, is it just a matter of picking some companies and then buying their stocks?
Kelley: What you’re referring to are individual stocks – which are inherently more risky than mutual funds because you’re purchasing a share of just one business versus a share of a basket of businesses.
Let’s say you bought one share of Apple stock and then you also bought one share of a technology mutual fund that contains some Apple stock. If a huge scandal surrounding Apple is announced your share of Apple is 100% susceptible to loss. Your share of the technology mutual fund will also probably take a dip in value, but eventually it will bounce back.
Q: So should anybody be buying individual stocks?
Kelley: Investing in individual stocks is best when you have several hundred thousand dollars or more, so that you can spread your risk out over several different companies. A general rule is that you don’t want to have more than 10% of your total savings invested in one particular company.
Q: Some of my friends invest in individual stocks through low-cost stock picking platforms as a hobby. What are your feelings on young investors trying that?
Kelley: I think this is a great way to learn about investing, actually! But the key is to only invest money you can afford to lose – “play money”.
It’s also important to have a disciplined buy and sell strategy – creating a plan for when you will sell before you even buy is the best way to make money. Otherwise you risk becoming a “reactive” investor and losing some of your gains to commissions or fees from excessive trading.
Q: So what’s a good way to get started with investing?
Kelley: In my opinion, the best way to dip your toe into investing is to start with index funds. Index funds are low cost mutual funds that are passively managed, meaning there isn’t a professional investment advisor actively trying to pick stocks.
This means your investment will basically perform the same as the market. And since we know that over time markets generally go up, I’m personally satisfied with that result. I don’t need to beat the market in order to achieve my investment goals.
Q: Would you mind explaining how an index fund works?
Kelley: Basically when you purchase shares of an index fund you’re investing in all of the stocks in a particular “class”. A class is made up of companies that have something in common, such as their size or industry. By diversifying like this you are greatly reducing your risk.
A well known example would be an “S&P 500 index fund” which would invest proportionately in the 500 large companies that make up the S&P (Standard & Poor’s) 500 Index.
In a way you’d be getting a little piece of those 500 companies with each share you purchase. For index funds that are less descript such as a “large cap value”, you can simply check out the fund’s fact sheet to find out what index it’s mirroring.
Q: Index funds are often linked to the new trend of robo-investors – which basically means that software algorithms are determining how your money gets invested. What do you think of robo-investing?
Kelley: I think robo-advisors are changing the face of the investment advisory industry by providing another professional investment management option to investors – especially for those who may not have been able to afford professional advice before.
However, one of the cons of a robo-advisor is that it can’t stop you from making a bone-headed move like liquidating your investments due to bad market news. A human investment advisor can remind you of your long-term goals and talk you off the ledge.
But for young people just getting started in investing, I really like robo-advisors if you can promise yourself you won’t try to micromanage it and will remind yourself to only focus on the long-term results, not the day-to-day fluctuations.
Q: A major decision you need to make when you start investing is how much risk you want to take. When markets are slow should young investors be willing to take on a bit more risk to increase their profits?
Kelley: No, risk tolerance is based on your individual situation – which includes your timeline as well as your ability to understand that to see long-term gains you have to tolerate short-term losses.
How a market performs should have no bearing on your risk tolerance, although once you actually start to see your investments drop in value you might realize you have a lower risk tolerance than you originally thought!
Q: What do you think about investing in real estate?
Kelley: As far as real estate goes, one way to invest is to buy a home. Beyond that, becoming a landlord can be a good way to build wealth, as long as you have the resources to maintain the rental property and could afford to hang onto it during periods of vacancy.
If going a month or two without a tenant would cause you to foreclose on the loan, it’s too risky. Another way to invest in real estate is via REITs, which are sort of like mutual funds except that they invest in buildings rather than businesses.
Q: How should you invest money if you’re planning to use it to buy your first home eventually?
Kelley: The first thing I’d say is that if you’re planning to purchase your first home in the next 5 – 7 years, the money you’re saving for that shouldn’t be invested in the markets at all. It should be in a cash savings account, where it is safe. I know you won’t earn much on that money, but the trade-off is that it will be there when you find your dream home.
Q: Finally, would you like to take out your crystal ball and give us your prediction for the near future? Do you think rates of return and interest rates will start to climb any time soon?
Kelley: I don’t pay that much attention to the day-to-day movements, but I am quite certain that interest rates will rise and stock markets will continue to grow over time, at least before I retire in the next 25 years or so.
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